Corporation Tax Marginal Relief Explained

Corporation Tax marginal relief is a reduction that applies when your company's profits sit between the lower and upper limits, stopping the tax rate from jumping in one step. Without it, a company earning a pound more than the lower limit would move straight from the small profits rate to the main rate on all of its profit.

In practice this means most small companies face three possible positions rather than two: below the band, inside it, or above it. This guide explains how the relief works, walks through the arithmetic with an invented example, and covers the one thing that catches directors out more than any other — associated companies.

Key takeaways

• Marginal relief applies to profits between the lower and upper limits, smoothing the step between the two Corporation Tax rates.
• It is calculated in your company tax return rather than claimed separately.
• Inside the band, each extra pound of profit is effectively taxed at more than the main rate.
• Associated companies divide both limits, which can remove the relief entirely.
• A short accounting period reduces the limits proportionately.

What the relief actually does

Corporation Tax has a small profits rate for lower profits and a main rate for higher profits. If nothing bridged the two, a company would face a cliff edge: cross the lower limit by a small amount and the whole of your profit would be taxed at the higher rate, leaving you worse off than a company that earned slightly less.

Marginal relief removes that cliff edge. Companies in the band are charged at the main rate and then given a reduction, calculated using a fixed fraction, so that the effective rate rises gradually from the small profits rate at the lower limit to the main rate at the upper limit. HMRC sets out the mechanics on GOV.UK's marginal relief guidance, which also links to an official calculator.

The rates, the lower and upper limits and the marginal relief fraction are set for each financial year. Always confirm the current figures on GOV.UK's Corporation Tax rates page before relying on any number, including the ones used illustratively below.

Augmented profits, not just trading profits

The test is not applied to your trading profit alone. It uses augmented profits, which are your taxable total profits plus certain exempt distributions received from companies that are not part of your own group.

For most owner-managed companies with no outside shareholdings, augmented profits and taxable profits are the same number. But if your company holds shares in an unconnected company and receives dividends from it, those dividends can push you into or through the band even though they are not themselves taxed.

Three positions your company can be in

The associated companies trap

This is the part that costs real money. The lower and upper limits are divided by the number of associated companies, counting the company itself. One company gets the full limits. Two associated companies each get half. Three each get a third.

Companies are broadly associated where one controls the other, or where both are under the control of the same person or connected persons. That definition is wider than many directors expect: a spouse's separate trading company can be caught in some circumstances, and a dormant property company you set up years ago can count too, depending on its activity.

The practical consequence is that a director who sets up a second company — perhaps to separate a new venture — can halve the limits for the original company without realising it, moving profit that previously attracted marginal relief into the main rate. Check the associated company position before incorporating anything new, not after.

Short accounting periods

If your accounting period is shorter than twelve months, the limits are reduced in proportion. A six-month period gets half the limits. This matters most in a company's first year or in the year it changes its year end, which is covered in our guide to company accounts deadlines and your year-end date.

Worked example (illustrative example)

"Alder Lane Systems Ltd", an invented illustrative example, has taxable profits of £120,000 for the year and no dividends from outside companies, so its augmented profits are also £120,000. It has one director and no other companies.

On that basis the company sits inside the marginal relief band. It is charged at the main rate and then given a reduction calculated from the gap between its profits and the upper limit, using the marginal relief fraction for that financial year. The result is an effective rate somewhere between the small profits rate and the main rate — lower than the headline main rate, but higher than the small profits rate.

Now change one fact. The director incorporates a second company during the year to hold a separate venture. The two are associated, so both limits are halved. The same £120,000 of profit may now sit at or above the reduced upper limit, with no marginal relief at all and the main rate applying to everything. Nothing about the trade changed; only the company structure did.

The figures and the company are invented to show the mechanism. Run your own numbers through HMRC's calculator, or ask your accountant, before making decisions.

What you can reasonably do about it

1. Work out your expected augmented profits before the year end, not after it.
2. Count your associated companies honestly, including dormant and family-held ones.
3. Check whether legitimate, commercially genuine costs are being recognised in the right period.
4. Review whether pension contributions for directors make sense as part of overall remuneration planning.
5. Think twice before incorporating an additional company purely for tidiness.
6. Use HMRC's marginal relief calculator to sense-check the figure your software produces.

Note what is not on that list. Bringing forward genuine expenditure you were going to make anyway is ordinary planning; inventing costs, backdating invoices or moving profit to a company that does not genuinely carry on the activity is not, and it creates far bigger problems than the tax it saves.

Common mistakes

• Forgetting associated companies. It is the single most common reason a marginal relief calculation turns out to be wrong.
• Using trading profit instead of augmented profits. Outside dividends count towards the test.
• Assuming the limits are annual regardless of period length. Short periods get proportionately smaller limits.
• Only looking at it after the year end. By then most of the legitimate options have gone.
• Relying on last year's rates. Rates, limits and the fraction are set per financial year — check GOV.UK each time.

Getting the calculation right

Marginal relief is arithmetic, but the inputs are where the judgement lies. Our corporation tax service starts from £250 per year and includes reviewing your associated company position, and our company accounts service from £350 per year covers the accounts the calculation is built on. If you want to compare levels of support first, see what is actually included in limited company packages or get in touch for a consultation.