Legal opinion forces Registered Provider Groups’ to review donations from their trading subsidiaries

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Registered Providers with a trading subsidiary should review how much trading profit is donated to the parent charity following recent guidance from the Institute of Chartered Accountants in England and Wales (ICAEW). This guidance highlights a concern that some donations may have exceeded the subsidiary’s distributable profits and therefore will be unlawful.


Many charities, including those in the social housing sector, set up a trading subsidiary to undertake trading activity which falls outside their charitable purposes (sometimes known as non-primary purpose trading). For example, in the case of a Registered Provider, the letting of affordable housing to those in housing need furthers its charitable purposes and would be primary purpose trading; in contrast, developing homes for private sale would be non-primary purpose trading and would usually be carried on through a trading subsidiary.

Since the Homes and Communities Agency new Regulatory Framework came into force earlier this month, what is clear is that protection of social housing assets and managing risk within an RP should be receiving greater focus within every RP, (and it will certainly be receiving greater focus from the HCA as regulator). Operating through a trading subsidiary helps RP Groups to reduce risk by ring-fencing the charity’s assets (particularly its social housing assets), from potential trading losses. The advice from both the HCA and the Charity Commission is that if non-primary purpose trading, such as development for outright sale, carries any significant risk then the charitable RP should consider carrying on this activity through an appropriate subsidiary.

This is also important for tax purposes. Non-primary purpose trading is liable to tax unless it falls within an exemption (e.g. the exemption on small scale trading activity). Charitable RP’s usually do not have the power in their governing document to carry on trading activity to such an extent that it incurs a tax liability. This is another reason why they may need to set up a trading subsidiary.

The trading subsidiary itself can reduce its tax liability by making donations to its charitable parent under the corporate Gift Aid scheme. In principle this can reduce the trading subsidiary’s taxable profits to zero, and depending on the complexity of the Group, can thereby completely eliminate any taxable profits within the RP Group.

Distribution of profits

The rules on distribution of profits under the Companies Act 2006 state that a distribution is “every description of distribution of a company’s assets to its members, whether in cash or otherwise”. A company intending to make a distribution must satisfy two essential rules:

1. it must have profits available to make the distribution (i.e. “distributable profits”); and
2. the distribution must be justified by reference to “relevant accounts”.

There is also a common law rule which restricts a company limited by shares from returning capital to its members.

Any distribution which does not satisfy these rules is deemed unlawful.

ICAEW technical guidance

However, the ICAEW has expressed concern where a trading subsidiary donates an amount to its parent charity which exceeds its “distributable profits” in order to reduce its taxable profits to zero. This is because a company’s “taxable profits” under tax legislation may not reflect the “distributable profits” under company law. These concepts are distinct and the two amounts are not necessarily the same.

The Charity Commission has nonetheless previously accepted this practice and the ICAEW likewise regarded it as “common practice” for a trading subsidiary to donate all its taxable profits. However, having obtained counsel’s opinion, the ICAEW has now published technical guidance confirming that this approach was not correct.

In summary, counsel has stated that, if a trading subsidiary makes a donation to its parent charity, this is a distribution under company law. But, if the donation is greater than the subsidiary’s distributable profits available as shown in its relevant accounts, the payment would be unlawful, just as it would be unlawful for the company to pay a dividend in those circumstances.

If the charitable parent receives a donation in these circumstances, it would be under an obligation to repay the unlawful element (i.e. the amount in excess of the distributable profits). The directors of the trading subsidiary would also be potentially liable to the subsidiary if the charity failed to make repayment. The trading subsidiary would also be liable to corporation tax on any taxable profits.

Next steps

HMRC is still considering the tax implications for charities. In the meantime, Registered Providers should identify if any historic (or planned future) donations might be in excess of the subsidiary’s taxable profits and, if so, what remedial action they should take. This is likely to require a detailed financial analysis. Because of the possible conflicts, it may be appropriate for the charitable parent charity and any non-charitable group subsidiaries to take independent advice separately.

If you would like more information, please contact John Devine on 0191 211 7905 or [email protected] or Chris Hook on 0191 211 7929 or [email protected].