Registered Providers with charitable status should review their relationships with trading subsidiaries following recent guidance from the Institute of Chartered Accountants in England and Wales (ICAEW) which indicates that some donations by companies to their parent charities may have been unlawful. The issue arises where donations by a trading subsidiary to a charitable parent have exceeded the distributable profits of the subsidiary at the relevant time. The charity would have to repay amounts which were unlawfully received.

Many charities, including those in the housing sector, establish trading subsidiaries to carry on trading activities which are outside their primary charitable purposes. Non-primary purpose trading is trading that is solely designed to raise funds for the charity rather than trading which furthers the charity's objects. So, in the case of Registered Providers, the letting of affordable housing furthers their charitable objectives and would be primary purpose trading while developing homes for private sale would be non-primary purpose trading.

The establishment of the trading subsidiary serves a risk management purpose by ring-fencing potential losses from trading. Generally, if non-primary purpose trading carries any significant risk, there have to be other very good reasons for not using a trading subsidiary to do this.

The use of a trading subsidiary can also mitigate tax. Non-primary purpose trading is taxable when carried on by a charity and is also taxable when carried on by the subsidiary. However, by making donations to its parent charity, the subsidiary can obtain tax relief for the charitable donation and reduce its corporation tax liability on its profits.

ICAEW’s issue

The issue identified by ICAEW arises where the subsidiary donates an amount to the charity which exceeds the profits which it has available for distribution. These are the profits which, under company law, could be used to pay a dividend to the parent company. This has happened in the past because charity groups have sought to eliminate taxable profits entirely by making donations equal to the full amount of that year’s taxable profits. But for a number of reasons, taxable profits may not reflect the accounting profits available for distribution in company law terms.

Although not all advisers took the view that this was permissible, the Charity Commission had approved this practice in public guidance and the ICAEW considered it to be “common practice”. However, the ICAEW has now obtained counsel’s opinion and published a technical release confirming that this was not the case. The Charity Commission has now withdrawn its incorrect guidance.

In short, it has been confirmed that, if a company makes a donation to its parent charity, this is a distribution for company law purposes. If the donation exceeds the profits available for distribution, this is unlawful in the same way that it would be unlawful for the company to pay a dividend in those circumstances.

The charity receiving the payment would have an obligation to repay the unlawful element of the distribution to the trading subsidiary. The directors of the subsidiary may also be liable to the subsidiary for breach of duty if the charity fails to make the repayment.

Review history of donations

While HMRC is still considering the tax impact on charitable groups, Registered Providers should review the history of donations between charitable members of their group and non-charitable trading companies to identify if any issues arise for them in relation to historic and planned donations and what remedial steps they should take. This will require a detailed analysis of historic payments, consideration of how any repayment obligations of the charity can be satisfied, and how future donations by the subsidiary to the parent can be managed. Given the possible conflicts, it may be necessary for subsidiary and parent - and the relevant directors - to take advice separately.