Use of trading subsidiaries and Gift Aid

It is common practice for a charity to establish a trading subsidiary company to undertake an activity which is not regarded as being a primary-purpose trading activity. By allowing a separate company to undertake the activity the charity is able to avoid a charge to corporation tax on any profits arising.

However, it is not only non-primary-purpose trades that are conducted via a subsidiary company: for VAT reasons, other tax planning possibilities might provide a better overall outcome if certain activities are ring-fenced in a subsidiary company. Additionally, the Charity Commission requires the use of a trading subsidiary in any case where there would be a significant risk to the assets of the charity if it were to carry on non-primary-purpose trading itself.

A trading subsidiary does not benefit from most of the charitable tax exemptions and is therefore taxable on its profits under normal corporation tax principles. However, it is usual for the subsidiary company to pay all its profits to the parent charity as a Gift Aid donation, thereby eliminating any corporation tax liability in the company. The receipt of the Gift Aid donation is not taxable in the hands of the charity.

Provided that the trading subsidiary is wholly owned by one or more charitable organisations, it has up to nine months after the end of its accounting period to make its Gift Aid payment to the owning charities, allowing plenty of time to calculate the level of taxable profits in the company. Note that this extended time limit only applies to subsidiaries wholly owned by a charity or group of charities (see HMRC audits for more information).

Gift Aid payments should be made as a payment of money from the company to the charity. The company and charity should avoid sharing one bank account so that this transfer can be seen to have taken place and should not use the intercompany account for Gift Aid payments

Charities need to be aware that the amount of taxable profit of the subsidiary may exceed the accounting profits. This is due to the impact of disallowable expenses such as depreciation. Consequently, charities may be faced with accepting that the subsidiary will encounter cash-flow problems from time to time or incurring some tax liability in the subsidiary. This is because the Gift Aid payment required to eliminate any tax liability may exceed the net profit generated from its trading activity.

Payments of Gift Aid are now considered to be distributions (see ICAEW Tech Release 16/14BL in October 2014), and such payments by the subsidiary of amounts greater than their distributable profits are unlawful as a matter of company law. Unless some remedial action is possible – such as generating further distributable profits by a reduction of share capital or share premium – the excess is technically repayable by the charity; and the directors of the subsidiary may also incur personal liabilities. The tax deductibility of excess payments in these circumstances is unclear and HMRC guidance on the point is awaited.

Where this is an issue, remedial action is recommended – for example, by holding property in the charity rather than the subsidiary and charging a tax-deductible rent rather than incurring disallowable depreciation in the subsidiary.

Adjustments to Gift Aid payments may also be required for prior periods where the original calculation proves to be incorrect.

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