Tax payment pain for private equity-backed companies

From 1 April 2023, the government has reintroduced the concept of ‘associated companies’, which impacts the application of the small profits rate of corporation tax. Whilst many businesses are aware they need to prepare for the increased rate, they may not have considered the potential impact the rule changes have on when they are required to pay their increased tax bill. Is this clever planning by the government to improve cashflow or an unintended consequence of the reintroduction?

Where a company has annual taxable profits between £1.5m and £20m, it is considered ‘large’ and has to pay its corporation tax in four quarterly instalments, two payments falling within the accounting period and two afterwards. Where its taxable profits are ‘very large’, ie over £20m, each payment is accelerated by six months, with all payments due within the accounting period. After 1 April 2023, the taxable profit thresholds will now be divided by the number of ‘associated companies’, which is where the potential problems arise.

The associated company rules were originally repealed in 2015, and for the last eight years, ‘51% subsidiaries’ were used to divide the relevant thresholds. This was a simpler and clearer rule to follow, so why bring the associated companies rules back now?

The associated company rules include companies under common control. One part of the economy that could be particularly impacted are those companies backed by private equity. These businesses may need to factor in the private equity house’s other investments when determining their quarterly instalment thresholds, instantly decreasing the thresholds they must apply. It may also be difficult for the business to determine the number of associated companies it has. In these circumstances, it may take a prudent approach and assume the ‘very large’ quarterly instalment regime applies, thereby accelerating its tax payments.

Another potential impact relates to those companies which have a tax charge on a loan to a participator. Broadly, where a close company makes a loan to a participator, if this is not repaid within nine months of the end of the accounting period, the company is liable to a temporary tax, known as ‘section 455’ tax (currently 33.75% of the balance outstanding nine months after the period end). Where a company pays in quarterly instalments, any 'section 455’ tax is also due under quarterly instalments. Given the year-end position may be unclear, never mind what the balance will be nine months after the year-end, it may be almost impossible for a company to accurately calculate the tax payments due.

Not only does the rule change benefit the government by pulling more companies into the quarterly instalment payments regime, it also potentially benefits from the late payment interest arising on those who underestimate their liability. Regardless of the intentions behind the reintroduction, it seems like a win win situation for the government and tough luck for those caught.