How to set up a charity trading subsidiary properly
It is a common myth that charities are not allowed to trade. In fact, most do.
Any charity that, for example, has a local authority contract to provide services, sells tickets for events, charges for use of a community venue or sells merchandise to raise funds is trading. As trading or “earned” incomecontinues to be increasingly important for charities, it is important that Trustees understand the rules around charities and trading.
Primary purpose trading
Charities are allowed to trade providing the trading is directly to further the charity’s purposes (its objects) and not primarily to raise money. This is called primary purpose trading. If a charity is charging individual beneficiaries (e.g. for a counselling service or for careers advice and guidance), then the public benefit requirements for charities include rules about what charities must do if charges are more than a person of modest means could afford.
Non-primary purpose trading
If trading is primarily to raise funds (such as a running a charity shop) or to deliver services that extend beyond the objects of the charity (e.g. services provided outside the charity’s area of benefit), then a charity will need to set up a subsidiary company to undertake that trading, unless the trading is small scale. This arises both from the requirements of charity law (a charity must be established for exclusively charitable purposes) and from the tax rules around charity trading.
What is a trading subsidiary?
In concept a trading subsidiary is a simple enough. A new company is set up that is wholly owned by the charity. That company provides the traded services, generating income and incurring the associated costs. It can donate some or all of its profits to the charity each year, thus reducing or avoiding any Corporation Tax liabilities and helping fund the charity’s activities.
In practice, things can get more complicated. For example, the charity and the subsidiary will often share some staff, assets and other costs. In some cases, the charity may have mixed purpose trading, where some trading services are primary purpose and some are not, and separating these may not be straightforward. And, of course, if the volume of traded services is high enough, there will be VAT implications.
What do the regulators say?
There are several Charity Commission and HMRC guidance documents that are relevant to charities and their trading subsidiaries, including:
· CC35: Trustees trading and tax
· Guidance for charities with a connect to a non-charity
· CC14: Investing charity money (because setting up a trading subsidiary is often an investment decision for trustees).
This guidance, when taken together, can appear complicated. It covers a wide range of issues including:
· How to deal with conflicts of interest and board structures.
· Whether a charity can (or cannot) fund its subsidiary.
· Balancing the duties and powers of trustees and directors, for example to ensure the subsidiary acts in the best interests of the charity.
· How the subsidiary can donate its profits to the charity.
· How to document the relationship between a charity and its subsidiary, particularly where there are shared arrangements for property, other assets, intellectual property, staffing, bookkeeping/accounting and insurance.
The risks of non-compliance
Perhaps because of this, many charities do not operate their trading subsidiaries in ways that comply with the guidance, even to the point of treating the subsidiary as little more than a cost code in the charities bookkeeping and an accounting device to avoid tax. Some trading subsidiaries don’t even have their own bank account.
This can be a high-risk approach that can lead to unexpected tax liabilities and/or regulatory action by the Charity Commission if concerns come to its attention.
Best practice
In short, a charity trading subsidiary should operate at arm’s length from the charity: as a genuine business. It should pay the charity for use of charitable assets, staff etc and these arrangements should be documented in an agreement between the two. The board of the subsidiary should include people who are not connected to the charity (and vice versa). Often the subsidiary and charity will each employ their own staff and the subsidiary should manage its own finances and have its own bank account.
This is not to say that the two organisations should not plan and operate in concert with each other. They clearly should. There should be a shared strategy and business plan that ultimately furthers the interests of the charity and supports it to deliver its purposes. Interdependencies between the two need to be clearly understood and risks that may arises should be carefully managed. For example, what happens if the profit from the subsidiary is not as much as the charity allows for in its budget?
Often the solutions are relatively simple, but each situation is different and the answers need to be tailored accordingly. Expert advice, including legal and VAT/Tax advice may also be needed to ensure trading arrangements are set up and operated properly.
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