Gift Aid and Subsidiary Trading Activities

Charities often use subsidiary companies to undertake trading activities that cannot be carried out in the charity itself, then make gift aid payments to the charity to shelter any profits made in the subsidiary from corporation tax. Recent developments suggest that such arrangements may need to be more formalised if they are to be effective in the future.

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In 2000, the rules regarding gift aid payments were changed so that donations to a charity became deductible from profits as qualifying gift aid payments. Such donations are usually deductible when payment is actually made, however in the case of a wholly owned subsidiary, the subsidiary has nine months after the year end to make the payment giving plenty of time to determine precisely the amount required to cover the profits.

This has worked well for over 15 years however, two recent developments may well have complicated this matter.

Institute of Chartered Accountants in England and Wales guidance

Last year the Institute of Chartered Accountants in England and Wales (ICAEW), issued new guidance in the form of technical release 16/14BL, that determined that any such payment to a parent charity is, in law, a distribution, and as such a charity must have sufficient distributable reserves to make such a payment.

Previously even the Charity Commission’s own guidance suggested that a gift aid payment could exceed the company’s distributable reserves as set out in CC35.This was withdrawn in October 2014 and revised guidance issued in February 2016 confirming that a company could not distribute any more than its available reserves.

Thankfully the tax legislation still allows the gift aid payment to be treated as a qualifying donation despite the fact that for the purposes of company law it is regarded as a distribution.

Why are profits different?

The reason why the profit in the accounts may be different to the taxable profit is firstly because of timing differences, such as a difference between the depreciation charge on tangible fixed assets and the available capital allowances thereon, and secondly permanently disallowed expenses such as customer entertaining or certain legal fees. In such cases it may be impossible to avoid paying some corporation tax.

Introduction of FRS 102

The second development has been the introduction of the new accounting framework commonly known as FRS 102. One of the effects of FRS 102 is that as there is no legal obligation to make a gift aid payment, there is a suggestion within the accounting profession that such payments should not be recognised in the accounts until they are physically made.

This does not directly affect the tax treatment. If payment is made within nine months after the year end then it can be included in the corporation tax computation in the previous year.

The question does arise though as to whether any tax charge should be recognised in the accounts given that the gift aid payment is not included. This is important as any tax charge would reduce the distributable profits and therefore the ability to make the gift aid payment. Discussions are continuing on this point and it is hoped that further guidance will be issued shortly.

Mitchell Charlesworth comment

It seems like this is another case of the lunatics taking over the asylum, however we have always agreed that a subsidiary of a charity is not in a position to make a gift aid payment in excess of its distributable reserves as otherwise it would make the subsidiary appear insolvent.

One way to deal with this would be to try to ensure that:

  • The charity owns the fixed assets that are used by the subsidiary and to charge the subsidiary a rental fee for their use;
  • Any expenses that are potentially disallowable are charged in the charity.

In this way the taxable profit of the subsidiary should always be equal to the accounting profit.

The subsidiary could also ensure the gift aid payment becomes a legal obligation, by the directors agreeing the payment before the year end at an amount to be determined, and noting this in the minutes of a meeting, then advising the charity of this.

In this way the gift aid amount can be provided in the accounts and no provision for corporation tax would be necessary as a result.

Alternatively it may bring back the use of a Deed of Covenant. They work in the same way as gift aid as far as taxation is concerned, however they are a legally binding document and there would be no need to annually agree gift aid payments before each year end.

If you have any queries or require further information please contact our team.

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