It has been common practice for companies that are wholly-owned trading subsidiaries of charities to donate all taxable profits to the parent charity and to claim charitable donations relief under Part 6 (s189 et seq) of the Corporation Tax Act 2010, even if, in some cases, the amount donated exceeds the amount of profits available for distribution under the Companies Act 2006.
This practice was endorsed by the Charities Commission in section D5 of Guidance Note CC 35 (now withdrawn) to the effect that the donation to the parent was not a distribution. Tax relief on the payment meant that no tax was payable by the subsidiary.
However, the Institute of Chartered Accountants in England and Wales (ICAEW) understood that the position in CC 35 was being questioned and sought counsel’s opinion on the matter. This legal advice confirmed that the payments in question are distributions and, therefore, to the extent that any payment exceeded profits available for distribution, payment of the excess was unlawful.
The ICAEW has therefore issued a Technical Release outlining guidance to minimise the risk practitioners continuing with the practice, but also to give guidance about what charities and their subsidiaries might do to correct the situation. Notwithstanding this Technical Release by the ICAEW, charities, their subsidiaries and advisors may wish to take legal advice in relation to their specific circumstances, in particular if there is any reason to suppose that the facts differ from those provided for illustrative purposes.
Further to discussions between ICAEW and HMRC, HMRC has issued revised guidance, stating that they would expect the guidance in the Technical Release to be followed by all charities and their subsidiaries for subsidiary accounting periods commencing on or after 1 April 2015.
The relevant section of CC35 has been withdrawn by the Charity Commission, and updated guidance has been issued indicating that they expect compliance with this Technical Release for the first subsidiary accounting period commencing on or after 1 April 2015.
What does this mean in practice?
- To the extent that the amount exceeds the subsidiary’s company profits available for distribution, which will often be the case, the excess payment is unlawful
- Where the subsidiary company has made unlawful distributions, its parent is liable to repay the excess and those who were directors of the subsidiary at the time of that distribution may be liable in certain circumstances
- This liability includes such excess amounts arising over the previous six years
- In accordance with the new HMRC guidance, the tax treatment is as follows:
- A Gift Aid payment that represents an unlawful distribution is not allowable as a qualifying donation
- A repayment of a previous unlawful distribution is not taxable
- The practical application of these rules to unlawful distributions made in previous periods will need to be considered on a case by case basis although the likely position based on discussions between the ICAEW and HMRC is set out in paragraphs 23 to 26 of the Technical Release.