Intergroup recharges between charities and their subsidiaries can be an overlooked area of tax risk. An inappropriate approach of recharging intergroup costs can lead to a corporation tax charge, even in circumstances where all income is generally exempt.
As organisations consider how to operate in the new normal, with the associated changes to activities and operational structures, it is particularly important to ensure that existing approaches to recharging remain fit for purpose, or are appropriately updated.
Questions that may trigger a reconsideration of charging methodologies could include:
- Are you undertaking new activities, or ceasing to operate old ones? Will the scale of these activities change significantly?
- Is the way that you engage workers changing in a way that may change the costs being incurred?
- Do changes in the way you will be using office space going forward mean that existing approaches for charging for space may need to change?
In any case, methodologies should be reviewed and, if necessary, updated regularly as part of effective tax governance.
An overview of the issue
Transactions between group companies are generally required to take place on an arm’s length or commercial basis. There are some exemptions from this for smaller entities but for charitable groups, these rules are augmented by HM Revenue & Customs and Charity Commission guidance.
What are the potential risks for your group? – recharges by charities
Costs incurred by a charity in relation to goods or services provided to trading subsidiaries can lead to a corporation tax charge in two ways:
- If the recharge to the subsidiary is in excess of the cost incurred, the profit likely to be taxable, and
- If the recharge results in a loss, this is likely to represent non-charitable expenditure that is not for the benefit of the charity. This can also lead to a loss of tax exemption on an equal amount of otherwise exempt income.
While in non-charitable groups, a mark-up applied to such services would generally lead to a corresponding tax deductible cost in the other company, this is unlikely to be the case in a charitable group because a subsidiary will generally expect to realise a nil corporation tax position as a result of a donation to a group charity.
The impact of this can be an increased tax cost in the charity without a corresponding decrease in the tax charge for the subsidiary.
As a result, in cases where the costs are genuinely shared between the entities, a cost-sharing approach may be appropriate. If carefully implemented this may lead to a nil corporation tax cost in relation to the recharged cost.
In other cases, it may be appropriate to apply a mark-up to cost, for example where the charity is providing a service or where the cost is not in fact shared between the two entities. In the latter case it may be more appropriate for the other party to incur the cost directly as a corporation tax charge is likely to arise for the charity on the profit, for example if a member of staff works only for the subsidiary.
In our experience, fixed fee charges are likely to lead to corporation tax costs because they are unlikely to lead to a consistent break even position. Most groups will therefore choose to identify and recharge based on a calculation of specific costs.
Recharges from subsidiaries
A trading subsidiary is subject to tax on profits under normal corporation tax rules. Therefore, HMRC expects that any goods or services provided to other group companies, are charged for at an arm’s length rate for tax purposes.
Where this is not the case, a subsidiary may have to impute notional income in its tax computation. This may lead to the following corporate tax risks:
- If a subsidiary has to recognise a transfer pricing income tax adjustment it is unlikely to have matching cash and/or distributable reserves to fully mitigate the notional profit through a donation the parent charity
- As the compensating tax adjustment would be to recognise an adjustment to expense in the charity, which would not benefit from the tax deduction, there will be no taxable income to offset it against, and there may be a one sided tax charge in the charity.
Methodologies and tracking of cost allocation
In order to mitigate the risk of tax arising, care should be taken to ensure the basis of calculation is appropriate. Does your methodology:
- Identify the types of costs which are to be recharged?
- Establish a basis for calculating the amounts to be recharged based on the costs actually incurred?
- Consider whether a mark-up is to be applied or a cost sharing approach is appropriate?
If you have any transfer pricing or recharge concerns regarding charity groups, we can help and support you. For any queries please get in touch.
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