Does my charity need a trading subsidiary?
Julian Lomas
A common situation we encounter when looking at charity governance is charities whose activities have developed and expanded over the years and, without realising it, the charity is now delivering services that extend beyond its charitable purposes (objects).
When that happens, it is a serious matter: trustees’ first duty is to ensure that the charity is carrying out its purposes for public benefit. This means that trustees must make sure that everything the charity does helps (or is intended to help) to achieve the purposes for which it is set up, and no other purpose. Delivering services/support that is not within the charity’s objects is, therefore, a breach of this legal duty.
In some cases, the solution is to amend the charity’s objects. To do this the trustees must first obtain the consent of the Charity Commission, which is not as simple to secure as it used to be following implementation of the Charities Act 2022. It requires significant information to be provided to the Commission to ensure any change meets the criteria and often prior consultation with beneficiaries and stakeholders.
Where objects cannot be changed or services/activities are proposed (or even being delivered) are not charitable or the personal benefits arising from them are not incidental to the public benefit, the usual solution is to set up a trading company, owned by the charity, which will undertake these “non-primary purpose” activities (including activities primarily aimed at raising funds to support the charity’s work).
It is important to understand that the charity cannot subsidise the trading company using charitable funds (unless the company will use those funds only to further the charity’s purposes).
Therefore, the trading company needs to be able to raise its own funds for those activities. That could be through trading activities (charging for its services) or through grants or other funding provided direct to the subsidiary (it will usually be helpful for the trading subsidiary to be a Community Interest Company to help secure this type of funding).
The charity must not be used to secure grant funding to fund the trading subsidiary’s non-primary purpose activities. If the activities in question are charitable and for public benefit, but do not fit within the charity’s objects and the objects cannot be changed, then it may be possible to set up a separate (or subsidiary) charity to undertake those activities, which would open up a wider range of funding sources.
By the way, it’s a myth that charities cannot trade. A charity does not need to set up a trading subsidiary to undertake trading activity that directly furthers its objects (i.e. primary purpose trading). This can be done by the charity itself, providing the public benefit requirements relevant to charging for services are complied with.
There are other reasons for setting up a charity trading subsidiary, the most common of which are:
To protect the charity from risk associated with a new activity (even if it would be a primary purpose activity) by running the activity through a separate company.
To manage VAT efficiently, for example if the activity would result in sufficient income for the charity to need to register for VAT but it does not wish to charge VAT on other services.
Administrative efficiency, for example if a café conducts both primary and non-primary purpose trading it will usually be simpler to run the whole of the café through the subsidiary.
If you do need to set up a trading subsidiary for your charity, there are some key things to make sure you get right:
Make sure it is a wholly owned subsidiary, i.e. the charity is the sole shareholder or member. If not, the accounting flexibilities that allow the full profits to be donated to the charity after the end of the accounting year won’t apply and there will inevitably be a Corporation tax liability as a result.
So that conflicts of interest can be managed properly, there must be enough directors on the board of the subsidiary who are not connected to the charity and enough trustees on the board of the charity who are not connected to the subsidiary (usually at least 2 in each case).
Each entity (the charity and the subsidiary) should pay its own direct costs as far as possible (including separate payroll for staff who work solely for the subsidiary) and there should be an agreement in place regarding shared costs (including shared staff and overheads).
Get your accountant on board early so you get your bookkeeping and end year accounts right from the start.
Where relevant get early VAT advice to ensure the VAT structure of the group is optimised.
You may need business rates advice if the subsidiary will be using part of a building owned or leased by the charity.
While all this can sound complicated (and sometimes it is), there are thousands of small charities around the country that have trading subsidiaries. Often the complexity is in the set up rather than operation of the subsidiary.
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Want to find out more? Contact us at julian@almondtreeconsulting.co.uk to discuss your organisation’s needs.