Implementing deeds of covenant could provide a solution to rules over how profits of subsidiary companies are traditionally gift aided up to the parent charity, accountancy firm Bishop Fleming has suggested.
Charities that receive income from their trading activities through a separate company need to be aware of the guidance, which was issued by the Institute of Chartered Accountants (ICAEW) in response to HMRC revising its guidance on corporate Gift Aid last year. It covers how profits of subsidiary companies are traditionally gift aided up to the parent charity and states that a subsidiary must have enough distributable reserves to cover the gift aid payment. The Charity Commission also updated its guidance in line with that of the ICAEW.
According to Bishop Fleming, although it has been made clear that a distribution can only be made out of available reserves, this creates an issue as trading subsidiaries will not have any reserves as they will have been given to the charity in previous years. This means that labelling a payment to the charity as a gift aid donation will no longer avoid it being seen as a distribution.
Bishop Fleming director and charity tax specialist, Jon Sparkes said:
“As the company is unlikely to have any reserves brought forward, any adjustments that have to be made to calculate its taxable profits will create a problem where the tax-adjusted profit ends up being greater than the accounting profit, as this will create an unwelcome tax charge in the company.”
Bishop Fleming is advising charities with trading subsidiaries to safeguard their trading profits from this tax issue by implementing deeds of covenant for their subsidiaries where they don’t already exist. It states that deeds of covenant would circumvent the ruling that gift aid payments should only be recognised in accounts when they are actually made, and that as a covenant creates a legally binding obligation on the subsidiary to make the payment, they give a certainty that the payment will be made.
“The rather ad hoc nature of gift aid payments from subsidiaries will need to be replaced by a more formal arrangement, and I would recommend that the best way to do this is to return to deeds of covenant. They may have fallen out of popularity, but they could be about to make a comeback.”
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