Routing commercial activities through trading subsidiaries can help charities to generate extra money more tax efficiently. We highlight some top tips to help you use trading subsidiaries more effectively.
Be clear on the reasons for the subsidiary
There are many reasons why a charity might set up a subsidiary. The main ones are to protect charity assets from the commercial risks of trading, and to minimise the tax payable on trading activities. Being clear on what you’re trying to achieve will help you to structure and manage activities effectively.
Establish what trades are taxable in the charity
Charities can trade without paying tax provided:
- The trade advances their charitable purposes, for example, fees paid to a care home for residential care; or
- Trading is ‘small scale’ – larger charities can generate up to £80,000 of income from non-charitable trading without paying tax on the profits.
Knowing the reliefs available to your charity helps you to make the most of commercial opportunities without worrying about unexpected tax charges.
Plan ahead
Where a charity’s income from non-charitable trading is more than the small-scale trading threshold, all the profits from relevant activities are subject to corporation tax. The rate of corporation tax for all but the smallest companies is 25%. This means that charities could pay £25,000 of tax on every £100,000 of profit from taxable trading. Planning is key.
Be realistic about the resources needed
Using a trading subsidiary will take management time and resources. Think about whether your charity can provide the necessary support or whether you’ll need extra resources. HM Revenue & Customs (HMRC) expects the charity to charge the subsidiary an arm’s length rate for any goods and services it provides. Include these expected costs in the subsidiary’s budget to help you assess its profitability more accurately.
Consider the VAT implications
As the trading subsidiary is a separate legal entity, it must register for VAT if its vatable supplies are more than the VAT registration threshold (currently £90,000). Charges from the charity to the trading subsidiary, for example, for staff time, are also likely to be within scope of VAT. This could cause the charity to breach the VAT threshold.
Often a charity will de-register and form a VAT group with its trading subsidiary. Where the trading subsidiary is generating taxable income, this can help to maximise the VAT recovery on general overheads. Bear in mind, however, that if the charity has a partial exemption special method (PESM) in place, this would be removed when they de-register. The charity would need to obtain HMRC approval to use a PESM moving forwards.
Make sure you have a strong business case
Trading subsidiaries are generally financed by the parent charity through a mixture of share and loan capital and intercompany accounts. The charity’s trustees must make sure that supporting the trading subsidiary is in the charity’s best interests, and there should be a strong business case backed up by plans and cash flow forecasts. If charities can’t show that investment decisions were made on a reasonable basis for the charity’s benefit, HMRC might see the investments as non-charitable expenditure, and tax them.
Distribute profits on a timely basis
Trading subsidiaries can eliminate corporation tax on their profits by distributing their profits to the parent charity (Gift Aid). To qualify for tax relief:
- The Gift Aid payments must be made in the year the profits are made or, if the trading subsidiary is wholly owned by the charity, within nine months of the year end.
- The Gift Aid payments must be made from the trading subsidiary’s distributable reserves.
- There must be an actual transfer of cash from the subsidiary to the charity (not just an accounting entry).
Consider the charity’s exposure to risk
The Charity Commission has expressed concern about the risks to charities from connections to non-charitable organisations. The Commission’s Guidance for charities with a connection to a non-charity can help the charity’s trustees make sure they effectively manage risk in this area. It includes a checklist for charities with trading subsidiaries.
Monitor performance and protect the charity’s interests
Although the company directors are legally responsible for the subsidiary, the charity’s trustees also need to keep its performance, activities and plans under review to protect the charity’s interests. Where the trustees are also directors of the trading company, you’ll need to manage the potential conflict of interest and make sure that the interests of the charity and the trading subsidiary are considered separately where appropriate.
Put written agreements in place
Putting written agreements in place can help to protect the charity’s interests and make sure it’s clear how things will work. Agreements may include:
- A deed of covenant – governing the distribution of profits from the trading subsidiary to the charity.
- A shared resource agreement – governing the shared use of staff, services and other resources.
- A loan agreement – confirming interest and loan repayment terms.
How we can help
If you’d like to talk about charity trading subsidiaries or any other points raised, please speak to your usual Saffery contact, or get in touch with Helen Wilkie.
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