Last week’s guidance from HM Revenue & Customs and the Charity Commission about using Gift Aid to transfer profits from charity trading companies to the parent charity might have raised concerns among charity readers. Many charities, after all, have trading subsidiaries, and passing the profits to the charity is standard procedure.
In practice, however, not many charities will be affected by this development, and those affected are likely to be running substantial trading operations. These charities are also likely to have specialist tax advisers to whom the details of the announcement will come as no surprise, because the issues involved have been under scrutiny for some time.
It is, of course, perfectly legal for any company, including a charity subsidiary, to make Gift Aid donations to a charity, thereby reducing its taxable profits. In 2014, however, a legal opinion, obtained from a specialist tax lawyer by the Institute of Chartered Accountants in England and Wales, determined that Gift Aid donations by wholly-owned charity subsidiaries are not in fact donations, but distributions of profits for accounting purposes.
Under the Companies Act, a company may not distribute an amount in excess of its accumulated accounting profits. But some charity subsidiaries have done just that in the past, usually because their profits for taxable purposes were higher than their accounting profits and they have passed up the taxable profit. They have, in effect, transferred profits illegally, even though they were acting in accordance with the guidance in force at the time.
So how can the taxable profit be higher that the accounting profit? It is usually because fixed assets, such as buildings, are held by the subsidiary, with the result that there is a difference between the depreciation charge on those assets – allowed as a deduction in calculating accounting profits – and capital allowances on the assets, which can be deducted when computing taxable profits. The taxable profits can also be higher because of various other items that cannot be set against tax, such as business entertaining.
The effects of the lawyer’s opinion – from which no one dissents to the extent of wanting to bring a case to court – were finally clarified in the joint statements last week. Amounts in excess of accounting profits transferred to the parent charity were indeed illegal distributions, the statements say, but charities are being permitted to repay those amounts without the trading company having to pay tax on them. In the case of trading subsidiaries carrying out activities that are within the parent charity’s objects, it is also possible for the charity to make the repayment by means of a grant to the subsidiary, which is not taxable income.
In terms of planning ahead, charities should be able to avoid problems of this kind in future by ensuring that the taxable profit is the same as the accounting profit. To achieve this, all fixed assets could be owned by the parent charity and leased to the subsidiary: this would avoid the
complications with depreciation and capital allowances referred to above. Alternatively, the subsidiary could adopt the tax capital allowance rate as its depreciation rate in order to avoid a difference.
For some larger subsidiaries, it won’t be quite as simple as that, particularly where there are assets such as goodwill that might have been included in commercial transactions but are not deductible for tax purposes. In such circumstances, a limited number of charities might have to accept a small corporation tax charge in the subsidiary. Generally speaking, however, this announcement is a tremor, not an earthquake.
Kate Sayer is a partner at specialist auditors Sayer Vincent