Companies that own and control other companies or are owned and controlled by the same person(s) must be treated as associated for corporation tax purposes, even if they are totally different businesses. This could have a dire effect on the amount of corporation tax payable, as it means that the £300k and £1.5m thresholds must be shared between the associated companies on an equal basis and any profits above the reduced thresholds will be taxed at higher rates.
For example, suppose that Mr A owns 50% of the shares in each of 2 companies. Mr B owns the remaining 50% in both companies. The companies are deemed to be associated as they are both under the control of the same people, even though neither of them controls either company on his own. The first company makes a profit of £250,000 and the other £50,000. The first company would pay corporation tax of £61,250 and the second £10,500 (based on 2009/10 rates). The total tax of £71,750 is approximately 24% of the combined £300,000 profit. If the companies were not associated, total tax would be £63,000 which is only 21% of combined profits. The fact that they are associated means that they pay additional corporation tax of £8,750.
This effect is more pronounced when companies make dissimilar profits. When profits are more or less the same, the associated company rules make very little difference to the total amount of tax paid (unless aggregate profits exceed £300,000). It is therefore important to estimate how much profit a new business is going to make at the outset so you can decide whether it is better to have separate companies or treat them as separate trades within the same company. If other investors are involved, it may be better to adjust the overall shareholdings in the main business to reflect the different stakes in the smaller business.
Of course, there are other factors to consider as well when deciding whether to set up a new company. Probably the most important is the need to limit liability for losses sustained by the new business so that creditors do not have any claim on the existing business. The tax advantages should therefore be weighed against the risk of having all your eggs in one basket. However, the new business can always be hived off into a separate company at a later stage if necessary when it starts making higher profits (and incurring more liabilities).
The other big advantage to having separate trades in the same company is that losses from one can be offset against profits from the other in the same accounting period. If the trades are not too dissimilar, you could probably get away with offsetting them against profits for different accounting periods too. This could be important for the first few years of a new start-up venture when losses are incurred. Rather than wait a few years for the business to start making profits, you could relieve the tax losses straight away against the profits of the main business (which may well be funding the new business anyway).
Dormant companies are not regarded as associated, so keen entrepreneurs who form one company after another in the hope of launching new businesses with them in the future will be pleased to know that they will not be penalised for their zeal. However, the companies must not have carried on a trade or business at any time during the accounting period, so it is important to ensure that no accounting transactions arise (apart from a holding company receiving dividends that it has distributed in full to its shareholders).
Unfortunately, non-UK registered companies are definitely associated whether they are dormant or not, even though they may not be subject to UK corporation tax in their own right, so it is best to avoid these completely unless you really need them.
Where companies are owned by more than one person, the question of control becomes crucial. If Mr A owns 50% of the shares in Company A but has no shares in Company B, they are not associated even if the other 50% of the shares in Company A are owned by Mr B who controls Company B. Mr B does not control both companies as Mr A could always veto his wishes by virtue of the fact he also owns 50% (assuming Mr B has no casting vote). However, if Mr A also owns at least 50% of the shares in Company B, then both companies are controlled by the same people. Mr A and Mr B would be deemed to be an irreducible group. If Mr A owned any less than 50% of one company, then the companies would not be associated as Mr B would be able to control one company by himself and therefore be an irreducible group on his own.
To be associated, companies must be controlled by the same irreducible group, so if one person can control Company A on his own but only control Company B in partnership with someone else, they are not controlled by the same irreducible group. However, the Revenue can deem an irreducible group to be any particular combination of minority shareholders that can together control 2 or more companies, whether or not they are acting in concert, so it is a double-edged sword. This is known as the minimum controlling combination.
It should also be borne in mind that control is not just a matter of who owns the shares. Voting rights are probably the biggest indicator, although they do usually (but not always) go hand in hand with share ownership. Loan creditors can sometimes be regarded as having or sharing control if they have a current or past connection with the company (apart from the loan itself). Rights conferred in the Memorandum and Articles may also muddy the waters. However, it is associates that most complicate the question as to who controls a company.
Your associates are deemed to be the following persons:
a) your spouse or civil partner
b) your business partners
c) your parents, grandparents and remoter forbear
d) your children, grandchildren and remoter issue
e) your brothers and sisters (full blood)
f) trustees of a settlement who are also settlers or beneficiaries
Fortunately there is an extra-statutory concession disregarding most of these relationships unless the companies have a substantial commercial trading interdependence. Note that the dependency must work both ways. If Company A is dependent on Company B but not vice-versa, there is no interdependence and the companies are not associated. They are also not deemed to be interdependent merely because they share the same premises or are run by the same directors.
The relationships that are excluded from this extra-statutory concession are spouses (and civil partners) and children who have not reached the age of 18 (apart from step-children). This poses serious problems for spouses who run their own businesses. Whilst they are unmarried they do not have to worry about the associated company rules, even if they share the same household and the companies are interdependent, but as soon as they tie the knot their companies become associated even if they have nothing to do with each other! This could have a dire effect on their corporation tax liabilities if either company is making profits above £150,000. The same problem could arise if your 17 year old son finds out that it costs just £30 to set up a company and that he only has to be 16 years old to be a director. And he doesn't even need to ask you to be company secretary any more!
Finally, it is worth noting that the associated company rules can also affect whether or not you have to pay your corporation tax quarterly in advance. The quarterly payment regime normally only affects large companies making annual profits of £1.5 million or more, but add in a couple of associated companies and you will have to start paying quarterly once profits reach £500,000.
All in all, associated companies are bad news when it comes to corporation tax. You can see that some kind of legislation is necessary to stop companies splitting up into smaller units just to avoid paying higher rates of tax, but these rules go way beyond what is necessary to prevent that and can have a perverse effect on small companies, especially since the £300k and £1.5m thresholds have been frozen since 1994 and now affect far more companies than they used to. They also tend to act as a deterrent to the entrepreneurial spirit.