The answer all charities trading through a subsidiary have been waiting for
It has been an accepted practice for a number of years for charities engaging in non-primary purpose trading (which is not covered by the charities’ exemption from Corporation Tax), to hive this activity down into a wholly owned subsidiary company. This subsidiary then pays out the profits back up to the parent charity in the form of a tax allowable Gift Aid payment, which is exempt in the hands of the charity. The profits donated usually equal the taxable profits of the subsidiary, so its tax liability is reduced to nil.
The problem with this arrangement is that sometimes the taxable profits can exceed the accounting profits, due to the different tax rules used to calculate the taxable profit which can depart from accounting standards. We find this is particularly the case where the subsidiary has invested heavily in fixed assets such as buildings, where the depreciation which will flow through the accounts is not allowable for tax purposes. This leaves the subsidiary company in a position where it can be paying out more money than its reserves as calculated for accounting purposes.
On 31 October 2014, the Institute of Chartered Accountants for England and Wales issued Technical Guidance Note 16/14BL which stated that in company law terms, any taxable profits gifted to the parent charity in excess of distributable reserves were considered to be an unlawful distribution, legally repayable to the subsidiary. A repayment from the parent charity of any part of the Gift Aid payment back to the subsidiary would mean that this element of the donation would not qualify for tax relief and be brought back into the charge to tax.
The Technical Note was based upon a legal opinion which the Institute sought earlier in 2014, and its publication caused the Charity Commission to withdraw its Guidance CC35 which endorsed the gifting of a trading subsidiary’s full taxable profits to its parent charity. This practice was also previously supported by HM Revenue & Customs (HMRC). However, since the Charity Commission’s withdrawal of this area of policy, HMRC has been dithering in issuing an official response.
On 24 February 2016, both HMRC and the Charity Commission issued updated Guidance which state the updated official position in tandem. HMRC’s ‘Annex iv: trading and business activities - basic principles’ Guidance states that for accounting periods commencing on or after 1 April 2015, any payments from subsidiaries to their parent charities in excess of distributable reserves, whether made as Gift Aid payments or not, will be classed as unlawful distributions and no longer receive a tax deduction. The Charity Commission’s Guidance CC35 has also been updated to this effect.
HMRC has also taken a fair stance in terms of unlawful distributions made in earlier accounting periods. In company law, the parent charity will be required to repay these amounts. However, HMRC has confirmed they will not be treated as a taxable receipt in the subsidiary company when the charity repays the amounts concerned. It has not been clarified whether the payment of unlawful distributions back to the subsidiary, in terms of the parent charity’s own assessment to tax, will be treated as non-charitable expenditure. However, we believe this is unlikely, as the charity is correcting an ambiguity in official charity policy published by HMRC and the Charity Commission. In terms of booking this entry into the charity’s Financial Statements, this may possibly take the form of a re-statement of prior years’ incoming resources.
This new Guidance comes just in time as charities and subsidiary companies with accounting periods ending 31 March 2016, the first full 12 months after the date of commencement of the policy, will be beginning to start their year-end reporting procedures. It is therefore important to consider whether a trading subsidiary might be exposed to a tax charge, as the qualifying Gift Aid payment to the parent charity will be restricted to the lower of the Gift Aid payment or reserves available for distribution, and use the ‘get out of jail free card’ HMRC has offered in terms of using this opportunity for the parent charity to repay any unlawful distributions.
For further information or assistance, please contact Andrew Scott.
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