It is unlawful for a charity trading subsidiary to use Gift Aid to donate all of its taxable profits to its parent charity, according to updated guidance from the Charity Commission and new advice from HM Revenue & Customs.
Many charity trading subsidiaries pay funds to the parent charity in the form of a donation that attracts Gift Aid, which can in some circumstances mean they pay no corporation tax.
The Institute of Chartered Accountants in England and Wales says it has been common practice for companies that are wholly-owned trading subsidiaries of charities to donate all of their taxable profits to the parent charity and then claim charitable donations relief, even if the amount donated exceeds the profits available for distribution under the Companies Act 2006.
This position was endorsed by the Charity Commission in its CC35 guidance on charity trading, although it advised charities considering this to first take professional advice.
But legal advice provided to the ICAEW in 2014, and circulated at the time in a technical release called Guidance on Donations by a Company to its Parent Charity, said that this position was unlawful.
The Charity Commission’s updated CC35 document says: "If the accounting profit is higher than the value calculated for distributable profits, only the lower figure can be paid across under Gift Aid. A consequence of this is that when the taxable profits of the trading subsidiary are greater than its distributable profits, the trading subsidiary may have a tax liability."
According to the latest HMRC guidance, parent charities will be liable to repay any unlawful distributions to the subsidiary and this repayment will not be treated as taxable income.
The new Charity Commission and HMRC guidance will apply for any accounting period starting on or after 1 April 2015.