Gift Aid for Companies and Wholly Owned Subsidiaries

Donations Made By Companies to Charities

A company that produces profits will be subject to Corporation Tax. However the company can enjoy the benefits of corporation tax relief on a donation made to a charity.

If a company decides to give money to a charity it simply makes a payment to that charity. The donation will be treated as a non-trade charge. No tax is deducted from the payment and the company does not have to make a Gift Aid Declaration to the charity. The charity will consequently not have to make a Gift Aid tax repayment claim because no tax has been paid on the payment.

In order to obtain the corporation tax relief the company will then deduct the amount of the donation from the total profits for that accounting year prior to the calculation of corporation tax. The claim will be made in the Corporation Tax Self Assessment Return (CTSA).

The company should keep normal accounting records to support its claim for relief in the CTSA. Any other relevant correspondence should be retained by the company such as a thank-you letter from the charity for the donation.

The donations cannot be carried over into another accounting period in-order to reduce the taxable profit for that year.

Example:

Company A makes a donation of £20,000 to Charity B. Company A makes a total profit for the year of £300,000. The £20,000 donation is deducted from the £300,000 profits to leave £280,000. The corporation tax payable by the company is calculated against the £280,000 figure, not the total profits of £300,000.

A qualifying Donation:

A company may claim tax relief on any donation so long as it is a ‘qualifying’ payment. A distribution of profit such as a dividend will not qualify as a donation for the purpose of tax relief.

Other non-qualifying Gifts:

-Gifts that are subject to a condition such as repayment
-Gifts which are associated with or conditional upon the charity’s acquisition of any property from the donor or any person connected to the company (except by way of Gift)
-Gifts where the company or a person connected to the company has received a benefit over a certain value in return.

The benefits which a donor may receive in return for a donation are restricted as follows:

-for donations of £0-100: 25% of the donation
-for donations of £101-1000: £25
-for donations above £1000: 5% of the donation
-for donations above £10,000: £500

Example:

Company A makes a donation of £950 to Charity B. As a thank-you gesture Charity B decides to make a gift to the company. In order for the original donation to remain as a qualifying gift the charity’s own gift to the company must not value more than £25.

A company wholly owned by a Charity:

Many charities now establish subsidiaries companies to carry out trading activities. These non-charitable subsidiaries will of course be liable to corporation tax on their profits. However these companies can make payments to the parent charity equivalent to some or all of its taxable profits.

The payment will be treated as a non-trade charge and will be deducted from the subsidiaries taxable profits. Dividends paid to the charity will still be viewed as a distribution of profits and therefore will not qualify as a donation for the purposes of tax relief.

Normally a company cannot carry any donation into another accounting period but special rules apply for companies owned wholly by a charity. A wholly owned subsidiary has nine months from the end of the relevant accounting period in which to make a donation. Therefore if the payment is made within nine months of the particular accounting period it can choose to treat it as if was paid in that earlier accounting period

For Example:

The accounting period ends in April 2010. The subsidiary can make the donation up to nine months after the April 2010 date and it will still be considered as having been made in the April 2009/2010 year.

Deferring the payment can assist in the cash flow of the company as subsidiaries will often want to make payment of their entire profits. The timing of the Gift Aid payments is primarily a matter for the directors of the subsidiary.

A company partly owned by a Charity:

A charity can establish a ‘joint venture’ company with another company which will be jointly owned by the two entities. Joint ventures can make Gift Aid donations and claim tax relief. However unlike companies wholly owned by a charity the joint venture does not enjoy the nine month rule. The tax relief must be claimed for the accounting period during which the payment was made.

Any payment made by the joint venture to the charity in its capacity as a shareholder will not be viewed as a qualifying donation by HMRC. Whether the payment is classed as a distribution of profits with respect to shares will depend on underlying nature of the payment.

If the payment was made in direct relation to the shareholding of the charity then this would not qualify for Gift Aid purposes.

For example:

The joint venture makes a profit of £400,000. The charity owns 50% of the venture. If 50% of the profits are donated to the charity this could be well viewed by HMRC as a distribution of profits with no subsequent tax relief for the joint venture.

Sources

See HMRC website for detailed guidance on this matter.

Charities & Trading Subsidiaries Part 6

The final part of this series takes a look at the role of trustees in the everyday management and running of a trading subsidiary.

Part 6

Role of the Trustees

The trustee must scrutinise numerous funding and general financial/legal matters when a subsidiary is established (see parts 3 & 4). But their role also extends to the running of the subsidiary itself. The extent to which they should interfere in the management of the trading subsidiary is a delicate matter which can have repercussions.

It will be standard practice for the charity as majority/sole shareholder to appoint trustees of the charity to directorship positions within the trading subsidiary. This will allow the charity to monitor the activities of the trading subsidiary. Such persons will have two distinct responsibilities, both to the charity and the trading subsidiary. They will therefore have to be mindful of any conflicts of interest which arise from their dual mandate.

Whilst a monitoring role will be acceptable if undertaken with adequate safeguards the charity should not become actively involved in the management of the charity. The subsidiary board should be independent of the parent charity and the charity should not dictate instructions to the subsidiary. If it does adopt such an active management role then serious liability issues can arise for the charity if the trading subsidiary falls into financial difficulties.

Therefore those with a dual role should be in the minority on the subsidiary board and should heed the advice of non-conflicted board members when any possible conflict arises. Only by engaging such governance procedures will the difficulties associated with a conflict of interest be avoided.

Charities & Trading Subsidiaries Part 5

Part 5

Transferring the Subsidiaries Profits

There are a number of ways in which profits generated by the trading subsidiary may be transferred back to the parent charity. The path taken will have tax implications and this will often be the deciding factor in choosing the appropriate method.

The two main methods are as follows:

- Funds may paid in the form of a share dividend pursuant to the share capital acquired by the charity.

- Gift Aid may be used to transfer the money from the subsidiary to the charity.

The payment of a dividend to a Charity, whilst retaining a certain 'prestige' factor will often not be the optimum way of transferring money. Whilst a dividend is not taxable in the hands of the charity, it does not reduce the trading subsidiaries taxable profits. Thus the subsidiary would be liable to corporation tax.

The most common method of paying funds therefore is through the Gift Aid Scheme. Like the dividend, the Gift Aid payment will be exempt from tax in the hands of the charity, so long as the money is used for charitable purposes. However where the Gift Aid scheme differs is that the payments do reduce the subsidiaries taxable profits. n fact it is possible for a subsidiary to mitigate its entire tax liability through paying all of the companies profits to the charity under Gift Aid.

There is nothing underhand with this approach, it is a perfectly acceptable way in which to reduce the amount of tax owed by the trading subsidiary.

However, giving all of the profits to the charity under the Gift Aid scheme can cause some difficulties. A transfer of all the profits may leave the subsidiary with a lack of working capital, with the cash-flow problems that would entail. HMRC do give subsidiaries wholly owned by a charity some lee-way in this regard but it may be prudent in some instances for the subsidiary to retain some of its profits to meet working capital requirements. The charity would have to accept the ensuing tax liability for the amount of profits retained.

Charities & Trading Subsidiaries Part 4

As highlighted in part 3 of this series, a charity must adhere to the qualifying investment criteria if it wishes to avoid the potential tax penalties incurred by non-charitable expenditure. It cannot simply give a certain amount of money to a trading subsidiary as a goodwill gesture. Any investment must be commercially sound. This underlying requirement will therefore dictate the type of investment which a charity can make to the trading subsidiary.

Part 4

TYPES OF INVESTMENT

The two main types of investment are the acquisition of share capital and/or the provision of loans.

Share Capital

It may sometimes be prudent to subscribe only a nominal sum for the issue of share capital so as to satisfy company law. If a parent charity does subscribe a greater sum as a means of investment then that investment will be subject to risk if the trading subsidiary ultimately fails. This is because the repayment of share capital has a lower priority than the repayment of loans in the event of liquidation.

On the other hand the capitalisation of the subsidiary by loan carries its own risks. The provision of loans may expose the subsidiary to the risk of insolvency if it cannot repay its borrowings. It must be remembered that any loan by the charity must be on a commercial basis and offer commercial returns. the subsidiary would be obliged to pay a reasonable rate of interest in addition to the capital and this could cause some difficulties for a newly established subsidiary with marginal profit margins.

Therefore in this instance where profit margins are likely to be marginal it may be reasonable to pay more than the nominal amount for share capital.

Of course a trading subsidiary does not have to rely on the parent charity for sole funding. outside financiers can play a role in capitalising the enterprise. However, investment through the acquisition of shares is unlikely to prove attractive to such persons or organisations as they would be motivated by profit. This would sit uncomfortably with a trading subsidiary which gives all or most of it profits to the charity, leaving little or no dividend.

The charity could market the acquisition of shares to wealthy supporters who would be willing to invest and possibly fore go a commercial return.

Loans

HMRC guidance stresses the requirement that any loan from the charity to the trading subsidiary must be at arms-length and bear a commercial rate of interest with suitable repayment terms. It is highly unlikely that HMRC would tolerate a loan agreement with no rate of interest and a repayment schedule over a 1000 year time period!

The loan must also ordinarily be secured against any assets of the trading subsidiary. Where this is not possible, because the trading subsidiary has no assets, then HMRC will likely scrutinise the loan through an assessment of the business projections, cash-flow forecasts etc.

A trading subsidiary is of course under no obligation to obtain a loan from the charity. it may approach commercial entities in-order to acquire finance. This obviously puts the trustees of the charity at less risk as they wouldn't have to grapple with the many issues surrounding charitable investments as has been previously discussed.

However banks and other lenders may require guarantees/security from the charity itself as part of any loan agreement. This would expose, both the charities assets and the trustees themselves to risk if the subsidiary got into difficulty. Such commercial lenders may also stipulate repayment terms which would be in excess of what the charity would be obliged to charge under any loan agreement with the subsidiary.

Therefore loans from commercial lenders may not always be a viable option. Well-wishers and supporters of the charity could offer loans to the subsidiary on more favourable terms.

Charities & Trading Subsidiaries Part 3

Part 3

FINANCING A SUBSIDIARY

A trading subsidiary like any newly formed business will require starting capital in-order to finance its activities before a profit is ever realised. Given the nature of the relationship between the charity and trading subsidiary it is normal to assume that the charity may wish to invest monies into the subsidiary. There are special rules that apply when a charity wishes to invest funds in a trading subsidiary which must be adhered to.

Firstly any trustees wishing to invest should insure that they have the requisite power to do under the charities constitution.

Any investment made in the trading subsidiary must be deemed a 'qualifying investment' for HMRC purposes. if it does not qualify then HMRC will view the investment as 'non-charitable expenditure@. This can be defined as expenditure on things that are not for the charitable purposes as set out in the charity's governing documents or any investments and loans made by the charity which are not qualifying loans or investments as detailed by HMRC regulations.

Any non-charitable expenditure may result in the charity losing its tax exemption on all or part of its income or gains. the amount is taxable at the same amount of non-charitable expenditure.

For example: A charity receives gross gift aid income of £40,000. the charity would normally be entitled to tax relief of £40,000. If £30,000 was spent on charity grants and administration and £10,000 on a non-charitable loan then the charity would lose tax relief on the same amount of the £10,000 loan.

The list of qualifying investments does not include investments in or loans to subsidiary companies per se. there is provision however that a charity can make a claim to HMRC to treat such investments as qualifying.

To satisfy this provision the charity must show that it was made for charitable purposes and that it is for the benefit of the charity, and not to avoid tax.

In order to achieve this, the investment should be commercially sound and the charity should ensure that the investments are secure, carry a fair rate of return and in the case of loans, provide for recovery of the amount invested in due course.

The trustees must be able to justify financial support for a trading subsidiary as an appropriate investment of the charities resources. The Charity Commission for England & Wales has stipulated the following guidance for trustees when considering the investment of charities resources, both in general and in the particular context of a proposed investment in a trading subsidiary which is used to carry on a non-primary purpose trade.

- be certain that the investment is within the charities investment powers;

- exercise such care and skill in the investment process as is reasonable in the circumstances;

- have regard to the suitability to the charity of investments of the same kind as the particular investment which it is proposed to make;

- have regard to the suitability of the particular investment in question, as an investment of the kind which it seems appropriate to make;

- have regard to the need for diversification of investments, as appropriate to the circumstances of the charity; and

- ordinarily obtain and consider advice about the investment from a person reasonably believed by the trustees to be qualified to give it by his or her ability in and practical experience of financial and other matters; the advice needs to have regard to the suitability and diversification points mentioned above;

- the trustees must reasonably consider that it is in the charities interests to make the investment, after making a fair comparison of this form of investment with other forms of investment which might be selected;

- this fair comparison must involve an objective assessment of the trading subsidiaries business prospects;

- the trustees must be satisfied as to the financial viability of the trading subsidiary, based on its business plan, cash flow forecasts, profit projections, risk analysis and other available information; and

- the trustees must ordinarily take appropriate advice on the investment, and the financial viability of the trading subsidiary. What is appropriate will depend on the circumstances: the cost of taking the advice is a relevant factor, and the cost should be commensurate to the size of the proposed investment.

- pay attention to the length of time over which funds may be tied up in an investment in a trading subsidiary, since funds needed in the short to medium term may not be easily realised when invested in this way;

- consider, and take suitable advice on, the possibility of obtaining independent funding as an alternative to funding by the charity.

Charities & Trading Subsidiaries Part 2

Part 2

WHAT IS A TRADING SUBSIDIARY?

It is an independent commercial body, quite distinct from the charity. Its legal structure will usually take the form of a non-charitable company limited by shares or a non-charitable company limited by guarantee.

Although the trading subsidiary does not enjoy the advantages of charitable status, it is not burdened with the stringent trading restrictions that a charity must comply with. It will therefore be able to undertake trading activities which the charity cannot.

WHY USE A TRADING SUBSIDIARY?

- trading subsidiaries offer greater flexibility and fashion the opportunity to generate greater sums of money for the charity.

- The trading subsidiary will be able to carry out non-primary purpose trading on a larger scale and obtain tax relief through the gift aid scheme. If a trading subsidiary gives all or part of its profits to the parent charity then it will not have to pay any tax on those profits. This can result in very significant savings for the charity through the reduction or elimination of tax liabilities. Where the non-primary purpose trading does involve a significant risk the Charity would have to establish a trading subsidiary if it wished to continue that form of trading.

- To protect the charities assets from the risk of trading. If the trading is carried out within the trading subsidiary then the risks associated with any losses will be ring-fenced within the subsidiary itself.

- To protect the trustees of a charity from personal risks & liabilities.

- The directors of a trading subsidiary may be paid for their work unlike their trustee counterparts. Therefore a more commercially savvy person may be attracted to run the business. It must be noted though that the establishment of a trading subsidiary should not be used as a backdoor method of paying charity trustees.

It is important to remember that it is not only where non-primary purpose trading is undertaken that a subsidiary may be established. A charity may set up a trading subsidiary for the purpose of primary purpose trading if it so wishes.

DISADVANTAGES OF SETTING UP A TRADING SUBSIDIARY

Where the establishment of a trading subsidiary is not essential the benefits enjoyed must be balanced with the drawbacks that such a move would entail.

The disadvantages may include:

- The tax benefits may not outweigh all the extra costs associated with setting up and running a subsidiary.

- The additional administrative burden of a legal entity, quite separate from the charity.

- Difficulties that can emerge concerning the financing of a subsidiary.

- Possible cash flow problems for the subsidiary if all of the profits are donated back to the parent charity.

- The possible conflicts of interest arising where trustees of charities sit on the board of the subsidiary as directors.

These potential drawbacks will not be relevant in every case but trustees must be careful to avoid having their positions compromised.

In Parts 3/4 I will take a look at the financing of a subsidiary. This is often a difficult proposition given the numerous constraints placed on charities but it is essential that trustees are alert to the potential pitfalls.

Charities & Trading Subsidiaries Part 1

Today sees the start of a 6-part series which considers the trading activities of charities and the role of non-charitable subsidiaries. This is a pertinent issue in today's climate as charities move towards sustainable funding models. In Northern Ireland where the various Grant monies have begun begin to dry up there will be an increased onus on local community and charity groups to utilise trading opportunities as a means of funding, as failure to do so could result in their very survival coming into doubt.

PART 1

TYPES OF TRADING CARRIED OUT WITHIN A CHARITY

Charities are allowed to trade by law provided that the trading falls within one of the following categories:

Primary Purpose Trading- covers trading which contributes directly to one or more of the objects of a charity as set out in its governing document. Also includes trading where the work is mainly carried out by beneficiaries of the charity (beneficial trading).

This form of trading is not subject to tax and is therefore an effective way of funding the charity.

Examples include: provision of education services by an educational charity or the charging by a hospital for health care services.

Work carried out be beneficiaries (beneficial trading) might include sale of furniture produced by those with learning difficulties.

Ancillary Trading- is not on its own primary purpose trading but is carried out as part (ancillary) of a primary purpose trade.

Examples include: a theatre charity established for the promotion of arts running a cafe bar which sells refreshments to those attending the performance or the provision of accommodation to the students by a University.

Again this form of trading is not subject to tax liabilities.

Non-Primary Purpose Trading- is a form of trading which does not contribute directly to one or more of the objects of a charity as set out in its governing document. A charity will be allowed to raise funds through the carrying on of a trade which is not primary purpose, but only if the trading involves 'no significant risk' to the resources of the charity.

There is however no tax exemption for non-primary purpose trading, subject to a small trading exemption.

Exemption for Small Trades

The exemption to tax is applied where total turnover from all non-primary purpose trading does not exceed the annual limit.

The annual limit is as follows: £5,000 or if turnover is greater than £5,000, 25% of charity's gross income, subject to an overall limit of £50,000

In Part 2 I will condsider the use of trading subsidiaries and their respective advantages and disadvantages.