Keith Arrowsmith from Counterculture’s legal team explains why trading subsidiaries may need to enter into a Deed of Gift with their parent charities
It is common practice for wholly owned trading subsidiaries to transfer their profits every year, to their parent charities. Many have not used a Deed of Gift (or Deed of Covenant) since the Gift Aid rules were introduced.
The UK’s Financial Reporting Council has recently published an update to how those profits should be accounted for. That update means that, with immediate effect, it may be necessary for the board of directors of a trading arm to review how those profits will be recorded in the accounts, and whether a binding commitment to transfer them to the parent charity exists before the financial year end.
Changes to the accounting treatment of profits
If the trading arm makes a gift of its profits to the parent company before the end of its financial year, then the new guidelines make no change to how the profits will appear in the accounts.
However, if the transfer does not take place in the financial year in which the profits occur, then the gift cannot be recorded in the group’s profit and loss account for that year unless there is a “legal obligation” to make the payment.
By way of example:
Scenario 1: Trading Company makes a transfer in the year the profits are made
Trading Company has made a £1100 profit in the year ending 31 March 2018. It transfers £1000 to its parent charity before the end of the financial year. RESULT: no change – the £1000 transfer will be recorded in the accounts in the year in which the profits are made.
Scenario 2: Trading Company does not make an in-year transfer
Trading Company has made a £1100 profit in the year ending 31 March 2018. It transfers £1000 to its parent charity three months after the financial year end. RESULT: if there was no legal obligation to make the transfer, then the transaction will not be recorded in the group accounts for the 2017/2018 year, but instead it will appear in the 2018/2019 accounts.
Scenario 3: Trading Company enters into a legal obligation to make the £1000 transfer
A trading company has made £1100 profit in the year ending 31 March 2018. It enters a legal obligation to transfer £1000 to its parent charity on 31 March, and makes the transfer three months later. RESULT: no change – the £1000 transfer will be recorded in the year in which the profits are made.
What is a legal obligation to make payment of the profits to the charity?
It is unlikely that a history of past payments will amount to a legal obligation to make future payments. Likewise, a board resolution to make a payment to the charity is unlikely to amount to anything more than an intention to make a payment.
So if the trading company wants to show that a legal obligation to make payment of the profits to a charity exists, we suggest that the group considers entering into a Deed of Gift (also known as a Deed of Covenant).
What is a Deed of Gift?
A Deed of Gift (or Deed of Covenant) is a short document that contains the legally binding obligation to make payment of a defined amount by the trading company to its parent charity. The document needs to be a formal deed to make sure that the promise to pay is a legally binding obligation.
Do these changes affect the tax position for the trading company?
The tax treatment of any gift aid payments does not change. As long as it is “probable” that the trading company’s profits will be paid to the parent charity within nine months of the end of the financial year in which the profits were made, then there is no need to recognise a deferred tax liability in the accounts.
Recommendation
Keith recommends that charities with trading subsidiaries review their accounting practices for profit transfers. If it is important to show that the profit transfer takes place in the year in which the profits are made, then the trading company should either ensure that the payment is transferred during that year, or that it enters into a Deed of Gift in that year.
If an organisation requires help to prepare a Deed of Gift, then please contact Keith.
Photo by Cytonn Photography on Unsplash