3rd April 2020
This article was last updated on 3 April at 17:25.
Although the Government appears to be making some welcome concessions in respect of individual Gift Aid, corporate Gift Aid is less flexible due to the nine month payment deadline and the potential for ‘wasted charitable donations’, both of which are enshrined in tax law.
Charity trading subsidiaries where income has dropped off may therefore need to reflect, plan ahead and take early action in order to avoid:
- Unexpected corporation tax liabilities due to insufficient cash and/or distributable reserves to pay up previously generated profits
- Not being able to claim tax relief in respect of a previously made donation (a ‘wasted charitable donation’) due to insufficient profits
Insufficient cash and/or distributable reserves
The first scenario is likely to be more common. The subsidiary may not yet have paid its taxable profits up to its parent charity, which must be done within nine months of the year end in order to be set against those profits for tax purposes.
Crucially, the payment must be physically made in cash (not just an accounting entry) and there must be sufficient distributable reserves at the time of the payment. This is particularly important in the situation where a subsidiary is already ‘borrowing’ reserves from the subsequent accounting period, perhaps due to, for example, expenditure disallowable for tax purposes or timing differences on fixed assets.
So, in the scenario where a previously profitable trading subsidiary is now likely to make a future trading loss, what options are available?
- If cash and reserves are still available, consider making any planned donations sooner rather than later, to ensure corporation tax relief can still be claimed against the previous year’s profits.
- Defer the payment and retain some profits and pay corporation tax at 19%, normally due nine months and one day after the year end. A planned retention of profits might be sensible if a full donation would leave it in difficulty and the charity is unable or unwilling to support the subsidiary (see below).
- Consider a carry back of future trading losses to the previous 12 months. Depending on timing, this may still result in cash flow issues, as any corporation tax for the earlier period would likely need to be paid prior to the loss carry back claim. We would hope that under the circumstances it might be possible to agree an extended deferral with HMRC, where it can be demonstrated there will be losses available to carry back that would eliminate the liability. By the date any corporation tax and/or corporate Gift Aid would be due, it is likely that a reasonable estimate of losses would be known.
- Loan or invest: could the parent charity justify making an investment (most likely a loan) in the trading subsidiary? This will be heavily dependent on individual circumstances but any injection of cash by the parent charity must be an “approved charitable investment”. This is a huge topic in itself, but broadly it must be, and should be possible to demonstrate, that any loan or investment is made for the benefit of the charity. This may be more difficult to demonstrate where the subsidiary is loss making and therefore it is very important that revised business plans and forecasts are examined to ensure it is in the financial interest of the charity to support its ongoing activities, with a particular focus on when it is expected to return to profitability. Amongst other considerations, loans will usually need to carry a commercial interest rate and all decisions should be formally documented. Ideally any loan or investment should be made after any corporate Gift Aid payment, rather than as a short-term solution simply to allow this to be paid. HMRC have been known to object to such circularity in arrangements. Loans and investments will be simpler to justify where a primary purpose trade of the charity is being conducted through the trading subsidiary, as any required funding is likely to be a charitable application of funds.
Corporate Gift Aid/donations cannot create or increase a tax loss. As such, wasted donations (where donations exceed taxable profits) could result in a future difficulty making sufficient donations to eliminate a tax liability, due to depleted cash and reserves, but without the benefit of additional brought forward tax losses.
Where it is possible to do so, we would recommend consideration of the charity making a repayment of any excess donations which are not necessary for corporation tax purposes, or otherwise reducing the planned donation (where this has not already been paid). Whilst the tax considerations of a charity making a repayment largely relate to timing, there may also be legal implications, particularly where a deed of covenant is in place. Legal advice should therefore be sought if this is to be considered.
Every trading subsidiary and its relationship with its parent charity will be unique and there are many options to consider, therefore please get in touch with your usual haysmacintyre contact to discuss your particular circumstances.