Associated Companies in 2024

Unfortunately, due to a technical issue, the articles which were due to be published last week and this week have been delayed. This is the first of those issues. The second, on remuneration planning will be issued later this week.

The associated companies rules are some of the most complex for the related impact they have in the entire corporate tax sphere. Pre-April 2015, when marginal relief applied up to £1.5m, they made more sense. However, now we have marginal relief only to the extent profits do not exceed £250,000; this isn’t where they have the biggest impact though. The thresholds for quarterly instalment payments are reduced by the number of associated companies. Falling within the quarterly instalment regime can be a significant cashflow hit for unsuspecting businesses and the onus will be on advisers to highlight the potential for this.

What are the issues?

There are two fundamental issues where there are associated companies:

1. The rate of corporation tax paid by each company.
2. The reduction in thresholds for quarterly instalments of corporation tax under the large or very large company regimes.

The complexity enters when we consider what is an associated company? There are limited exceptions for companies without a trade or business, and passive holding companies. But there are grey areas in the former, and the strict rules of the latter may not help in as many situations as we would hope for.

What is an associated company?

At its most simple, a company is an associate of another company if at any time one of the two has control of the other, or both are under common control. Control here is broadly the close company control test - but there are some modifications which add further complexity. We’ll explore this later.

Association only has to exist for one day in an accounting period for the companies to be associated for the entirety of the period - and this can impact scenarios where a company is purchased or sold - HMRC consider this applies even where a purchase is immediately followed by a hive-up of the trade and assets.

Control

The meaning of control for these purposes is based on the close company rules found in section 450 CTA 2010, with some modifications. The big difference is that one assumes the person has no associates unless there is ‘substantial commercial interdependence’ between the companies (see below).

The control test looks at whether a person can exercise, is able to exercise, or entitled to acquire direct or indirect control over the company.

A participator is treated as controlling the company if the person has (or is entitled to acquire)

1. The greater part of the share capital or issued share capital
2. The greater part of the voting power in the company
3. Rights to income distributions such that they would receive the majority if all the income was distributed.
4. Rights in a winding up (or any other scenario) such that they would receive the greater part of the distribution in that situation.

When looking at (3) above, we must disregard any rights as a loan creditor. However, loans can (in some rare situations) mess with control under (4). It is normally straightforward to see who holds the majority of the issues share capital, and the voting rights are often straightforward too. However, the rights to income distributions and the rights in a winding up can create complexity here that goes far beyond what one might expect.

Loan Creditors

Where there are loans which are not ‘proper’ trade loans, or from lending institutions, we must look at what the loan creditor might receive on a notional distribution of the company’s assets on a winding up. If this means they're entitled to the greater share of assets, they will be deemed to have control of the company. This happened in the case of Executive Benefits Services (UK) Ltd [2011] TC00803. In this case, a father made a loan to his “son’s” company, in which he also held a minority shareholding. This meant the father became entitled to the ‘greater part’ of the company’s assets available for distribution to participators. The son’s company was therefore associated with another company controlled by the father.

Section 453 CTA 2010 defines loan creditor and it excludes ‘normal’ trade creditors, lease creditors, and bank borrowings.

Where a loan creditor is not a close company, or is a bona fide commercial loan creditor and there are no other current or prior connections between the companies (other than because of the loans), then section 18I CTA 2010 can prevent control arising because of the loan. This can be important for venture capital or private equity investors.

Takeaway

Where a company has received investment from friends and family, it can be important to ascertain whether this will allow that lender to receive the majority of assets in a winding up. If they too control other companies, they may become associated.

Rights of associates

The normal control test in section 450 includes the attribution of rights held by an ‘associate’. When we apply the test to determine whether a company is associated with another or not, we disregard the rights of any of that person’s associates unless the relationship between two companies is one of substantial commercial interdependence. We have special regulations to explain what this means: The Corporation Tax Act 2010 (Factors Determining Substantial Commercial Interdependence) Regulations 2022 (SI 2022/1203). There are three types of linkage of which only one need apply for two companies to be interdependent:

1. Financial interdependence - this arises where one company financially supports (either directly or indirectly) the other.
2. Economic interdependence - If the two companies share customers, economic objectives, or the activities benefit one another then they may be economically interdependent.
3. Organisational interdependence - This arises if the two companies have common employees, management staff, equipment, or premises.

’Substantial’ for these purposes isn’t defined but HMRC consider that one must consider both the extent and duration of interdependence. HMRC imply a 10% test could be used in relation to the indicators above, but that (as with many of these things) one must consider the whole picture.

I’m not so sure that this would be right if tested. However, it is something to be aware of and highlight to clients where it might be a risk and particular where a contrary position is taken (perhaps, to avoid quarterly instalments becoming due).

Let’s consider two examples.

Firstly, imagine the scenario where a husband and wife each own 100% of their respective companies. The husband runs a bicycle shop, whilst the wife runs an HR consultancy business. The payroll is completed by the HR consultancy, and for cashflow purposes, the two companies do make loans to each other from time-to-time. However, they are always repaid and the loans are to save on bank interest, as opposed to propping up either company. In this scenario, I would expect the husband and wife to not need to attribute each other’s rights to one another and therefore the companies would not be associated.

In our second examples, imagine the same husband and wife with the same businesses. However, the wife owns the premises from which she trades, and allows the husband to set up his bicycle shop in the vacant ground floor of the commercial premises. The lease is provided on uncommercial terms and the HR consultancy business makes significant financial loans to help the bicycle business get off the ground. I would expect these businesses to be associated because of the attribution of rights.

Minimum Controlling Combinations

We’ve looked at what control might be, and also when we can attribute the rights of a person’s associates. But, what happens when it isn’t as straightforward as one person controlling two companies?

HMRC talk about the ‘minimum controlling combination’. This is best shown by way of example. Imagine three shareholders: Verity, Gina, and Norman. They each own shares in various business interest as below:

Company 1 can be controlled by Gina alone.

Company 2 cannot be controlled by a single shareholder. The minimum controlling combinations are: Verity and Gina, Gina and Norman, or Verity and Norman.

Company 3 can be controlled by Verity and Gina, Gina and Norman, or Verity and Norman.

In this scenario, Company 2 and Company 3 are associated, but Company 1 isn’t: Gina can’t exercise control over companies 2 & 3 alone.

This can be very useful in the scenario where two individuals may each have a company they wholly own, but they also together hold a company 50-50. In that scenario, the three companies should not be associated absent any other connection or special circumstances.

When are companies not associated?

Thankfully, there are some useful exemptions from the associated company rules. Unfortunately, they have their own limitations and complexities.

The two rules we’re going to talk about are the passive holding company exemption, and exemptions for companies with no business.

Passive Holding Companies

A company is not treated as an associate of another in an accounting period if it meets various conditions. These can be boiled down to:

• It only holds shares in one or more 51% subsidiaries.
• It has no trade during the period, and is a passive company.

This passive company requirement is quite extensive. The holding company must meet all of these conditions:

(1) it has no assets other than shares in 51% subsidiaries, dividends meeting conditions (3) and (4), or the right to receive such dividends.

(2) It has received no income in that period other than dividends.

(3) the redistribution condition is met in relation to any dividends received.

(4) any dividends received are exempt distributions of a qualifying kind

(5) No chargeable gains arise in the period.

(6) There are no expenses of management of the business referable to the period.

(7) There are no qualifying charitable donations deductible from the company’s profits.

The redistribution condition requires that any dividends received are paid onwards to one or more of its shareholders in the period, and the total amount of dividends paid equals the company’s dividend income in the period (or exceeds it).

As you can see - these requirements are extensive and many holding companies are used to ring-fence assets from a trading subsidiary. It could therefore fail to meet the requirements. However, not all is lost: the exemption for companies with no trade or business can apply to a holding company, even if it fails the passive holding company exemption.

Companies with no trade or business

Where a company has not carried on a trade or business at any time in the accounting period, or it was associated for only part of the accounting period and it didn’t carry on a trade or business during that overlapping period, then the company will not be an associate of the other company.

This sounds simple, but what amounts to a business is not necessarily straightforward! HMRC guidance is that ‘to be in business a company should be actively engaged rather than passive’. However, there will be many scenarios in the grey area where we as advisers must make a judgement call.

Generally, where funds are put in a bank account which pays interest this will not amount to the carrying on of a business.

In Salaried Persons Postal Loans Ltd v HMRC (2006) BTC 423, the special commissioner ruled (and the High Court agreed) that where a company’s only activity since ceasing to trade was the collection of a modest amount of rent under a long-standing lease of former business premises, this was not carrying on a business. Contrast this with Land Management Ltd v Fox (HMIT) (2002) SpC 306 where the special commissioner found a company letting freehold property, incurring expenditure, and holding and making investments was carrying on a business.

The key message is that each of these cases will depend on their own facts, but for clients if there is little to no engagement in making money in the company, this may not amount to a business and therefore the company will not be associated to others.

Finally, it is worth mentioning that HMRC’s guidance where a company is purchased by another and the trade and assets are hived up on the same day, is that there will be an overlapping period where the trade is carried on. I.e., even if only for a few minutes, they will count as associated companies for that period of acquisition - remember, that when companies are associated for a day, they are associated for the entirety of that period!

What to do?

As you can hopefully see, whether companies are associated or not can be very complicated. In many cases, it might not be relevant. For example, where there is a risk that two companies are associated, but both have profits over £250,000, and well below £750,000: Here, there is little risk of quarterly instalments becoming due and all profits will be taxable at the main rate of corporation tax. In my mind, the question can be effectively ignored.

However, where there are many potential associated companies, it will be important to ask clients and understand the relationships that exist between companies. This can include companies which are not resident in the UK! The worst case scenario for a client is that a company falls into the large or very large regimes for payment of corporation tax which greatly accelerates the payment of corporation tax: Under the large regime, the first payment of tax is due 6 months into the year (as opposed to 9 months after), and the very large regimen the payment is due after only 2 months! It is easy to see that when there are multiple companies involved, these thresholds could be exceeded quickly.

My advice - be open with clients about the stupidity of these rules and make sure they tell you about all the companies they may be involved with. Who knows, it may give rise to further work!

Later this week

Later this week, the article on remuneration planning will be live, followed shortly by a look at the principal private residence relief and evidential requirements.

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