Gift Aid subsidiary to parent charity

Eva Hanley, Executive

In many cases, charities can carry out trading activities without becoming subject to corporation tax on the profits. This applies when the trading activity advances the charity’s primary charitable purpose or if it is small in scale — meaning it generates no more than £80,000 annually or 25% of total income. Certain fundraising events and lotteries can also benefit from tax exemptions on their trading income.

If a charity wishes to carry out trading activities that do not fall within these exemptions, then it is common for the charity to establish a trading subsidiary to undertake these activities. The subsidiary can reduce its taxable profits to nil by making a gift aid payment to the parent charity. This means that ultimately no tax is payable on profits arising from these trading activities.

There are some key requirements that must be met for the distribution of profits to qualify as a gift aid payment:

the subsidiary must be wholly owned by one or more charities
the payment must be paid within nine months of the subsidiary company’s year end
money must have been transferred (it is therefore necessary for the subsidiary to have a separate bank account)
the subsidiary must have sufficient distributable reserves at the time of the payment.

There are various other issues for consideration in operating a trading subsidiary.

Sometimes the taxable profits may be greater than the accounting profits. This might lead to cash flow issues in the subsidiary. This issue can be minimised by ensuring that the subsidiary does not incur costs which are not deductible for corporation tax purposes (for example, capital expenditure), so that taxable profits and accounting profits are aligned.
If the gift aid payment exceeds distributable reserves, then this would be unlawful, and no tax deduction will be available for the unlawful payment. The subsidiary’s management accounts should be reviewed to ensure that reserves are available at the time of payment.
If the trading subsidiary’s taxable supplies exceed the VAT registration threshold, then it may need to register for VAT. Intercompany charges from the charity for items such as staff time are included within this threshold. It might in some cases be beneficial for the charity and subsidiary to form a VAT group.
If the charity provides any funding to the subsidiary (including informally through an intercompany account, if this remains outstanding for a long period) then it must be demonstrable that the investment was in the charity’s interests to make. HMRC may ask to see the business plans, cashflow forecasts and other business projections which informed the charity’s decision to make this investment.
An additional company creates additional administrative requirements including preparing accounts and tax returns annually for the company.

For more information or to discuss this topic further, please contact Jon Daley or your usual Crowe contact.