The Regulator for Charities in England and Wales

CC35 - Trustees, trading and tax

How charities may lawfully trade

Contents

D. Charities with trading subsidiaries

D1 What is a ’trading subsidiary‘, and when must a trading subsidiary be used?

The short answer L symbol

A ’trading subsidiary‘ is a company, owned and controlled by one or more charities, set up in order to trade. The purpose of a trading subsidiary is usually to generate income for its parent charity. Trading subsidiaries must be used for non-primary purpose trades involving significant risk.

In more detail

A trading subsidiary must be used in any case where there would be a significant risk to the assets of the charity, if it were to carry on non-primary purpose trading itself (see C8). The trading subsidiary must be set up in such a way as to protect the parent charity and its assets from the risks involved in the trading. The need to protect the charity's assets from any significant risk involved in non-primary purpose trading is paramount. The fact that the trading profits would have been exempt from tax if the trading had been carried on by the charity itself does not necessarily mean that it is appropriate for the charity to carry on the trading.

The profits from a trade which is carried on by a trading subsidiary do not qualify for charity tax exemption. They are liable to corporation tax in the usual way. But payments made by the trading subsidiary to the charity or charities which own it can reduce the level of profits which are taxable in the trading subsidiary. And tax exemption is available to the recipient charity in respect of the income which it receives from the trading subsidiary.

This explains why it may be beneficial for a charity to use a trading subsidiary even where there is no legal barrier to the charity carrying on the trading itself. Where the profits from trading carried on by a charity would be liable to corporation tax (or income tax in the case of charitable trusts), the use of a trading subsidiary to carry on the trading may enable the liability to tax in respect of the trading profits to be, in effect, reduced or eliminated.

The provision by a charity of advertising and other promotional services in return for business sponsorship is an example of trading which is unlikely to present significant risk to the assets of the charity, since the outgoings which a charity faces in the course of such trading are likely to be minimal. So there may be no charity law imperative to hive off this type of trading to a trading subsidiary but there may be a tax benefit from so doing, if the profits would not qualify for any charity exemption. This is because the charity would be liable to tax on the trading profits, if it were to carry on the trade itself, whereas if the trading were to be conducted by a trading subsidiary, the profits of the trading subsidiary could be transferred to the charity as a Gift Aid donation, and thus restrict or eliminate any tax liability.

If primary purpose trading is conducted through a trading subsidiary, much of the guidance in this Part does not apply: the funding of the trading subsidiary would be a charitable application of funds, rather than an investment of funds for profit.

A trading subsidiary should become financially viable as soon as possible. It is therefore important to have a business plan in place that clearly identifies the point at which trading is expected to be profitable and to assess progress against the business plan. Where financial viability is not anticipated within two years of operation, careful consideration should be given to the appropriateness of undertaking the planned trading activity.

D2 What are the benefits of using a trading subsidiary?

The short answer

The main benefits of using a trading subsidiary are to protect the parent charity's assets from the risks of trading; to create a separate administrative unit; and to reduce tax liabilities. However in those cases where the use of a trading subsidiary is not essential, trustees need to bear in mind that there may be drawbacks to the use of a trading subsidiary, and those drawbacks do, of course, have to be balanced against the benefits.

In more detail

A trading subsidiary must be used in any case where there would be a significant risk to the assets of the charity, if it were to carry on a trading activity itself. However trustees may use a trading subsidiary for other reasons, for example:

  • to protect the charity's assets from the risks of trading, even where the risks are not significant;
  • to protect the charity's assets from the risks of trading, even where the trading is primary purpose or ancillary;
  • to create a separate administrative unit for accounting and/or management purposes in order, for example, to facilitate the undertaking of contracts for public service delivery whilst protecting the assets of the charity; or
  • to reduce or eliminate the tax liabilities arising from trading activities.

However, for a charity to pass its trading activities to a trading subsidiary can have disadvantages. For example :

  • where the use of a trading subsidiary is primarily tax-driven, the tax benefits may be insufficient to justify the additional costs associated with establishing and operating a trading subsidiary; and
  • the use of a trading subsidiary may have disadvantages in that some benefits which charities enjoy may not be available, eg charity rate relief (see D14) and exemption from stamp duty land tax (see D21).

Further information

See also the Commission’s guidance booklet CC37 Charities and Public Service Delivery, page 44.

D3 Do trading subsidiaries pay tax like other companies?

The short answer L symbol

Yes. There are few legal distinctions between trading subsidiaries of charities and other companies. However it is possible for a trading subsidiary to pay some or all of its trading profits to its parent charity, so excluding those profits from the calculation of the trading company’s liability to corporation tax purposes, and thus reducing the level of that liability.

In more detail

A trading subsidiary is liable to corporation tax on its profits, in the same way as any other company. But the trading subsidiary can make payments to its parent charity as Gift Aid, and this may reduce or eliminate the subsidiary's corporation tax liability. See D4, below.

Trading is a business activity, and a trading subsidiary (or indeed a charity) which carries on a trade must be registered for VAT if the taxable turnover exceeds the statutory limit. Some of the parent charity's VAT privileges may be enjoyed by trading subsidiaries (see D13, below).

Further information

General advice on the use of trading subsidiaries can be found in the HMRC website guidance Trading and business activities within the ’Charities‘ section.
Information on the VAT threshold can be found in the current edition of VAT Notice 700/1. The VAT notices 701/1 (Charities) and 701/5 (Clubs and Associations) give further information. These are also available from in the ’Charities‘ section of the HMRC website.

D4 How can a trading subsidiary pay funds to its parent charity?

The short answer

Funds may be paid in the form of a share dividend, interest on, and repayments of, loan capital, or as Gift Aid. There are considerable tax benefits in making the payments in a way which has the effect of reducing the level of corporation tax liability in the trading subsidiary.

In more detail

Gift Aid is a common means for a trading subsidiary to pay funds to its parent charity. This is because:

  • Gift Aid payments reduce the trading subsidiary's taxable income by the amount of the payment. It is often possible, therefore, by making such payments, to eliminate the trading subsidiary's entire potential corporation tax liability (see also D5, below).
  • Gift Aid payments to the parent charity from a trading subsidiary are exempt from corporation tax (or income tax in the case of charitable trusts) if they are applied for charitable purposes only.

A trading subsidiary can make Gift Aid payments to its parent charity at any time from the start of the relevant accounting period until nine months from the end of that period. Deferring payments may assist cash flow in the trading subsidiary.

The timing of the Gift Aid payments is primarily a matter for the directors of the trading subsidiary. Trustees of the parent charity would not be expected to intervene unless they had reason to believe that the directors of the subsidiary were not giving proper consideration to the interests of the charity when taking the relevant decisions.

Funds are now rarely, if ever, paid to the parent charity by way of share dividend. Dividends, like Gift Aid payments, are exempt from tax in the hands of the parent charity, but they do not reduce the trading subsidiary’s taxable profits. So, this method of paying funds to the parent charity would leave a liability to corporation tax in the trading subsidiary.

Where a parent charity provides loan capital to a trading subsidiary, the trading subsidiary must, of course, make interest payments and repayments of principal in accordance with the terms of the loan agreement with the charity. For more information see D10 and D11, below. The costs of servicing a loan may be effectively offset when calculating what the taxable income of the trading subsidiary actually is, either directly as expenses of the trade, or through capital allowances.

D5 Can a trading subsidiary pay more to its parent charity in Gift Aid than the level of trading profits (in accounting terms) which it has earned?

The short answer

Yes. This issue will generally arise when the trading subsidiary's level of trading profits for tax purposes is greater than its level of profits for accounting purposes. Any tax liability will depend on the level of taxable profits. If that liability is to be eliminated entirely, the whole of the taxable profits will have to be paid to the charity, even if that is greater than the profits for accounting purposes. The balance will, in most cases, need to be financed out of share capital, since the trading subsidiary is otherwise likely to be insolvent.

In more detail

If a trading subsidiary earns, in an accounting period, taxable profits in excess of its profits for accounting purposes, it may pay to its parent charity a greater sum in Gift Aid than it has profits for accounting purposes, in order to eliminate its corporation tax liability. As a result, all or part of the Gift Aid payment may be made out of the company's subscribed share capital, including any share premium account.

Although there are differences of legal opinion on this issue, it is considered that such Gift Aid payments may be made out of the trading subsidiary's subscribed share capital, provided that the objects of the trading subsidiary authorise such gifts. The parent charity can, by subscribing additional share capital in the trading subsidiary, enable the subsidiary to do this, without making the subsidiary insolvent.

It is possible that the trading subsidiary may prefer to acquire the resources needed to make the full Gift Aid payment out of funds borrowed from the parent charity. However HMRC Charities take a critical view of any apparently circular arrangements. Parent charities and their trading subsidiaries contemplating such a course of action should take professional advice, and take into account the investment propriety and insolvency issues discussed in D8.

D6 How should trading subsidiaries be funded?

The short answer L symbol

Trading subsidiaries are usually funded by their parent charities, although outside finance may also be obtained. The finance may be provided as share capital and/or loan capital. Trading subsidiaries may also retain profits, subject to tax considerations.

In more detail

When a trading subsidiary is formed, its parent charity can freely make a nominal subscription of share capital in the trading subsidiary in order to comply with the requirements of company law concerning the formation of companies. However the trading subsidiary will usually require more than a nominal amount of capital in order to operate effectively.

Most companies fund their business through a mixture of share capital, loan capital, and retention of profits. However the tax system encourages a trading subsidiary to transfer its profits to its parent charity as Gift Aid. Consequently a trading subsidiary has an incentive not to meet its funding needs out of retained profits (see D7, below).

A trading subsidiary's need for funding will therefore, in most cases, be met mainly out of share capital and/or loan capital. This capital is normally, though not always, provided by the parent charity.

This provision has to be justifiable as an investment of the charity’s assets (see D8, below). Parent charities must not provide support to trading subsidiaries, on terms which involve a greater or lesser element of gift. For example:

  • a parent charity must not make donations to the trading subsidiary, in cash or in kind, whether by purchasing stock for the subsidiary, and donating that stock to the trading subsidiary, or otherwise;
  • a parent charity must not settle the debts of a trading subsidiary; and
  • a charity must, if allowing the use of its staff, buildings or equipment by a trading subsidiary, make fair charges for those uses (see D21 and D22).

D7 Can a trading subsidiary fund itself by the retention of profits?

The short answer

Yes, this is possible. However retained trading profits will be liable for corporation tax.

In more detail

As noted in D4 above, if all the trading subsidiary's taxable profits are paid to the parent charity as Gift Aid, the trading subsidiary 's liability to corporation tax is eliminated. However, the trading subsidiary's needs for finance then have to be met entirely out of capital.

Some parent charities prefer to accept the corporation tax consequences of the trading subsidiary retaining taxable profits. Indeed such retention may be required, where funding by way of loan has been obtained from commercial banks or other third parties, in order to service the loan. This approach:

  • enables the trading subsidiary to fund itself by a combination of capital and retained profits in a way which is closer to ordinary commercial practice; and
  • may also make it easier for the parent charity to justify investments in the trading subsidiary, especially where significant equity finance is required to fund ongoing trading activities. However, such retention of profits by a trading subsidiary can also prejudice VAT reliefs which would otherwise be available (see D13, below).

Further information

Professional advice should be taken in any case where trustees have doubts about the level of Gift Aid payment to the parent charity which is, overall, most beneficial to the charity.

D8 What are the legal obligations of trustees investing charity funds in a trading subsidiary?

The short answer L symbol

The parent charity's trustees must be able to justify financial support for a trading subsidiary as an appropriate investment of the charity's resources. In all cases the interests of the charity must be paramount. Any investment should be consistent with the charity’s overall investment policy.

In more detail

The same considerations apply to an investment by a parent charity in a trading subsidiary, as to any other investment of a charity's resources. Trustees must, whenever investing a charity's resources:

  • be certain that the investment is within the charity's investment powers;
  • exercise such care and skill in the investment process as is reasonable in the circumstances;
  • have regard to the suitability to the charity of investments of the same kind as the particular investment which it is proposed to make;
  • have regard to the suitability of the particular investment in question, as an investment of the kind which it seems appropriate to make;
  • have regard to the need for diversification of investments, as appropriate to the circumstances of the charity; and
  • ordinarily obtain and consider advice about the investment from a person reasonably believed by the trustees to be qualified to give it by his or her ability in and practical experience of financial and other matters; the advice needs to have regard to the suitability and diversification points mentioned above.

In the context of a proposed investment in a trading subsidiary which is used to carry on a non-primary purpose trade, this means that:

  • the trustees must reasonably consider that it is in the charity's interests to make the investment, after making a fair comparison of this form of investment with other forms of investment which might be selected;
  • this fair comparison must involve an objective assessment of the trading subsidiary 's business prospects;
  • the trustees must be satisfied as to the financial viability of the trading subsidiary, based on its business plan, cash flow forecasts, profit projections, risk analysis and other available information; and
  • the trustees must ordinarily take appropriate advice on the investment, and the financial viability of the trading subsidiary. What is ’appropriate‘ will depend on the circumstances: the cost of taking the advice is a relevant factor, and the cost should be commensurate to the size of the proposed investment.

Trustees should also:

  • pay attention to the length of time over which funds may be tied up in an investment in a trading subsidiary, since funds needed in the short to medium term may not be easily realised when invested in this way;
  • consider, and take suitable advice on, the possibility of obtaining independent funding as an alternative to funding by the charity. See D9, below.

Precisely how the investment in the trading subsidiary is structured is a decision for which the parent charity's trustees (with professional advice) are responsible, having regard to the trustee investment duties summarised above. Trustees must also consider periodically whether or not an existing investment should be retained or disposed of. When reviewing investments, duties similar to those outlined above apply.

Trustees must also take into account section 506(4) of, and schedule 20 to, the 1988 Act. These provisions can create a tax effect where loans to, or equity investments in, trading subsidiaries are inappropriate. This subject is summarised in D12, below.

Further information

More information about trustees’ investment duties can be obtained from the detailed guidance on charities and investment which is published on the Commission's website in the ’Guidance for Charities‘ section.

D9. Can a charity seek outside investment in a trading subsidiary?

The short answer

Yes. It is good practice for trustees of a parent charity to consider the desirability of obtaining investment from others in its trading subsidiary. This would spread the risks of the trade, and it may contribute positively to the charity’s liquidity. However it may be difficult to attract such investment at reasonable cost.

In more detail

Sharing the risk of trading failure with an independent financier may be a sensible option for a parent charity, provided that the cost is not excessive. An additional advantage of involving an independent financier is that such a person will provide an independent assessment of the economic viability of the trading subsidiary 's operation.

Careful thought needs to be given to the nature and terms of any outside investment. In order to minimise its corporation tax liabilities, the trading subsidiary will normally pay all its taxable profits to its parent charity as a Gift Aid donation (see D3, above). This would leave no remaining funds to distribute to shareholders as dividends.

Share capital investment in a charity's trading subsidiary will usually, therefore, be unattractive to outside financiers motivated by profit. However a share capital investment in a trading subsidiary could be marketed to supporters of the parent charity, who might not be looking for a commercial return.

In most cases, outside investment in a charity's trading subsidiary will be in the form of loan capital, since interest payments on loans and repayments of the principal will take place before any Gift Aid payments to the parent charity. Loan finance may be available from banks, and from other private lenders, including supporters of the charity.

Trustees should pay close attention to the terms on which loan capital is acquired since interest payments could significantly reduce the level of trading profit in the subsidiary. Even if the subsidiary’s trading operation is profitable before loan charges, it may not be so after them. Charities should consider the possibility of obtaining loan capital from their supporters, who may be prepared to provide finance on preferential terms.

When entering into a joint venture of this nature, it is important that the investment is in the charity's interests. As an aspect of considering the appropriateness of the joint venture, the trustees should consider whether any due diligence checks should be made regarding the financial status of the other partner(s), and should be satisfied that they share with their joint venture partner(s) similar views regarding the scale of investment required, the level of trading risk accepted, the mechanism for setting the direction of the trading activity and for reconciling for any disagreements between the partners.

When entering into a joint venture, whilst all parties will anticipate a successful outcome, it is also important to consider the 'exit strategy', should insuperable difficulties arise.

It is considered that one of the main underlying causes of joint venture failures is an irreconcilable difference in the understanding of the partners about the direction the joint venture is taking. Consequently it is recommended that all partners should consider and agree the objectives of the joint venture, should ensure that all of the necessary documentation is completed, and that a business plan has been agreed. Trustees are recommended to take further professional advice, where appropriate.

Trustees contemplating a joint venture of this nature need to bear in mind the following two tax points:

(1) Unless the joint-venture company is wholly-owned by one or more charities, any payments made to a charity as Gift Aid must actually be made during the financial year in which the payments are to offset the company’s taxable profits. The facility to make Gift Aid payments up to 9 months after the end of the relevant financial year (see D4) is only available to companies which are wholly-owned by one or more charities;

(2) Where the commercial partner receives a distribution of profit from the company, HMRC may challenge the use of Gift Aid to make a corresponding payment to the charitable partner.

D10 What considerations apply to a charity's investment of share capital in a trading subsidiary?

The short answer

In the event of business failure, shareholders are less likely to recoup their investment than investors of loan capital. However an investment of share capital by the parent charity will give confidence in the trading subsidiary to suppliers and others with whom it does business.

In more detail

A shareholder in a trading subsidiary is not, as such, a creditor of the company. Share capital can normally only be repaid in the event of the company’s dissolution, and then shareholders will only get a distribution in respect of their share capital if all the company's creditors have been repaid in full. As a shareholder, the parent charity has no absolute right to receive dividends or gifts from its trading subsidiary.

Normally, the attraction of a share capital (as compared with loan capital) investment is that it gives (or increases) a right to participate in the profits of the company in the form of dividends as and when declared. This justifies the greater investor risk when compared with loan capital. But that attraction clearly does not exist if the trading subsidiary is already wholly owned by the parent charity.

However, there are valid reasons why a parent charity might choose to capitalise a trading subsidiary by means of share capital rather than loan capital. For example:

  • the subscription by a parent charity of substantial share capital in its trading subsidiary can give confidence to suppliers, customers, creditors, prospective creditors and others with whom the trading subsidiary has a business relationship; or
  • where a trading subsidiary would be exposed to the risk or actuality of insolvency if it were to be capitalised by loan, trustees will have little choice but to invest share capital (subject to the considerations set out in D8, above).

The fact that share capital subscribed by the parent charity in a trading subsidiary might not be repaid in full, or even in part, on the dissolution of the subsidiary, is only one factor which the charity's investment adviser should consider when deciding whether to recommend the trustees of the parent charity to subscribe for share capital. The adviser would have to consider the overall economic return to the charity, balancing Gift Aid payments and any anticipated distributions against the risk of capital loss.

D11 What considerations apply to a charity's investment of loan capital in a trading subsidiary?

The short answer L symbol

As a provider of loan capital to its trading subsidiary, a parent charity has a contractual right to repayment of the principal. This gives the parent charity greater assurance of repayment, but can also give rise to the company's insolvency if it is unable to service its loans.

In more detail

A lender has a contractual right to the payment of interest on the loan, and to repayment of the principal at the end of the loan's term. The provision of loan capital therefore gives the investing charity greater security than the provision of share capital, which offers no such guarantees.

However the amount of any loan capital held by a company is taken into account when determining its solvency. A company must not trade whilst insolvent. Trustees should not, therefore, invest loan capital in a trading subsidiary, if it is reasonably foreseeable that the subsidiary may not be able to service the loan or repay it when the term expires. In such cases trustees should:

  • consider whether it is in the charity's interest to maintain the company at all, or whether it is best to dissolve it or to sell it as a going concern (based on the principles set out in D8, above) (see also D16);
  • provide the investment as share capital (see D10, above), if it is indeed in the charity's interest to provide additional finance.

The provision of loan capital can inadvertently create insolvency in a trading subsidiary even where it is trading profitably. This is because, in order to eliminate corporation tax liability, a trading subsidiary will often pay to its parent charity as Gift Aid all its profits which would otherwise be liable to corporation tax (see D4, above). As a result the trading subsidiary may retain insufficient resources for it to repay loans made by the charity as and when due. That would render the trading subsidiary insolvent, in that it would be incapable of paying its debts.

If a charity makes a loan to a trading subsidiary, trustees must decide on the terms as regards the interest rate and repayment of principal. They must also decide how the loan is to be secured. These decisions are part of the duties of trustees as set out in D8 above.

Trustees might wish to provide a trading subsidiary with an interest-free loan, or a loan which is secured only by the contractual undertaking of the subsidiary, and not by a charge over assets of the subsidiary. However HMRC Charities takes a critical view of loans which are not made on proper commercial terms (see D12, below). In particular:

  • it is unlikely that interest-free loans to a trading subsidiary could be justified as an investment, unless the amount of the loan was small; and
  • whilst the creation of a charge over property of the trading subsidiary to secure a loan involves expense, it is unlikely that a loan secured only by the contractual undertaking of the trading subsidiary could be justified as an investment, unless the amount of the loan is small, or the value of the security which is available in the subsidiary is limited.

D12 What other tax implications need to be considered when investing in a trading subsidiary?

The short answer

It is important to ensure that any investment by a parent charity in a trading subsidiary is not treated as ’non-charitable expenditure‘, as defined in section 506 of the 1988 Act. If it is so treated, then tax liabilities may arise.

In more detail

Any investment in a trading subsidiary, whether in the form of share capital or loan capital, will be treated as ’non-charitable expenditure‘within the meaning of section 506 of the 1988 Act if is not a qualifying investment or loan as defined in Schedule 20 to that Act. If treated as non-charitable expenditure, some of the charity's tax exemptions may be restricted.

To avoid treatment as non-charitable expenditure, the trustees must be able to satisfy HMRC Charities that the investment in the trading subsidiary was made purely for the benefit of the parent charity, and not for the avoidance of tax, by the charity or anyone else.

An investment would not be considered to be ’for the benefit of the parent charity‘, if, for example, the investment was speculative, or driven by a desire to keep the trading subsidiary going, regardless of the prospects of economic return to the parent charity.

A loan which purports to be an investment may also be regarded by HMRC Charities as “non-charitable expenditure” if :

  • the loan agreement does not include proper provision for repayment;
  • the loan is unsecured where the company has assets on which the loan might have been secured;
  • the loan agreement provides for a rate of return that does not reflect the level of risk; or
  • it was envisaged from the outset that the loan agreement would not be worked out, eg the loan would be written off by the parent charity.

It is important for trustees to keep a record of the deliberations which precede any decision to make an investment in a trading subsidiary, and to be able to demonstrate to HMRC Charities that the investment duties described briefly above have been properly discharged in relation to the making of that investment.

The ‘substantial donor’ provisions which were enacted in the Finance Act 2006 can also have the effect of treating a charity’s investment in a business as non charitable expenditure, where that business has made substantial donations to the charity. However, a trading subsidiary cannot be a ’substantial donor‘ in relation to its own parent charity, regardless of the size of the payments which it makes, or has made, to the parent charity.

Further information

Please refer to HMRC website guidance Trading and business activities.

D13 Does a trading subsidiary enjoy the VAT and corporation tax privileges accorded to its parent charity?

The short answer

A trading subsidiary enjoys some, but not all, of the VAT privileges of its parent charity, provided that certain conditions are met. There are no corresponding privileges as regards corporation tax.

In more detail

Provided that the trading subsidiary passes the trading profits derived from the relevant sales to the charity under a written agreement or other legal obligation, the following privileges of the parent charity also apply to a trading subsidiary:

  • the zero-rate of VAT on the sale or letting of donated goods (see C3)
  • the VAT exemption on sale of goods and services by a trading subsidiary in connection with fundraising events (see C13).

No corresponding corporation tax exemptions apply. However the trading subsidiary may reduce its corporation tax liability by making payments to the parent charity as Gift Aid (see D1 to 4).

D14 Do trading subsidiaries qualify for rate relief?

The short answer

Trading subsidiaries have no absolute right to rate relief in respect of the properties which they occupy. However the rating authority may grant rate relief at its discretion.

In more detail

Non-domestic premises occupied and used by a charity are entitled to 80% mandatory rate relief, known as ’charity rate relief‘. The remaining 20% may be waived at the discretion of the rating authority. In order to qualify for this relief, a property must be:

  • occupied by a charity, or the trustees of a charity; and
  • used wholly or mainly for charitable purposes.

In this context, the term ’charitable purposes‘ normally excludes fundraising activities, but includes the sale of donated goods.

This mandatory relief is not available in the case of premises occupied by a trading subsidiary. However rating authorities have discretion to grant rate relief to some bodies which are not charities.

Premises occupied partly by a charity and used for charitable purposes, and partly by a trading subsidiary, qualify for the mandatory charity rate relief only in respect of the part occupied by the charity.

Charity rate relief may be available if a charity is in occupation of premises even though the premises are used partly for fundraising, provided that they are used ’mainly‘ for ’charitable purposes‘. Even if the fundraising trade is being carried on by a trading subsidiary, the charity may be able to argue that it is occupying the whole of the premises, and using them ’mainly‘ for charitable purposes.

For example, where donated goods are being sold at the same shop as bought-in goods, the charity may sell the donated goods itself (bearing in mind that this is not ’trading‘ (see C3) and may sell the bought-in goods as agent for a trading subsidiary (see C10). The charity may then be able to claim charity rate relief in respect of the shop by satisfying the authority that the shop is occupied by the charity ’mainly‘ for the purpose of selling the donated goods.

There is no statutory definition of ’mainly‘. However it is often argued that, if in a particular period the value of the sales of the donated goods exceeds the value of the sales of the bought-in goods, the premises are used ’mainly‘ for the sale of the donated goods, and thus for charitable purposes. In such cases the trustees should contact the appropriate rating authority, and if necessary their own legal advisers, for further advice.

D15 Can charity trustees and employees also work for a trading subsidiary?

The short answer

It is normal for some of the trustees and/or employees of a parent charity also to be directors of a trading subsidiary. However the usual restrictions on paying charity trustees for any work they do for the charity apply also to any work they do for the trading subsidiary.

In more detail

In order to ensure that the trading subsidiary is managed in the interests of the parent charity, and to monitor its performance, some of the trustees and/or employees of the charity often become directors of the trading subsidiary. However, they must bear in mind that the charity and the trading subsidiary are different entities. Anyone involved with the administration of both has two distinct responsibilities, and it can at times be difficult to balance conflicting pressures.

A charity trustee cannot be paid for his or her services as a director or employee of the charity's trading subsidiary unless either:

  • the governing document of the charity specifically provides for this; or
  • there is some other specific authority, such as an order from the Charity Commission.

The establishment of a trading subsidiary, where the directors of that subsidiary are the same people as the trustees of the parent charity, cannot be used as a means of paying the charity's trustees ’by the back door’.

As a matter of good governance, there should be both:

  • at least one person who is a trustee, but not a director or employee of the trading subsidiary; and
  • at least one person who is a director of the trading subsidiary, but not a trustee or employee of the charity.

These people are described as ’unconflicted‘ as they have no conflict of interest in their roles. These unconflicted trustees and directors should advise their colleagues as to the proper course of action where the duties of those with dual responsibilities are in conflict. This reduces the risk of any transaction between the parent charity and the trading subsidiary being challenged or questioned.

If trustees have delegated responsibility for monitoring the operation of the trading subsidiary to a committee made up entirely of people who are directors or employees of the subsidiary, they should ensure that systems are in place for ensuring that advice is obtained from an unconflicted trustee wherever appropriate.

D16 What should trustees do if the trading subsidiary is in financial difficulty?

The short answer L symbol

Trustees must always put the interests of the parent charity first. This will sometimes mean liquidating, or selling, a failing trading subsidiary. If trustees keep a failing trading subsidiary going at the charity's expense, they may be personally liable for consequential losses to the charity.

In more detail

If the trading subsidiary has been running at a loss for a significant time, without any special short-term factors in play, trustees must consider the trading subsidiary's viability. Trustees must minimise any losses to the charity, regardless of any sense of moral obligation the trustees may feel towards the trading subsidiary, its directors and employees.

If the trustees sink further funds into supporting an ailing trading subsidiary at a time when it was reasonably clear that the failure of the subsidiary was likely, this could constitute a breach of trust on their part, putting them at personal risk to make good any losses to the charity. Trustees facing these circumstances should take advice from their professional advisers.

If a trading subsidiary defaults on a loan agreement with the charity, the trustees must consider enforcing the charity's rights under the agreement. In deciding on their precise course of action, trustees must exercise their commercial judgement, based on appropriate professional advice. Their decision needs to be based on the best interests of the charity which owns the trading subsidiary.

Trustees have similar responsibilities where the charity has invested share capital in the trading subsidiary, even though share capital is not liable to repayment. The ultimate response for the parent charity - in its role as shareholder - to the trading subsidiary's trading failure is either to procure the subsidiary's termination or to sell the business as a going concern to a third party.

Trustees might fear that allowing a trading subsidiary to go into insolvent liquidation would adversely affect the charity's reputation. This might seem to justify making a further investment, and/or retaining existing investments in the subsidiary, to prevent or reduce losses to the subsidiary's creditors.

However the main point of carrying on a trade through the trading subsidiary is to protect the charity's assets from the risks of the trade (see D1). To use those assets to protect the subsidiary's creditors is the very outcome which charity law restrictions on trading by a charity itself are designed to prevent. If trustees act to keep the trading subsidiary in business, regardless of the interests of the charity, they may be personally liable for any consequential loss in the value of the charity's investment in the trading subsidiary.

D17 What duties do charity trustees have in regard to trading subsidiaries?

The short answer L symbol

Trustees must routinely monitor the performance of all trading subsidiaries, and of the parent charity's investments in them, with a view to ensuring the good and proper use of the charity's assets. They must be prepared to assert the rights of the parent charity as shareholder.

In more detail

Trustees must review regularly the relationship between the parent charity and the trading subsidiary. The purpose of establishing a trading subsidiary is normally to raise funds for the charity, and its effectiveness in doing this should be monitored. Investment review must not await a specific trigger, such as the discovery that a trading subsidiary is in financial difficulty.

The parent charity's trustees must also exercise the charity's rights as shareholder in the trading subsidiary so as to promote the charity's interests. The directors of the trading subsidiary are responsible for its management, but other major decisions are for the trustees, as representatives of the parent charity. For example, trustees are responsible for:

  • the appointment/removal of the directors of the trading subsidiary;
  • the directors' terms of service, including any remuneration; and
  • the continuation, or dissolution, of the trading subsidiary.

D18 Can a trading subsidiary be owned by more than one charity?

The short answer

Yes. This type of organisational structure used to be discouraged by a prohibition on the making of Gift Aid payments by a trading subsidiary with more than one charitable owner to those owners. But this prohibition no longer exists.

In more detail

A trading subsidiary may be wholly owned by one charity, or it may be owned jointly by a number of charities. Clearly, in the second case, the participating charities need to agree on the division of the trading profits of the subsidiary.

The comments about joint ventures which are made in the last two paragraphs of D9 apply equally to joint ventures with other charities.

D19 Can a charity guarantee the liabilities of a trading subsidiary?

The short answer

Such guarantees, if given, will often be unenforceable against the charity and may expose trustees to personal liability.

In more detail

A parent charity or its trustees may be invited to guarantee liabilities of a trading subsidiary. For example, the trading subsidiary's bank may be reluctant to provide overdraft facilities to the trading subsidiary unless the parent charity (or its trustees) guarantees the trading subsidiary 's obligation to repay.

If such a guarantee is given by trustees of a parent charity, and liability under the guarantee is enforced by a creditor of the trading subsidiary, trustees are unlikely to be entitled to an indemnity from the charity, and will have to settle the liability personally, where:

  • the liability arises out of a failure of a trade carried on by a trading subsidiary; and
  • the parent charity could not itself properly have carried on that trade.

The effect of allowing the guarantee to be enforced at the expense of the charity would simply be to frustrate the purpose of the charity law restriction on the carrying on of the trade by the charity itself.

If such a guarantee is given by an incorporated parent charity, it may not be valid at all. The validity of such a guarantee will depend on:

  • the provisions of the charity's constitution, and
  • the provisions of section 65 of the 1993 Act (this section applies to charitable companies, but similar provisions apply to charitable industrial and provident societies). This provision will be replaced by a similar provision in the Companies Act 2006 (section 42).

If liability under the guarantee is enforceable, and is enforced by the creditors of the trading subsidiary, the trustees may be personally liable to make good the corporate charity’s liability under the guarantee, where:

  • the liability arises out of a failure of a trade carried on by a trading subsidiary; and
  • the parent charity could not itself properly have carried on that trade.

In addition, payments made by a parent charity under a guarantee of the liabilities of a trading subsidiary may be considered to be non-charitable expenditure, creating a potential adverse tax effect for the charity.

The registration of a ’VAT group‘ comprising a charity and its trading subsidiary or subsidiaries means that each entity within the group guarantees the settlement of the VAT liabilities of the other entities within the group. There is no objection in principle to the registration of a charity as part of a VAT group. But before doing so, trustees need to satisfy themselves that the overall benefits of group registration outweigh the risk of loss to the charity's assets, if those assets have to be used to settle a VAT liability of a trading subsidiary.

In general, trustees must aim to ensure that all arrangements are demonstrably on commercial terms and for the benefit of the charity, and do not give rise to the difficulties mentioned above.

Further information

Guaranteeing the liabilities of trading subsidiaries can be a complex area, and trustees should seek professional advice before reaching decisions.

D20 Can a parent charity and its trading subsidiary consolidate their bank accounts?

The short answer L symbol

Yes, there is no objection in principle to the consolidation of bank accounts in order to obtain better terms of business from the bank. However the financial structures of the parent charity and the trading subsidiary must be kept separate.

In more detail

The bank accounts of a charity and its trading subsidiary or subsidiaries may be consolidated so long as:

  • a proper record is kept of the state of the balances on the individual accounts which have been consolidated;
  • the benefits and burdens of the consolidated account are fairly apportioned between the parent charity and the trading subsidiary or subsidiaries, having regard to the state of the individual accounts; and
  • the consolidation does not result in the charity incurring non-charitable expenditure, creating in turn a potential tax effect, or otherwise suffering a tax disadvantage.

Further information

Pooling arrangements can be a complex area, and professional advice is recommended, with the aim of ensuring that all arrangements are demonstrably on commercial terms and for the benefit of the charity.

D21 Can a trading subsidiary use its parent charity's land and buildings?

The short answer L symbol

Yes. However such use must be on a proper contractual basis and on proper commercial terms.

In more detail

Any use of the parent charity's land and buildings by a trading subsidiary should be covered by a formal lease or licence of the property concerned from the charity to the subsidiary. The trading subsidiary must pay a rent or fee which is comparable to that which would be payable for letting the property on the open market.

The granting of a lease will, and the granting of a licence may, constitute a disposition of the charity's land. Any such disposition will need to be authorised by the Commission because the trading subsidiary is a ’connected person‘ in relation to the charity. If a charity purchases land for use by a trading subsidiary, this must be justifiable as an investment of the charity's resources in terms of the commercial return received.

Charities enjoy an exemption from stamp duty land tax on their purchases of land (which includes buildings). However the relief does not apply to purchases by trading subsidiaries. The exemption will be lost if the purchase of the land and buildings cannot be justified as an investment of the charity's resources; or is made in order to avoid tax by the trading subsidiary.

Further information

See the Commission guidance Disposing of Charity Land (CC28).

D22 Can a charity invest indirectly in a trading subsidiary?

The short answer L symbol

Yes. Indirect investment such as allowing the use of staff time and office equipment is an important means of support to a trading subsidiary. However the charity must charge the subsidiary, at fair value, for such services and use of facilities.

In more detail

Indirect investment in a trading subsidiary can be as important to the trading subsidiary 's viability as capital formally provided by the charity. Allowing the trading subsidiary the use of the charity's land and buildings has already been mentioned (see D21). Indirect investment may also take the form of the parent charity allowing the trading subsidiary to use the charity's staff and equipment.

However the indirect investment must not involve any element of subsidy of the trading subsidiary, as that would prevent the objective evaluation of the subsidiary's performance as an investment. Arrangements which involve a subsidy by the charity to the trading subsidiary can also have an adverse tax effect as, in general, such subsidies are unlikely to be ’charitable expenditure‘ under the 1988 Act.

The parent charity should therefore charge for any services and facilities which it provides to the trading subsidiary. Accordingly:

  • Where staff employed by the charity do some work for the trading subsidiary, or where the trading subsidiary uses facilities owned by the charity, appropriate charges must be made by the charity.
  • Such charges must be paid within a reasonable period of time. Unpaid charges can become a significant form of long-term financing, and amount to a form of subsidy of the trading subsidiary by the charity.
  • Such charges should not normally go beyond the reimbursement of the charity's costs; if they do, they will be considered to be a receipt of trading carried on by the charity, the profits of which may not qualify for exemption from tax.

Cost-sharing arrangements could be subject to challenge by HMRC Charities, if the costs are not calculated in an acceptable way or shared appropriately.

Such arrangements should be used only where staff and facilities are shared between the parent charity and the trading subsidiary. Where staff are employed exclusively on the trading subsidiary's business, the trading subsidiary should employ the staff. Where equipment is used exclusively by the trading subsidiary, the trading subsidiary should own the equipment.

Sharing arrangements between the parent charity and the trading subsidiary need to be carefully considered, with a view to ensuring that they do not damage the charity's ability to carry out its objects. Trustees wishing to enter into such arrangements should seek advice from their own professional advisers and contact the Commission at an early stage.

Some very large charity groups may also need to consider the implications of transfer pricing legislation. Where applicable, this requires ’arms-length‘ pricing of transactions within the charity group for tax purposes, regardless of the terms of the actual agreement between the parent charity and the trading subsidiary. The substitution of an arms length price for the actual price (for tax purposes) may increase the receipts of a trade, increasing the profits of the trade, and so give rise to a tax liability. It should be noted that HMRC Charities do not normally expect charities to commission expensive transfer pricing reports, but that charities should be in a position to demonstrate that arrangements are on commercial (arm’s length) terms.

Further information

HMRC guidance on transfer pricing legislation is to be found in manuals published on their website – INTM 432090. Professional advice should be taken if this guidance causes concern. HMRC Charities will also answer specific queries about legislation and practice, but cannot advise on tax-related planning.

D23 How may trading subsidiaries be named?

The short answer

The names of trading subsidiaries ought to be distinct from those of their parent charities to avoid confusion of identity. Company law also contains other restrictions on the choice of names.

In more detail

The key principle when naming a trading subsidiary is that the separate identities of the parent charity and the trading subsidiary are made clear to all concerned. The names of the parent charity and the trading subsidiary ought therefore to be different to prevent any confusion between the two organisations.

However the parent charity's name can be included in the name of the trading subsidiary, so long as this does not give the false impression to those dealing with the subsidiary that they are dealing with the charity itself. For example it would be acceptable to name a trading subsidiary as ‘[charity name] Sales Company Ltd’.

Company law restricts the use of the words ’charity‘ and ’charitable‘ in the name of any company – the approval of the registrar of companies is required to such use. These words should normally be avoided in the name of a trading subsidiary except where they form part of the name of the charity itself, and that name is being integrated into the name of the trading subsidiary.

Acknowledgements

The Charity Commission is grateful to HM Revenue and Customs and to the individuals, charities and other organisations who helped to develop and review this guidance. The Commission also gratefully acknowledges the work of James Tickell and Oliver Tickell for their help in drafting this version.