Associated Companies

By | 1 February 2010

When dealing with small and owner-managed companies, it can often be difficult to ascertain the number of associated companies.

For small companies relief purposes, the lower (£300,000) and upper (£1.5 million) ‘relevant maximum amounts’ are divided between active associated companies in the accounting period. The small companies’ rate of 21% applies to profits up to the lower limit, marginal relief at the effective rate of 29.75% applies to profits between the two limits, and the main corporation tax of 28% applies to profits in excess of the upper limit.

The ‘associated companies’ rule is essentially an anti-avoidance provision. It is designed to prevent the creation of multiple, closely controlled companies (as part of a wider economic whole) to take advantage of the small companies’ rate of corporation tax. The rule therefore establishes who controls a company and thus which companies are associated for small companies’ relief purposes.

Current rules

However, the associated company rules for small companies’ relief purposes looks set to change. HM Treasury and HMRC propose to change and simplify the rules in the near future. A consultation document was issued in October 2009. The consultation period ended recently.

A major problem with the current rules is that they have a very long reach. They determine control in a very arbitrary way, which does not take into account of commercial reality. In particular, the rights and powers of an associate are automatically attributed to the shareholder for the purpose of determining control (ICTA 1988, s 416(6)).

There are exceptions and relaxations to the rules in certain circumstances. Firstly, under ESC C9, HMRC will not seek to attribute rights held by relatives where there is no substantial commercial interdependence between otherwise associates companies, unless the relative is a husband, wife or minor child. Secondly, the attribution of rights held by associates who are business partners is restricted to situations where ‘relevant tax planning arrangements’ exist (ICTA 1988, S 13(4)-(4C)).

Unfortunately, these relaxations in the associated companies’ rules do not go far enough. In particular, ESC C16 can result in companies being associated even though there is no commercial relationship between them. The proposed new legislation seeks to end this automatic attribution of rights where companies are linked merely by what the consultation document refers to as an “accident of circumstance”.

Proposed new rules

Companies controlled by the same person(s), or within a group, will still automatically be treated as associated. However, the proposed new rules provide for the attribution of rights and powers between ‘linked’ persons in establishing control only if there is sufficient economic, financial or organisational interdependence between them. This change is achieved by a change in the wording of ICTA 1988, s 13. The result is that the attribution rule in s 416(6) would not apply when determining control unless relevant tax planning arrangements have had effect in relation to the taxpayer company. ‘Relevant tax planning arrangements’ is already defined in the legislation, but the proposed rules widen its scope. The widened term broadly means arrangements to reduce corporation tax by means of small companies’ relief.

The changes to the existing legislation are brief. However, the test of whether companies are fragments of a wider commercial whole requires consideration as to the degree of economic, financial and organisational interdependence between them. To what extent can interdependence exist between companies before the associated companies rules apply? Each case would depend on its own facts. Unfortunately, this means that advisers will be forced to reply on non-statutory HMRC guidance for an indication of their possible approach to a particular case.

The lack of certainty resulting from ‘legislation by guidance’ will not be ideal. However, the draft HMRC guidance offers some reassurance that the associated companies rule is intended to apply to a real fragmentation of business activities, but not where any association is a mere ‘accident of circumstance’. It is estimated that up to 3,000 companies will pay a lower rate of corporation tax as a result of the proposals, which should therefore be welcomed as a positive step forward.

The above article is reproduced from ‘Practice Update’ (January/February 2010), a tax Newsletter produced by Mark McLaughlin Associates Ltd. See the Newsletters section.