Counsel has recently advised the Institute of Chartered Accountants in England and Wales (ICAEW) that the practice of a wholly owned trading subsidiary making payments to its parent charity in excess of the company's distributable profits is unlawful. For a long time it has been common practice for a wholly-owned trading subsidiary of a charity to donate all taxable profits to its parent charity and to claim charitable donations relief under the Corporation Taxes Act 2010 (CTA 2010). It has also been common practice for the amount donated by the trading subsidiary to exceed the amount of profits available for distribution under the Companies Act 2006 (CA 2006). This practice was endorsed by the Charity Commission (the Commission) in its guidance on trustees, trading and tax. However, the Commission acknowledged that there were differences in legal opinion.
The rules on distribution under the CA 2006 state that a distribution is “every description of distribution of a company’s assets to its members, whether in cash or otherwise” (section 829 CA2006).
A company proposing to make a distribution must satisfy two basic rules:
- It must have "profits available" to make the distribution ie, "distributable profits"
- The distribution must be justified by reference to "relevant accounts"
There is also a common law rule that restricts a company limited by shares from returning capital to its members.
Any distribution which does not satisfy these rules is deemed unlawful.
As the Commission’s position on the matter was being questioned, ICAEW sought Counsel’s opinion which they published in their technical guidance. Looking at these rules, Counsel advised that a gratuitous transfer (such as a gift of money) made by a company limited by shares to a member is caught by the rules on distribution. A donation by a wholly-owned trading subsidiary to its parent charity is also a distribution of the company's assets to a member. These distributions will be unlawful where they exceed the trading subsidiary's profits available for distribution as shown in its relevant accounts (usually the last annual accounts circulated to members).
As a consequence of Counsel’s opinion, a charity parent may be liable to repay the unlawful distribution (section 847, CA 2006) and directors who authorised the payment of an unlawful distribution may be in breach of their fiduciary duties and may be personally liable to repay the trading subsidiary to the extent that the relevant amounts are not repaid by the parent charity. However, the court has discretion to relieve a director of liability where he has acted honestly and reasonably and ought fairly to be excused (section 1167, CA 2006). Claims by the trading subsidiary against the directors are time-barred after six years has lapsed from when the cause of action accrued. The Commission has withdrawn their guidance in order to consider it. HMRC is considering the tax impact for charities and their trading subsidiaries and will publish its view in due course.