What Is the SME Exemption in Corporation Tax?

The SME exemption in corporation tax is not a single relief but a group of concessions the UK gives smaller companies. The two that matter most are the small profits rate, which taxes profits up to £50,000 at 19% instead of the 25% main rate, and the exemption from transfer pricing rules, which spares qualifying SMEs from the documentation and benchmarking that large companies must produce for related-party transactions. Together these can meaningfully reduce both a company’s tax bill and its compliance costs.

The Small Profits Rate

For the financial year beginning 1 April 2026, companies with taxable profits of £50,000 or less pay corporation tax at 19%. Companies with profits above £250,000 pay the full 25% main rate.¹ If your profits sit between the two figures, marginal relief slides the effective rate up from 19% toward 25% as profits grow. The formula reduces the bill by a fraction of the gap between the upper limit and your actual profits, so there is no cliff edge at £50,000.

A common trap: the £50,000 and £250,000 thresholds are divided by the total number of associated companies you have.¹ Control three active companies and the lower threshold drops to roughly £16,667 for each. This stops groups from splitting profits across several entities to keep every one below the small profits ceiling.

Who Counts as an SME

For transfer pricing purposes, the UK uses the European Commission’s 2003 SME definition.² A medium-sized company has fewer than 250 staff and does not exceed at least one of two financial limits: €50 million in annual turnover or €43 million in total balance sheet value.³ A small enterprise has fewer than 50 employees and either turnover or balance sheet total under €10 million. The distinction between small and medium is about to become more important, for reasons covered further down.

Staff headcount includes employees, owner-managers, partners, and anyone seconded in to work for the business. Part-time and seasonal workers count as a fraction of a head.² The thresholds are set in euros; HMRC publishes monthly exchange rates for conversion, with the April 2026 rate at €1.1570 to the pound.⁴

Your status is tested for each accounting period on its own. HMRC’s guidance states that qualification is “determined solely by reference to the period for which a return is being made,” so a company that outgrows the thresholds mid-year loses SME status straight away.²

How Group Ownership Affects Your SME Status

A truly standalone company just checks its own numbers against the ceilings. Autonomous means no outside entity or person controls more than 25% of the capital or voting rights, and your company does not hold more than 25% in another. Once ownership crosses that line, the rules split related companies into two categories with different aggregation rules.

Partner Enterprises

A partner relationship exists where one company holds 25% or more of another’s capital or voting rights, but the two are not linked. You add a proportional share of the partner’s figures to your own. Hold 30% of a partner and you include 30% of its turnover, balance sheet total, and headcount when testing yourself against the SME thresholds.⁵ The proportion follows whichever is greater, capital or voting rights.

Linked Enterprises

Linked enterprises are those where one effectively controls another. The main test is a majority of voting rights, though control can also arise through the right to appoint or remove directors, a dominant influence under contract, or a shareholder agreement granting majority control. When companies are linked, you aggregate 100% of the linked company’s headcount, turnover, and balance sheet with your own, regardless of the exact ownership percentage.⁶ Where consolidated accounts already exist, HMRC normally uses those. The practical effect: a company small on its own books can be classified as large once a parent or subsidiary is folded in.

The Venture Capital Carve-Out

Investee companies get relief from the linked-enterprise rules where the investor is a genuine venture capital company. To qualify, the investor must specialise in financing start-ups or developing businesses, spread risk across a significant number of investments, and treat venture capital as the principal character of its business. A large corporate group making one-off strategic investments does not qualify.⁷ Limited partnerships, the standard VC vehicle, are generally accepted.

The Transfer Pricing Exemption

Transfer pricing rules require related-party transactions to be priced at arm’s length, meaning the price two unrelated businesses would agree to on the open market. For large companies, proving compliance means benchmarking studies, economic analysis, and formal documentation that can run into tens of thousands of pounds. Section 166 of the Taxation (International and Other Provisions) Act 2010 exempts SMEs from these rules for the vast majority of their related-party transactions.⁸

In practice, an exempt SME can conduct intercompany transactions without producing master files, local files, or formal benchmarking reports. The largest businesses face mandatory OECD-style documentation under the Transfer Pricing Records Regulations 2023.⁹ SMEs are spared all of that.

The exemption is not a licence to price transactions any way you want. If HMRC opens an enquiry and finds intercompany prices are clearly off-market, the broader anti-avoidance framework still applies. Keeping basic records of how you set prices is sensible insurance even when the formal documentation rules do not reach you.

When the Transfer Pricing Exemption Does Not Apply

Two situations remove the exemption from companies that would otherwise qualify.

Transactions With Non-Qualifying Territories

If a related party sits in a jurisdiction without a double taxation agreement with the UK that contains a non-discrimination clause, transactions with that party fall outside the exemption.⁸ For those specific deals, you must show arm’s length pricing the same way a large company would. The rest of your transactions remain exempt. This carve-out targets arrangements with low-tax or secretive jurisdictions where the profit-shifting risk is highest.

Transfer Pricing Notices to Medium-Sized Companies

HMRC can issue a transfer pricing notice to any medium-sized enterprise, requiring it to apply arm’s length pricing to a specific transaction for a particular accounting period.⁸ Small enterprises are not subject to these notices. Once issued, the company must recalculate its taxable profits as if the transfer pricing rules had applied all along, which usually means producing the documentation the SME exemption had spared it from.

Proposed Changes for Medium-Sized Companies

Anyone planning ahead should watch this closely. In April 2025 the government launched a consultation proposing to remove the transfer pricing exemption entirely for medium-sized enterprises, saying the current exemption “creates a gap in the definition and protection of the UK tax base which gives rise to a significant risk of cross-border profit diversion.”⁹ The consultation ran from 28 April to 7 July 2025, and the government has said it will publish a response and, if it proceeds, implement changes at a future fiscal event.

Small enterprises would keep the exemption under the proposals. The government also floated converting the euro thresholds into sterling, setting the small enterprise ceiling at £10 million turnover and £10 million balance sheet total.⁹ A second proposal would introduce a two-consecutive-period rule so that a small enterprise breaching the threshold in one year would not lose its status unless it exceeded the limits again the next year, adding stability for companies whose revenue fluctuates near the boundary.

If these changes become law, any company with 50 or more employees, or with turnover or assets above the small enterprise thresholds, would need full transfer pricing compliance for cross-border related-party transactions. That means investing in documentation, benchmarking, and specialist advisers. Companies currently classified as medium-sized are the ones most exposed.

1
GOV.UK. Corporation Tax Rates and Reliefs
2
HM Revenue & Customs. International Manual – INTM412080 – Transfer Pricing: Legislation: Rules: Exemptions: SME Definition
3
European Commission. SME Definition
4
HM Revenue & Customs. April 2026 Monthly Exchange Rates
5
HM Revenue & Customs. Corporate Intangibles Research and Development Manual – CIRD91700 – R&D Tax Relief: SME Definition: Partner Enterprises
6
HM Revenue & Customs. Corporate Intangibles Research and Development Manual – CIRD91600 – R&D Tax Relief: SME Definition: Linked Enterprises
7
GOV.UK. Corporate Intangibles Research and Development Manual – CIRD92100 – R&D Tax Relief: SME Definition: Venture Capital Company
8
GOV.UK. International Manual – INTM412070 – Transfer Pricing: Legislation: Rules: Exemptions: SME Exemption
9
HM Revenue & Customs. Transfer Pricing Scope and Documentation