The FRC has noticed a range of practice in accounting for distributions within groups headed by charities, so has released an Exposure Draft clarifying the accounting treatment and proposing an amendment to deal with the tax-related consequences of this amendment.
When a limited company is a wholly owned subsidiary of a charity, it can pay up its profits to the parent within nine months of its reporting date and benefit from Gift Aid on those payments, meaning the payment is tax deductible for the paying company. It seems that in some groups, any planned payment has been accrued in the relevant financial year, leaving the company showing no apparent taxable profits.
Unfortunately for these groups, a careful reading of FRS 102 shows that payments like this to owners should be classified as a distribution and therefore firstly should not be deducted from accounting profits, and secondly cannot be accrued – they are not recognised until there is a binding commitment (comparable to a dividend being formally declared).
But if a charity’s subsidiary updates its accounting for this, it would, under current FRS 102, end up showing profits in a reporting period, and an accounting tax charge, even where it was confident that tax relief would be obtained. So the proposed amendment says that where it is probable that a Gift Aid payment will be made within nine months of the year end, the income tax effect of that (ie, the tax deduction) should be recognised in the current period. So in a group setup where the subsidiary always distributes all of its profits to its charitable parent, that subsidiary will be able to report its underlying position, ie no tax charge reported in its accounts, because the tax charge will not crystallise.
The proposed amendments also clarify that there is no deferred tax accounting to do, and that when the payment is actually made after the year end it will still be treated for accounting purposes as a distribution to owners, ie through equity, even though the tax deduction is through the P&L and transactions and their tax effects are normally recognised in the same primary statement.
The full FRED 68 can be accessed here – the comment period closes on 20 October 2017 and the amendments would have an effective date of 1 January 2019, with early adoption permitted.