FRED68: Changes to the way charitable groups account for gift aid

Posted on October 20, 2017 by Wylie & Bisset

The Financial Reporting Council (FRC) is consulting on plans to radically change the way the subsidiary of a charity accounts for gift aid.

Trading subsidiaries are able to take advantage of HMRC rules allowing the payment of monies to their parent charity to be treated as an allowable expense in their tax computation, thereby sheltering profits made by the subsidiary from tax.

HMRC allow the payment to be charged as an allowable deduction as long as it is physically paid within 9 months of the subsidiary’s year end. This allows the subsidiary time to prepare its accounts and calculate its tax liability, allowing the gift aid payment to be calculated to optimise tax savings.

Thus, a charity’s wholly owned trading subsidiary reporting an accounting profit of £50,000 for the year ended 31 December 2016 which gives rise to a taxable profit of £40,000, makes a gift aid payment of £40,000 to its parent charity by 30 September 2017 and pays no corporation tax.  The charity receives £40,000 tax free.

Historically the gift aid payment has been accounted for by both the parent charity and the subsidiary in the year to which it relates. Thus, in the example above, the parent charity reports income of £40,000 (and a corresponding debtor due from the subsidiary) and the subsidiary reports a cost of £40,000 (and a corresponding creditor due to the parent charity of £40,000).

In recent years, the legal status of such payments has been reconsidered and it was decided that they are actually distributions (in the same way that a trading company might pay a dividend to its shareholders).

The immediate consequence of this was that subsidiaries could only make gift aid payments to the extent that they had distributable reserves, i.e. retained profits, or a balance on their Profit & Loss Reserve.

This restricted the extent to which some subsidiaries were able to shelter their profits from tax, particularly where the taxable profit exceeds the accounting profit, and has led to some subsidiaries paying corporation tax for the first time.

The changes that the FRC is now proposing in Financial Reporting Exposure Draft 68 (FRED68) will mean that (in common with the treatment of dividends payable) charities and their subsidiaries will no longer accrue the gift paid payment in the year to which its relates; instead it will be included in the accounts in the year in which it is paid.

Thus, in our example above, the subsidiary reports a profit in the year ended 31 December 2016 of £50,000 but the gift aid payment of £40,000 relating to the subsidiary’s taxable profits for that year will appear as income in the charity’s accounts in the year ended 31 December 2017 and a cost in the subsidiary’s accounts for the same period: a mismatch we have not seen before.

If the subsidiary makes broadly similar profits each year, the effect of this may be minimal but if the subsidiary’s profits fluctuate, it will be more significant.

The FRC have confirmed that the subsidiary will be able to take account of the tax effect of a gift aid payment it is probable to make within 9 months, meaning that deferred tax will not need to be provided on the profits.

This change is currently subject to consultation, and if implemented, will come into effect for accounting periods beginning on or after 1 January 2019.

Charities and subsidiaries will require to make a prior year adjustment on adoption to bring comparative figures in line with this treatment.

Charitable groups may wish to consider looking at the subsidiary’s performance after say 11 months of the year, and making an interim gift aid payment, which is physically paid over in advance of the year end. This would enable both the charity and subsidiary to reflect the gift aid in their accounts.

For example, a subsidiary reviews its position for the year ended 31 December 2019 on 30 November 2019. Management information is indicating a profit for the year to date of £60,000 and a taxable profit of £57,000.  Budgets indicate a further profit for December.

The directors of the subsidiary may decide to make a payment to the parent charity in December 2019, cashflow allowing, of £55,000 (slightly less than the taxable profit to be prudent – this will be a judgement call). The £55,000 is paid by the subsidiary and received by the charity prior to 31 December and is therefore reflected in their accounts for that period.  This leaves potentially just a small ‘mop up’ payment to be made post year end and accounted for in the following year.

This is a highly complex technical area. If you wish to discuss it further please don’t hesitate to contact your usual Wylie & Bisset contact – or myself.

Jenny Simpson