Charitable organisations often establish trading subsidiaries to undertake commercial trading activities to raise money for their charitable work. Doing so protects the charity’s assets from the risks associated with such trading and offers potential tax efficiencies and freedoms.
This article will cover important considerations in setting-up and running a trading subsidiary. Plan carefully and think ahead!
Why set-up a trading subsidiary?
There are a number of reasons why a charity may choose to (or have to) use a trading subsidiary. They include:
- Commercial trading activities that are too large or too risky to be undertaken by the charity.
- Focusing management of particular activities into the distinct trading company (normally commercial activities, such as fundraising trading, but sometimes specific charitable activities, in which case a charitable subsidiary will be used, not a trading subsidiary).
- Management of tax and VAT aspects of trading, where a charity’s non-charitable trading ceases to qualify for exemption as a ‘small trade.’ Placing such activities within a trading subsidiary means they can be pursued without liability to Corporation Tax. Under certain conditions, a wholly owned trading subsidiary can donate its taxable profits under Gift Aid from its trading to its parent charity, thereby minimising any tax liability incurred.
Considerations
A trading subsidiary is only successful when it is generating funds for the charity, so it can further its purposes and support beneficiaries.
It’s worth noting that a subsidiary can undertake a diverse range of commercial trades, but think about how its activities will reflect upon your wider charity. Is this the right trade to pursue? Step back and consider your strategy carefully; and seek professional advice if needed.
When establishing/running your subsidiary, think about:
1. Commitment: Remember, a subsidiary will require a significant investment of time, energy and resources. Is establishing an entity like this viable in your current situation? How much adaptation would it require for this to become feasible?
2. Separation: Keep accounts separate between the parent charity and your subsidiary; funds transferred between the two must be recorded as transactions and be at arm’s length. Likewise, people that work for both the charity and subsidiary should have their costs attributed to each on a fair and reasonable basis. The use of any other equipment or assets must also be treated in this way. Charity property should be rented to the subsidiary in such a way that the charity is not disadvantaged. This will reduce the risk of charitable resources being used for non-charitable purposes.
3. Distraction: Don’t let your primary charitable activities get sidelined by diverting too much of your assets, staff and focus into non-charitable trades, no matter how well-intentioned these activities might be.
Governance
You will need to appoint a board of directors to your trading subsidiary. This should include at least one or two trustees and ideally an individual who is not a trustee, or not connected to the charity at all. This will give diversity in perspective, a broader range of commercial expertise, as well as reducing the chance of future conflicts of interest.
Directors should be primarily focused on generating profits from the subsidiary. However, they will also need to keep an eye on how it affects the parent charity and ensure there isn’t undesired crossover of activities, that might cause complications or conflict with the wider charitable purposes.
The board of directors should meet separately to the charity board, as their discussions will be different in tone and content. From this, the directors can report back to the parent charity with the important details. Communications between the two boards should be regular, with supporting documentation to confirm discussion points and actions.
Trustees should hold the directors accountable for their decisions, so they’re sure that the subsidiary is best serving their charity.
Financing the subsidiary
From a charity’s point of view, the investment in a subsidiary is just that, an investment. Consequently, it requires appropriate management and oversight.
If a charity cannot demonstrate its investment decisions were made in line with its key purposes and the needs of its beneficiaries, HMRC might deem these investments as non-charitable expenditure and therefore subject to tax.
Like any other business, a trading subsidiary needs some initial capital, to purchase assets, rent space, employ the team, etc.
You might fund your trading subsidiary by:
Loans: A loan from the parent charity can be secured against the assets of the subsidiary to minimise risk. Additionally, the charity should plan forward to when the subsidiary (once self-sufficient) can repay this loan, with a plan of how and when this will happen. Any loan should be subject to a written agreement and carry an interest rate and repayment date.
Equity investment: Whilst share capital might be the norm for businesses, it’s less preferable than loan finance for a parent charity, as it cultivates greater uncertainty. However, it is an option for consideration.
When things go wrong
In the not-so-distant past, many charity trading subsidiaries started to make losses due to the lockdown and economic downturn, driving them into a net liabilities position.
What action would your charity take if your subsidiary made a loss?
In planning ahead to mitigate these risks, you may consider it wise to retain some profits in the subsidiary, which would involve paying some tax on residual profits. This reserves buffer could protect the company (and the charity) from a one-off performance dip and ensure its working capital levels are adequate.
In any event, it’s important that the charity does not blindly ‘bail-out’ its subsidiary by transferring funds to it to keep it afloat or stop making management charges for use of the charity’s resources. This is not an appropriate use of charity funds and both the Charity Commission and HMRC will take a dim view of such actions.
Seek professional assistance
Burton Sweet has a longstanding commitment to charities and civil society organisations, offering practical, professional and passionate support. We want to assist you, so you can deliver effectively for the communities you serve and show the good you do.
We can help you set-up a trading subsidiary for success, whilst avoiding the pitfalls. Please contact us and we will be happy to assist…
