Gift Aid payments from charity trading subsidiaries

Many charities use trading subsidiaries to undertake activities that are taxable or commercially risk-bearing. In those structures, it is common for the subsidiary to make a qualifying charitable donation to its parent charity, which is equal to the subsidiary’s taxable profits, as the donation is deductible for corporation tax purposes. In practice, that often means 'gifting up' profit to reduce or fully eliminate the subsidiary’s corporation tax liability. 

However, taxable profit is only part of the picture. A qualifying charitable donation (often referred to in practice as corporate Gift Aid) by a trading subsidiary to its parent charity must also be lawful under company law, correctly reflected in the accounts, and supported by appropriate governance and documentation. If those wider requirements are overlooked, a payment intended to be tax-efficient can instead become an unlawful distribution with adverse consequences.

This point has been established for some time. In 2016, the Charity Commission, HMRC and ICAEW aligned their guidance to confirm that a Gift Aid payment by a subsidiary to its parent charity is a distribution for company law purposes. Today, that remains the accepted technical position: the payment is unlawful to the extent it exceeds distributable profits.

Under Part 6 of the Corporation Tax Act 2010, a company can obtain relief for a qualifying charitable donation, and section 199 of the Act contains a special rule for companies which are wholly owned by one or more charities. Where that ownership condition is met, a payment made within nine months of the end of the accounting period may be deducted for tax purposes as though it had been paid in the earlier accounting period. That is the statutory basis of the well-known nine-month rule. 

But the tax rules do not determine whether the payment is lawful. For company law purposes, the relevant question is whether the payment is a lawful distribution under Part 23 of the Companies Act 2006. ICAEW’s analysis in TECH 16/14BL, which was adopted in revised Charity Commission and HMRC guidance issued in 2016, is that donations made by a subsidiary to its parent charity are distributions under company law. Under the Companies Act 2006, section 830, a company may make a distribution only out of profits available for the purpose.

The practical consequence is straightforward: a subsidiary may be able to justify a deduction for tax by reference to its taxable profits, but it may still be unable to make the payment lawfully if it does not have sufficient distributable reserves. HMRC’s published position is that an unlawful distribution also does not qualify for corporation tax relief.

In many charity trading subsidiaries, taxable profits and distributable profits do not align perfectly. That is often because tax deductions do not always mirror accounting expenditure. Common examples include differences between depreciation and capital allowances, and the effect of tax-disallowable expenditure, such as penalties or client entertaining. In those circumstances, taxable profits can exceed accounting profits, meaning the Gift Aid payment needed to fully eliminate corporation tax may exceed the amount the company can lawfully distribute. 

This is where many of the practical problems arise. A finance team may identify the taxable profit for the year and assume that the same figure can be paid to the parent charity. In fact, the company law analysis is separate. If the payment exceeds distributable profits, the excess is unlawful even if the tax computation would otherwise support a larger deduction. 

For company law purposes, the starting point is the distributable reserves shown in the company’s last annual accounts. However, Companies Act 2006 section 836 allows a distribution to be justified by reference to interim accounts where the last annual accounts would not support it. In practice, this is often useful where the statutory accounts do not show sufficient reserves, but later profits have been realised by the proposed payment date.

Example A subsidiary may have taxable profits of £150,000 for the year ended 31 March 2026, but only £120,000 of accumulated distributable profits on the balance sheet of its accounts for the same period. It could not lawfully make a Gift Aid payment of £150,000 on 31 March 2026. However, if properly prepared interim accounts show distributable reserves of £180,000 at, say, 30 September 2026, the company may then be able to make a lawful payment of £150,000 and then make a claim to treat the payment for the purpose of corporation tax as though it had been paid in the year ended 31 March 2026.

Where a Gift Aid payment exceeds distributable profits, the excess is unlawful. HMRC’s position is that no corporation tax deduction is available for that excess for accounting periods beginning on or after 1 April 2015. In some circumstances, the parent charity may also be liable to repay the unlawful amount, as set out under the Companies Act 2006 section 847. 

A point that is easy to overlook is that the Gift Aid payment should be an actual payment of money. Directors of charity subsidiaries should exercise caution against relying on a shared bank account or treating a book entry as sufficient evidence that a valid payment has been made. It is specifically set out as a condition under the Corporation Tax Act 2010, section 191, that a qualifying charitable donation by a company must be a “payment of a sum of money”.

This also matters because of the possible interaction with the connected company loan relationship rules. If the subsidiary does not actually pay the Gift Aid amount but instead waives or releases amounts from an intercompany account, HMRC may contend that the tax consequences are governed by the loan relationship tax rules, where released debts between connected companies in most cases take place on a tax-neutral basis. In that situation, the intended tax deduction may simply not arise.

For finance teams, the practical lesson is simple: if the intention is to claim tax relief for a Gift Aid payment, the safest course is to ensure that the amount is actually paid in money from the subsidiary to the charity and that the payment can be evidenced clearly.

One key change since the original 2016 guidance has been in the accounting treatment. The FRS 102 Triennial Review 2017 Amendments clarified that where there is no legal obligation at the reporting date for the subsidiary to make the Gift Aid payment, the payment should not be accrued as a liability merely because the board intends to make it after the year-end. A board decision alone is not enough to create that obligation.

Instead, the payment is treated as a distribution. In the subsidiary’s accounts, it is recognised in equity rather than as an expense in the income statement, unless a legal obligation already exists at the reporting date. At the same time, the FRS 102 Triennial Review 2017 Amendments introduced a pragmatic exception for tax: where it is probable that the payment will be made within nine months of the reporting date, the tax effect of that expected payment may still be reflected in the balance sheet date. In practice, this can mean that the corporation tax charge and the associated relief net to nil, even though the Gift Aid payment itself is not accrued.

The parent charity must also consider its own accounting position. Under the current Charities SORP, gift aid income should be accrued by the parent only where the amount is payable under a legal obligation at the reporting date. Where charities historically accrued such income without that legal obligation, a prior period restatement may have been required if the amounts were material.

These accounting developments are important because they made the position clearer, but also less intuitive. Finance teams that are familiar with the tax result may still be surprised to find that the accounting treatment in the subsidiary and the income recognition in the parent do not automatically follow the intended Gift Aid payment unless there is a binding obligation in place at the reporting date.

Some charity subsidiaries may have been advised to put in place a deed of covenant or similar binding arrangement so that the Gift Aid payment could be recognised in a preferred way in the accounts. That may be the right approach, but it should be considered carefully. A binding covenant can create onerous and restrictive obligations, reduce flexibility over cash flow and reserves management, and force a Gift Aid payment regardless of later developments such as losses in a later period. A covenant may solve one problem while creating others.

1. Use the nine-month rule 

The nine-month rule is valuable. Where a company is wholly owned by one or more charities, a payment made within nine months of the year-end may still qualify for relief in the earlier accounting period. That can be particularly useful where the year-end reserves position is tight, but the subsidiary is expected to generate sufficient realised profits in the following months.

Directors should consider whether properly prepared interim accounts can be used to demonstrate that distributable profits exist at the date of payment.

2. Use debt waivers with care

The parent charity waiving or restructuring an intercompany debt could help repair the subsidiary’s balance sheet. Under the loan relationship rules, the waiver will often be tax-neutral and hence may introduce non-taxable income into the subsidiary, which will increase its distributable profits.

But any waiver by the charity must be capable of being justified as genuinely in the charity’s interests. The Charity Commission expects trustees to act within their powers, be sufficiently informed, take account of relevant factors, manage conflicts and properly record decisions. Any release should therefore be supported by clear documentation explaining the governance decision and why the waiver is in the charity’s best interests. The solvency of the subsidiary and its ability to meet other liabilities should also be considered.

3. Approach capital reductions cautiously

Capital reduction is also technically possible for a private company limited by shares, and ICAEW’s technical release identifies it as a possible route. A capital reduction will increase the distributable profits of the subsidiary. But it requires careful handling. ICAEW’s note highlighted HMRC’s concern where circular steps are undertaken solely to generate reserves from which Gift Aid can then be paid; for example, where a charity subscribes for £100,000 of share capital into its subsidiary and then immediately reduces capital by the same amount.

With careful consideration and a well-documented rationale, however, capital reduction could be another useful option for improving the subsidiary’s reserves position.

4. Consider whether later losses reduce the earlier Gift Aid requirement

A trading loss in the subsequent accounting period may also be relevant. Under the Corporation Tax Act 2010, section 37, a trading loss of a later period must first be set against profits of that same period, but any excess may then be carried back against profits of the preceding 12 months. In the context of a subsidiary of a charity, the losses can reduce the earlier period’s taxable profits and therefore reduce the amount of Gift Aid needed to eliminate corporation tax for that earlier period.

This can be particularly important where taxable profits exceed distributable reserves. If tax losses of a later period can be carried back against an earlier period, the amount of Gift Aid required may fall to a level that the subsidiary can lawfully mitigate out of existing distributable profits.

The difficulty here is timing. The nine-month rule gives only a limited window after the end of the earlier profit-making period. If the latter loss-making period has not yet ended, and hence the subsidiary has not yet reported the losses in the relevant tax return, that window may already have passed. If the directors of the subsidiary are aware that it will have losses in the subsequent period, they could decide not to make a Gift Aid payment and instead pay the tax on the profits with a view to then reclaiming the tax paid once they are able to file an amended return with a loss carry-back claim.

HMRC also outline a process in their Company Taxation Manual (CTM92090) whereby a company might claim back this tax in advance: Officers may, however, consider [early repayment of corporation tax] claims made before the end of AP2 [accounting period 2] in exceptional circumstances where, for example, the expected allowable tax losses will be so great in AP2 that they are likely to comfortably exceed any relevant income in AP2 and the amount of taxable profits of AP1 that relate to the repayment claim […] Companies will be expected to provide HMRC with full evidence to support such claims.

This approach could be beneficial where a subsidiary has taxable profits exceeding its distributable reserves in one accounting period, but then clearly will have substantial losses in the subsequent period. The claim should, however, be approached with care. If those losses turn out to be less than expected, there may be a tax exposure and no option to make a Gift Aid payment after the usual nine-month window.

5. Accept that some corporation tax may be the right answer

Not every mismatch has a clean planning solution. TECH 16/14BL expressly recognised that, where no suitable restructuring or remediation is available, the need for the subsidiary to pay corporation tax may simply have to be accepted. In some cases, that is the most robust and commercially sensible outcome, particularly where the alternatives could involve artificial or circular transactions. 

Where a subsidiary repeatedly encounters a mismatch between taxable profits and distributable reserves, the answer is rarely to repeat the same year end exercise and hope for a better outcome. Charity-subsidiary groups should instead review whether assets are held in the most appropriate entity, whether inter-company transactions are appropriate, and whether expenditure that would be allowable or more appropriately borne by the charity is being left in the subsidiary.

Any transfer or reorganisation should be analysed for company law, corporation tax, VAT, stamp taxes and charity law consequences. It should not be assumed to be automatically tax-neutral simply because the entities are connected.

Governance and process are equally important. Finance teams should ensure that the year-end timetable allows enough time to assess taxable profits and distributable reserves separately, that directors have contemporaneous evidence to support any payment, including interim accounts where needed, and that the accounting treatment in both the subsidiary and the parent charity is reviewed in line with current FRS 102 and SORP requirements. Trustee and board decisions should also be documented in a way that reflects current Charity Commission guidance.

The central lesson has not changed since 2016. A Gift Aid payment from a charity trading subsidiary is not simply a mathematical exercise. Its effectiveness depends on the interaction of tax, company law, accounting and governance.

Before a subsidiary makes a Gift Aid payment, the proposed amount should be reviewed against distributable reserves, the accounting treatment should be considered, the payment mechanics should be handled properly, and the basis for the decision should be clearly documented. Where the position is complex, early advice can prevent avoidable problems.

For more information on any of the above, please contact your usual Crowe contact.