October 19th, 2017 / Insight posted in Articles

Draft amendments to FRS 102, The Financial Reporting Standard for the UK and Republic of Ireland

We are pleased to respond to the Financial Reporting Council’s Consultation on revising FRS 102 in respect of the treatment of gift aid payments and the potential related tax effects and have set out our responses below.

Draft amendments to FRS 102, The Financial Reporting Standard for the UK and Republic of Ireland

Kingston Smith LLP is a mid-tier firm of accountants and auditors with a strong specialism in providing expert advice to not-for- profit organisations. Our collaborative approach to gaining an understanding of our clients, their needs and their aspirations has helped us to maintain our position as one of the leading advisers to the UK charities sector. We are pleased to respond to your Consultation on revising FRS 102 in respect of the treatment of gift aid payments and the potential related tax effects and have set out our responses below.

Do you agree with the proposed amendments to FRS 102 and that this will improve the relevance of information provided to users of the financial statements? If not, why not?

We believe that this question has two elements, the first being that the proposed change appears to mandate the ‘treatment as a dividend’ method of accounting for gift aid payments. The second is that the proposed change will allow charities to recognise in the current period financial statements the effect of the tax relief that will be claimed in future periods. The ‘treatment as a dividend’ method at present appears technically to require the recognition of a tax expense which will never actually be paid which in our view entirely misrepresents the substance of the transaction. We have considered each of these elements separately below.

Treat as a dividend vs treat as a gift

For some time, there has been divergence in practice in respect of the accounting treatment of gift aid payments. The divergence arose as a result of legal advice obtained by the ICAEW that gift aid payments by a trading subsidiary to its parent charity were legally distributions. Whilst some firms recommended accounting for the distributions as dividends many firms, including ourselves, considered that presenting them as gifts, and therefore as an expense in the profit and loss account for the year, reflected the substance of the transaction. As financial statements are prepared based on the substance of the underlying transactions rather than their legal form, this treatment was considered appropriate regardless of the legal form of the transaction being that of a distribution.

The first argument is that reflecting the gift of profits as an expense in the year reflects the substance of the transaction. From FRS 102 para 2.8:

Transactions and other events and conditions should be accounted for and presented in accordance with their substance and not merely their legal form. This enhances the reliability of financial statements.

Our view is that the substance of the transaction is that the trading subsidiary, having made profits for the year, is donating these profits up to its parent charity.

The next argument is that, in our view the payment of profits to a parent charity creates a constructive obligation. From FRS 102 para 2.20:

A constructive obligation is an obligation that derives from an entity’s actions when:

a) by an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities; and

b) as a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities.

In our view the annual payment of gift aid fully meets this definition. There will be very few conceivable situations where a charity will not pay up its profits to a parent charity. The charity, when considered the other party in (b) above, will have a clear expectation, based on established patterns of past practice, that these amounts will always be paid and that the amount paid will always equate to the profit for the year. We are also concerned that not permitting the recognition of a constructive obligation in this specific circumstance but instead requiring the construction of a legal obligation (for instance by means of a deed of covenant) to permit the gift aid payments to be provided for, risks undermining the whole concept of constructive obligations which has been enshrined in accounting standards for many years, and could therefore have unintended consequences.

We would also note that section 57 of the Finance Act 2006 addresses gift aid relief and explicitly states that a “payment (other than a dividend) made by a company which is wholly owned by a charity is not to be regarded as a distribution for the purposes of this subsection”. So, from the perspective of the tax legislation the payment of gift aid is not considered a dividend, regardless of the ICAEW opinion referred to above.

This is also a contrast to the income recognition requirements within FRS 102 and the SORP. For the parent charity, income should be recognised when there is entitlement, it is probable that income will be received and it can be measured. Looking at these three criteria:

  • Entitlement – this is control over the rights to the economic benefits. As the parent charity controls the subsidiary and can control the profits paid up we believe this is met
  • Probable – As a trading subsidiary is by it’s very nature going to gift its profits to its parent, it is clear that this criterion is met
  • Measurement – 100%, or 100% less a set sum of profits will be paid up. We believe this criterion is also met.

Following this logic, it would make sense that the other side of the transaction should be recognised in the current year by the trading subsidiary.

We therefore believe that on this basis there is a strong case to permit the ‘treat as gift’ treatment and strongly recommend that you reconsider this when finalising the proposed amendments. The fact that, (per the opinion obtained by the ICAEW although not, as noted above, the Finance Act) the gift aid payments are legally a distribution does not mean that the accounting for the payments should automatically be the same as for a dividend as the facts and circumstances are very different.

However, if the final decision is that the ‘treat as a dividend’ treatment is the only acceptable way to account for gift aid payments we believe that this change should be communicated in a far more explicit manner in order to allow for uniformity of treatment for all trading subsidiaries. This might best be done within the standard, perhaps as an appendix to the PBE section of Section 34 of FRS 102, but alternatively could be covered in a staff education note. The guidance should cover:

  • Why treatment as a gift is inappropriate
  • Whether distributions should be treated as an adjusting post balance sheet event and if not why not. We note in the current version of practice note 11 (paragraph 217) it states explicitly that they should be. (We note this has been omitted from the recent exposure draft of the practice note).

Recognition of tax relief that will be claimed in future periods

Notwithstanding our preference to retain the ‘treat as a gift’ treatment we agree with the amendments to the standard if the ‘treat as a dividend’ accounting treatment is to be mandated. The proposals will, in our opinion, reflect the substance of the tax effects of the transaction far better than accounting for an essentially fictitious tax expense that will never be paid (and indeed any related deferred tax) with consequential effects on distributable profits.

In relation to the Consultation stage impact assessment do you have any comments on the costs and benefits identified? Please provide evidence to support your views of the quantifiable costs and benefits of these proposals.

Trading subsidiaries are currently accounting for gift aid payments in a variety of ways – treat as a gift, treat as a current year dividend and treat as a dividend in a subsequent year. The Consultation Impact Stage Assessment does not appear to consider the cost of changing these accounting policies on subsidiaries not accounting for these as distributions in subsequent years. This will involve a prior year adjustment to reflect the new policy and enhanced disclosures explaining the change. This exercise repeated on every trading subsidiary in the country will add up to a very significant cost.

We also see one the main consequences of the change being charities engaging lawyers in order to put in place deeds of covenants that will allow for profits to be accrued. This will result in a cost to the industry whilst providing no net benefit.

We would also like to express our disappointment at the very short consultation period. It is our opinion that one month is too short a timescale to get engagement from the industry.


As stated above we believe that the FRED has only considered part of the issue and would welcome guidance with a far wider remit.