Several tax implications can arise due to the relationship between the companies, particularly affecting corporation tax, VAT, group relief, and transfer pricing, as well as having an impact on the PAYE employment allowance (EA).
EA reduces an employer’s National Insurance contributions (NICs) liability by up to £5,000 per tax year. Importantly, no claim can be made by sole director companies where the director is the only employee. An employer can claim less than the maximum if this covers their total Class 1 NICs bill. The allowance is only available to employers with employer NICs liabilities of under £100,000 in the previous tax year.
Connected Companies
A ‘connected company’ generally refers to companies with a specific relationship or connection through common ownership, control, or influence.
The rules for determining when companies are considered to be ‘connected’ can be found primarily in CTA 2010, s 1122 (1) and (2), which confirms that a company is ‘connected’ with another company if either the same person has control of both companies (or that person and a person connected with him together have control of both companies), or if a group of two or more persons has control of each company and the group consists of the same persons (or could be regarded as consisting of the same persons if one member is replaced with another person with whom he is connected).
What is ‘Control’?
‘Control’ is present where the person or company can exercise or is entitled to acquire direct or indirect control over the company’s affairs and possessions or is entitled to acquire the majority of the shares or voting rights or distributions or assets on an eventual winding up of the company. In the case of a limited liability partnership, that control is where the other company possesses or has the right to get a share or more than half the assets or more than half the income of the limited liability partnership.
The definition looks at real control (i.e., the ability to get the company to do what the controlling person wants), and it is not enough for that person to hold the majority of the shares.
These rules are particularly relevant in relation to corporation tax thresholds, which determine the applicable tax rate and any marginal relief divided between the total number of associated companies. Connection and the EA However, ‘connection’ is also relevant when considering the PAYE employment allowance. Where companies are connected, the restriction is that the companies share a single EA.
In addition to the usual definition of ‘connected’ companies, under an EA claim companies will only be connected if there is ‘substantial commercial interdependence’ between the two. Two companies are financially interdependent if either one gives financial support (directly or indirectly) to the other, or each has a financial interest in the affairs of the same business. HMRC will determine ‘connection’ by examining the degree to which the companies are financially, economically and organisationally interdependent.
If two or more companies are deemed connected at the start of the tax year, the companies will be treated as being connected for EA purposes for the remainder of the tax year, regardless of any later change of circumstance in that year.
Two Payroll Schemes
It is up to the two connected companies to decide which one will make the claim. Where the companies are connected, there are two payroll schemes but the full EA is not used, the remainder of the allowance cannot be used by the other PAYE scheme. Notably, the ‘connected’ rules do not apply to unincorporated businesses. Therefore, where an unincorporated business does not use the full EA in one year, the remainder of the allowance can be set against another unincorporated business’s PAYE schemes (if available).
Practical Tip
Note that EA can only be used against the employer’s Class 1 NICs liability and not against the employer’s NICs liability chargeable against benefits-in-kind (Class 1A) or expenses (Class 1B). EA claims need to be re-submitted each tax year.