Corporation Tax Marginal Relief, and the 26.5% Nobody Mentions

Between £50,000 and £250,000 the headline rate is not what you pay. The effective rate on profit in that band is 26.5% — higher than the main rate, which surprises people.

Illustration of UK Corporation Tax marginal relief between the small profits and main rates

Corporation Tax has two headline rates and a stretch in between where neither applies. Most small companies sit in that stretch, and the effective rate there is higher than the main rate — which is counter-intuitive enough to be worth setting out properly.

The two rates

19% — the small profits rate, on profits up to £50,000
25% — the main rate, on profits of £250,000 and above

Between those figures, marginal relief applies. The main rate is charged on the whole profit and then reduced, so the effective rate climbs gradually from 19% towards 25% rather than jumping at a cliff edge.

The calculation

Relief is the upper limit less the profit, multiplied by 3/200. On £100,000 of profit:

£100,000 × 25% = £25,000
Less relief: (£250,000 − £100,000) × 3/200 = £2,250
Tax due: £22,750, an effective rate of 22.75%

The 26.5% nobody mentions

Here is the part that catches directors out. The average rate on £100,000 is 22.75%, but the rate on the next pound of profit is 26.5% — higher than the main rate itself.

That is because each additional pound is taxed at 25% and simultaneously reduces the relief. It is the same mechanism as the personal allowance taper, where income between £100,000 and £125,140 suffers an effective 60%.

It matters for decisions at the margin. A £10,000 increase in profit inside that band costs £2,650 in tax, not £2,500. Equally, £10,000 of additional deductible expenditure — genuine expenditure, incurred for the business — saves £2,650 rather than £2,500.

Associated companies

If you control more than one company, the limits are shared. Two associated companies each get a £25,000 lower limit and a £125,000 upper limit. Three companies divide by three.

This is the most common unpleasant surprise in this area. Setting up a second company for a new venture can quietly push the first from the 19% rate into the marginal band. It is worth taking advice before incorporating rather than discovering it at the year end.

Short periods

Both limits are pro-rated for accounting periods of under twelve months. A six-month period gets £25,000 and £125,000. First periods and changed year ends are where this bites.

Our Corporation Tax calculator handles marginal relief on whatever profit you enter, so you can see the effective rate for your own figures rather than working from the headline ones.

Getting help with this

AJH Accountants handles limited company for clients across the UK. We deal with HMRC, tell you what you can claim, and file on time, so nothing rests on you remembering a deadline. See how the service works, ask for a fixed-fee quote, or call the office on 01204 840303.

Originally published at ajhaccountant.co.uk/blog/corporation-tax-marginal-relief-explained.