Contents
What is this publication about?
Meaning of expressions
Introduction
What constitutes trading?
Trading by charities
What types of trading can a charity normally undertake?
What is an ancillary trade?
Charities' lotteries
Is the conduct of a lottery trading?
Is the sale of donated assets trading?
Is the conduct of private research trading?
Commercial sponsorship of charities
Occasional trading
Mixed trades
What is a mixed trade?
Shops selling both donated and bought-in goods
Establishing a subsidiary trading company
Problems that can arise when separation is considered
Rate relief
Value Added Tax
Additional cost of operating a subsidiary trading company
Trustees as directors of a subsidiary trading company
Funding by the charity
Powers of investment
What form should the investment take?
Secured loans
Unsecured and interest free loans
Are there any tax implications for investing in a subsidiary trading company?
Continuing funding by charities
Advice for whole profit-shedding
Advice for profit retention
Non-financial support
Use of the charity's land by the subsidiary trading company
Shared use of staff and/or equipment
Points to consider when establishing and funding a subsidiary trading company
Commercial funding
Problems with commercial funding
The tax treatment of trading profits
Reviewing the relationship between the charity and the subsidiary trading company
What is this publication about?
1. This publication explains when charities may engage in trading activities for fund-raising purposes, and when a separate subsidiary trading company should be established to carry out those activities. It does not address issues arising out of fund-raising by means other than trading. Information on this can be found in our publication Charities and Fund-raising (CC20).
2. This publication also contains some basic information on the implications of income and corporation tax on trading revenues. Detailed information on the taxation of trading by charities can be obtained from the Inland Revenue. They have produced a comprehensive booklet entitled Trading by Charities: Guidelines on the Tax Treatment of Trades Carried out by Charities (CS2). Throughout this publication we have referred to this booklet and trustees are advised to obtain a copy (it is available from the address given at Annex A).
Return to Contents
3. In this publication:
Governing document means any document which sets out the charity's purposes and, usually, how it is to be administered. It may be a Royal Charter, trust deed, constitution, memorandum and articles of association, will, conveyance or Scheme of the Commissioners.
Trustees means charity trustees. Charity trustees are the people who are responsible for the general control and management of the administration of the charity. In the charity's governing document they may be called trustees, managing trustees, committee members, governors, or directors, or they may be referred to by some other title.
The 1976 Act means the Lotteries and Amusements Act 1976, as amended by the National Lottery etc Act 1993.
Subsidiary trading company means any non-charitable trading company owned by one or more charities to carry out trading activities on behalf of the charity(ies) with a view to raising funds in a tax efficient manner.
Primary purpose trade means a trade that is exercised in the course of the actual carrying out of a primary purpose of the charity, or a trade in which the work in connection with the trade is mainly carried out by beneficiaries of the charity.
Return to Contents
4. To be effective, charities need to have a regular source of income and trustees may wish to increase their charity's revenues through trading activities. Charity law does not permit charities to exercise a trade on a substantial, or regular basis simply for the purpose of raising funds. This is because of the general expectation that contributions made to a charity will be applied for its purposes or invested prudently, rather than being risked in trading activities which are undertaken simply to raise money.
5. Trustees have a duty to ensure that their charity's resources are used in effectively fulfilling their objects. If they do not do this there may be a breach of trust. One way in which trustees may be in breach of trust is by incurring unnecessary tax liabilities. If a charity exercises a trade simply for the purpose of raising funds, it may not only be in breach of charity law, but may also incur tax liabilities on trading surpluses.
6. Charity law does, of course, allow charities to exercise a trade in the course of the actual carrying out of a primary purpose of the charity. The following examples will generally be regarded as trading in this manner:
7. Charities which wish to trade on a substantial or regular basis for the main purpose of raising funds, may separate out, or "hive off", those trading activities to a subsidiary non-charitable trading company (see paragraph 39 below). This protects the property of the charity from the risks and liabilities of the trade. Under tax law there may also be advantages for the charity in hiving off any trade which is not exercised in the course of the actual carrying out of a primary purpose of the charity. The profits of a non-primary purpose trade which is exercised directly by a charity will often be taxable. For details please refer to the Inland Revenue booklet CS2.
8. Charity law, however, requires trustees to follow low-risk investment policies and they will need to bear this in mind when considering whether to invest any funds belonging to the charity in the subsidiary trading company. This is considered in more detail in paragraphs 52 to 68.
9. In this publication we have used the words should or must to refer to actions that trustees, or their agents or employees, are obliged to take by law. Where however the words recommend or advise have been used we are suggesting to the trustees actions which we consider to be good practice but which are not a legal requirement.
Return to Contents
What constitutes trading?
10. What constitutes a "trade" for tax purposes is primarily a matter for the Inland Revenue, but the fact that all profits or surpluses are to be used for charitable purposes is irrelevant.
11. Income from the following activities will, generally, not be regarded as trading income (please refer to the Inland Revenue booklet CS2 for more information):
12. It will usually be necessary for trustees to obtain the advice of their own qualified surveyor regarding a proper rent for the property (see our publication Disposing of Charity Land (CC28)).
Return to Contents
Trading by charities.
What types of trading can a charity normally undertake?
13. A charity may carry out a primary purpose trade. For example, if it is within the trustees' powers to do so, it is quite proper for fees (even if set with a view to generating a reasonable profit) to be charged for:
14. Section 505(1)(e) of the Income and Corporation Taxes Act 1988 exempts the profits of a primary purpose trade from tax, provided that the profits are applied solely to the purposes of the charity. The Inland Revenue can advise trustees about the tax implications of primary purpose trading, but in case of any doubt or difficulty trustees may need to consult their own legal and accountancy advisers as well.
15. A charity may also exercise a trade which is ancillary to the carrying out of a primary purpose of the charity (and is, therefore, treated as a primary purpose trade for both charity law and tax purposes).
Return to Contents
16. An ancillary trade is one which is not directly in furtherance of a primary purpose but is exercised in the course of the actual carrying out of a primary purpose of the charity. The raising of funds will not, in itself, be regarded as a trade ancillary to a primary purpose. Ancillary trades include in some cases the sale of refreshments - for example, the sale of food and drink in a restaurant or bar by a theatre charity to members of an audience.
17. Our publication Providing Alcohol on Charity Premises (CC27) gives further advice on the issue of the sale of alcohol from charity premises.
18. The question whether a trade is ancillary is not determined by reference to the level of turnover.
Return to Contents
19. A charity lottery will be either:
20. A small lottery must be genuinely incidental to what are called in the 1976 Act "exempt entertainments" (fetes, bazaars, sales of work, etc) where the total value of the prizes does not exceed £250 and the proceeds of the lottery and the exempt entertainment (after deduction of expenses) are devoted to purposes other than private gain. No cash prizes may be given, and the sale and issue of tickets and the announcement of results must be carried out during the entertainment and on the premises where it is held.
21. The general public can be invited to participate in a society's lottery. A society's lottery can only be conducted by a body registered with the Gaming Board, or with a local authority, depending on the size of the lottery business. Charities and their trading subsidiaries are amongst the bodies which can seek registration. The address of the Gaming Board is given in Annex A.
22. Further information about lotteries can be found in our publications Charities and Fund Raising (CC20) and Charities and Local Authorities (CC29).
Return to Contents
Is the conduct of a lottery trading?
23. Yes. The tax treatment of lotteries is dealt with more fully in the Inland Revenue booklet CS2. Briefly, however, section 505(1)(f) of the !income and Corporation Taxes Act 1988 exempts the profits of a lottery from taxation, provided that:
24. The exemption contained in section 505(1)(f) applies to chargeable periods beginning after 31 March 1995 for companies, and 5 April 1995 for all others. The conduct of a lawful lottery will not be regarded as contrary to the charity law restriction on direct trading for fund-raising purposes
25. It should be noted that, where a subsidiary trading company (rather than the charity itself) has been registered as the "society" under the 1976 Act and conducts the lottery as the "society", the subsidiary company remains taxable on its profits in the usual way. In order to obtain relief, the subsidiary trading company will have to continue to transfer its profits to the charity by covenant, Gift Aid or dividend. This is considered in more detail in the Inland Revenue booklet CS2.
Is the sale of donated assets trading?
26. Generally, no. A charity may sell assets (the term includes goods, land, buildings and investments) which have been given to it specifically for the purpose of raising funds. This is not regarded as the exercise of a trade, and accordingly, there is no need for it to be carried out by a subsidiary trading company. The sale of donated goods is within the scope of VAT, but is zero-rated, if the goods are exported, sold through charity shops, or sold through charity auctions or similar events. In some circumstances the sale of donated goods by a subsidiary trading company would also he zero-rated (see paragraph 64). If land, or buildings, are to be sold the provisions of section 36 of the Charities Act 1993 will apply. Our publication Disposing of Charity Land (CC28) gives more information about this.
27. If the donated assets are substantially altered or improved prior to sale (eg by turning donated raw materials into finished, saleable goods) then the proceeds of that sale may be treated as trading income. Simply sorting and cleaning items, or giving them minor repairs does not have the effect of making the proceeds of their sale trading income. The situation where donated goods are sold alongside ordinary trading stock is described in paragraph 37 below.
Return to Contents
Is the conduct of private research trading?
28. Where a charity, by agreement with a non-charitable body, undertakes private research (an example of this is research commissioned by a commercial organisation where there is to be no, or limited, publication of the results), the research can only properly be undertaken for the purpose of producing income for the charity. The conduct of private research may, or may not, amount to the exercise of a trade. Often private research is undertaken with the expectation that it will only be making some contribution to the fixed costs of running a charity. If, in accordance with ordinary accounting principles, there is no actual profit, the activity is not likely to be regarded as trading and charity law would not require it to be hived off to a separate body. The above guidance relates to the charity law position; the tax treatment of income from this type of activity is complex and appropriate professional advice needs to be taken.
Return to Contents
Commercial sponsorship of charities
29. Commercial sponsorship of a charity often involves the public linking of the charity's name or logo with that of the sponsor. This can be fraught with difficulties in terms of assessing the value to both parties and the effect it may have on public perceptions of charitable fund-raising generally. Again, the tax treatment of payments received by a charity from this source is complex. Where trustees are considering entering into such an arrangement we strongly recommend that the Inland Revenue booklet CS2 is studied and, if necessary, further advice is sought from them, and their own lawyers or accountants.
30. Sponsorship agreements can give rise to a number of legal issues, notably the question whether the agreement should be between the sponsor and the charity, or between the sponsor and the charity's trading subsidiary. The implications of Part II of the Charities Act 1992 also need to be considered. Trustees should consider carefully whether they should take legal advice before entering into such agreements They may also want to consider carefully any ethical questions arising from the operation of such an agreement.
Return to Contents
31. The surplus of some forms of occasional charitable fund-raising events such as dinner dances, carnivals, firework displays and jumble sales are, by extra-statutory concession (the text of which is set out at Annex B) regarded as non-taxable. Small-scale trading of this nature will not be regarded as contrary to charity law. Accordingly, there is no need for this type of trading - which may also include car boot sales and discos - to be carried out by a trading subsidiary.
32. The operation of the concession means that tax will not be payable on the profits generated by admission charges, or from ancillary activities such as the sale of programmes. More detailed advice on this subject can be found in the Inland Revenue's booklet CS2.
Return to Contents
Mixed Trades. What is a mixed trade?
33 A mixed trade is one which is partly a primary purpose trade and partly not. For example, a shop run by a charitable art gallery or museum may sell a range of goods some of which are, and some of which are not, related to a primary purpose.
34. Must mixed trades be conducted by a subsidiary trading company? Not always. Much depends on the ratio of the turnover of both parts of the trading activity. The Inland Revenue should be consulted at an early stage on the tax implications of undertaking a mixed trade. However, the Inland Revenue will accept that all of the profits of the trade will be within the primary purpose exemption from tax if the non-primary purpose part:
35. Where the scale of the non-primary purpose trade is not so large as to cause the profits of the whole trade to be taxable, it will not be regarded as being contrary to charity law.
36. Where the non-primary purpose part does not meet these criteria, the whole of the profits of a mixed trade may be subject to tax (see paragraph 34 above). In these circumstances, we normally recommend that the trade should be separated into two parts, and that the non-primary purpose part should be conducted by a subsidiary trading company. More detailed information on mixed trades can he found in the Inland Revenue's booklet CS2.
Return to Contents
Shops selling both donated and bought-in goods
37. This is not the same as mixed trading. The sale of donated goods is not considered to be trading at all. The sale of ordinary trading stock should normally be undertaken by a subsidiary trading company - see paragraph 7. Where donated goods are sold together with ordinary trading stock from the same shop, (which, in order to facilitate claims for rating relief, has to he 'occupied' by the charity - see paragraphs 44 to 45 below) the trading activity may, in certain circumstances, be undertaken by the charity as agent for a subsidiary trading company. This means that the subsidiary "employs" the charity or its trustees to sell the trading stock to customers; the subsidiary trading company owns the stock and all profits on its sale accrue to it. Such arrangements will satisfy the charity law requirements which inhibit charities trading directly for fund-raising purposes, as the profits and liabilities of the trade are legally those of the principal (ie the subsidiary company) not the agent (ie the charity). For tax purposes the profits of the trade will be treated as belonging to the subsidiary company and not to the charity. As a matter of charity law the charity should make a charge for the services and facilities which it provides to the subsidiary company as its agent. But if this charge goes beyond the reimbursement of the charity's costs, any surplus may be taxable. Apart from tax questions, the legal relationship between principal and agent needs to be carefully considered and trustees wishing to enter into such an arrangement should seek advice from their own lawyers about all aspects of the arrangement. We recommend that they should also contact us and the Inland Revenue at an early stage.
38. Where such an arrangement is being proposed, we advise that trustees ask themselves whether it is in the best interests of the charity. For example, trustees may need to consider whether:
Return to Contents
Establishing a subsidiary trading company
39. Where a charity wishes to benefit substantially from permanent trading for the purpose of fund-raising, consideration should be given to the establishment of a separate non-charitable trading company. In this way, the risk of committing a breach of trust is avoided, and the profits of the trade may be passed to the charity in a tax-efficient way (by deed of covenant, or dividend, or under the Gift Aid scheme; please refer to the Inland Revenue's booklet CS2 for more information). Such a trading company may be wholly owned by one charity, or may be owned jointly by a number of charities. Where the latter is the case, consideration should be given as to how the profits of the company are to be divided between the participating charities.
40. Three questions which the trustees (with advice from their own lawyers, accountants and stockbrokers as necessary) will need to address are:
There is also a tax point to be considered - please see paragraph 58 below.
41. The share capital of such companies is usually small, perhaps £100, and we will, usually, not object to a nominal subscription of capital being provided by the charity. However, where substantial capital investment is required such an investment must be:
42. As a subsidiary trading company is formed as a method of raising funds for the charity, funds should flow in one-direction only: from the subsidiary trading company to the charity. We recommend that a fixed period should be specified for the payment of any funds owing to the charity by the company (perhaps 30 days from the date when payment falls due).
Return to Contents
Problems that can arise when separation is considered
43. The establishment of a subsidiary trading company may solve some of the problems facing a charity which either wishes to, or already undertakes, trading activities. However, there are some less positive factors which the trustees might wish to consider before deciding whether the establishment of a subsidiary trading company is the best way forward. Some of these factors are outlined below.
Return to Contents
44. Non-domestic premises used by a charity for its purposes are entitled to 80 per cent mandatory rate and Council tax relief. The remaining 20 per cent may be waived at the discretion of the rating authority. In order to qualify for relief a property must be occupied by a charity or, the trustees of a charity, and be occupied wholly or mainly for charitable purposes. 'Charitable purposes' normally exclude fund-raising but include the sale of donated goods. Premises used partly by a charity for its purposes and partly by a non-charitable subsidiary trading company, will qualify for relief only in respect of the part actually occupied by the charity.
45. Where the charity is acting as agent for the trading company (see paragraph 37 above) the charity may claim that it is in occupation of the whole of the shop premises used for the sale of both donated and bought-in goods. In such a case, the charity would be occupying the shop partly for its (charitable) purposes and partly for another purpose (which would not by itself qualify for relief). This does not mean, however, that the relief is necessarily lost because it may be possible to satisfy the authority that the shop is occupied "mainly" for charitable purposes. In such cases the trustees should contact the appropriate rating authority and if necessary their own legal advisers for further advice.
Return to Contents
46. Charities should consider with their local Customs and Excise Office and if necessary with their own lawyers and accountants, the VAT implications of adopting particular organisational structures and methods of operation.
47. In general, however, charities receive no special treatment in respect of VAT on their business activities, and registration is required if their taxable turnover exceeds the statutory limit (at the time of printing £51,000). The VAT leaflets 701/1/95 ("Charities") and 701/5/90 ("Clubs and Associations") give further information and may be obtained from the local office of HM Customs & Excise. For the address, see the local telephone directory.
Return to Contents
Additional cost of operating a subsidiary trading company
48. Trustees will need to weigh up whether they ought to hive off very small trading operations to a subsidiary trading company (thus incurring some administrative expense) or whether they ought to contain the activity within the charity (thus possibly incurring a tax liability on any profits).
49. If the trading activity is to be contained within the charity, the trustees need to ensure that they are not acting in breach of the charity's trusts by direct trading simply for fund-raising purposes. If the trading is on a small enough scale for it to be more worthwhile to incur a tax liability on any surplus (rather than bear the costs of hiving off the activity to a separate non-charitable body), the trustees would not ordinarily be open to criticism that they are breaching the charity law restrictions on trading. The trustees should, however, seek their own legal and accountancy advice on the tax implications of retaining the trading activity within the charity.
Return to Contents
Trustees as directors of a subsidiary trading company
50. People who are trustees of a charity often become directors of a subsidiary trading company owned by that charity. We accept that there may be some need for the trustees to be represented on the board of the subsidiary trading company. It should be noted, however, that there are difficulties if all the trustees become directors of the trading company, and there are no independent directors. Anybody who is both trustee, and a director of a subsidiary trading company, will have a conflict of interests and duties in some circumstances. It may be difficult for such a person to be able to isolate their distinct responsibilities to the charity and to the trading company respectively. Transactions involving both the charity and its subsidiary may be invalidated if the same people are managing both, and loss to the charity may result. We recommend that there should be at least one person who is a trustee of the charity and not a director of the trading company, and at least one person who is a director of the trading company and not a trustee of the charity. The people without dual interests can be expected to give suitable advice to their colleagues as to the proper course of action in a conflict of interest situation and this should reduce the risk that any transaction will he invalidated.
51. A charity trustee cannot automatically be paid for his services as a director, or employee, of the subsidiary trading company (or, of course, as an employee or trustee of the charity) unless the governing document of the charity specifically provides for this. Where trustees are to be appointed as directors of the subsidiary trading company, the trustees as a whole will need to bear in mind the following points:
Return to Contents
52. This should always be viewed in the context of the charity making an investment in the subsidiary trading company. Charity law requires trustees to follow low-risk investment policies.
The charity should not guarantee any liabilities of the company. This is because if the trustees allow the charity to guarantee the liabilities of the company they will, in effect, lose the protection of the charity's funds (gained by the separation of the activities) by leaving them liable to the debts of the company. By doing so the trustees may well lose their own protection from personal liability. They should note that if they give guarantees themselves, they will be personally liable if the company cannot meet the liabilities.
Return to Contents
53. Where trustees intend to finance a subsidiary trading company from the charity's own resources, they should first make sure that they have the power to do so. Where a suitable power exists, it must be exercised consistently with the fulfilment by the trustees of their usual investment duties (in particular the need for diversity of investment and obtaining professional advice). As a first step, the financial viability of the subsidiary trading company needs to be assessed by the charity. Appropriate advice will need to be taken based on the business plan, cash flow forecasts, profit projections, risk analysis etc. provided by the subsidiary trading company. The trustees must take all reasonable steps to minimise any loss to the charity should the venture fail and must be particularly careful in situations where the subsidiary trading company is operating at a loss and requires new capital. Investing too high a proportion of the charity's funds in its subsidiary trading companies will not be consistent with the discharge of the trustees' usual investment duties. Our publication Investment of Charitable Funds: Basic Principles (CC14) gives details of these duties.
54. We would advise trustees that they should also pay particular attention to the length of time funds may be tied up in investments in subsidiary trading companies. Funds needed in the short to medium term may not be easily realised when invested in this way.
Return to Contents
What form should the investment take?
55. Normally, investment in a subsidiary trading company should take the form of secured loans by the charity on market terms. Charities should not ordinarily subscribe anything more than nominal sums for the issue of share capital by the subsidiary trading company (in order to satisfy the formal requirements of company law). The subscription of shares in the subsidiary trading company by the charity normally exposes the charity's investment to greater risk (because the repayment of share capital in the event of the liquidation of the subsidiary trading company, has a lower priority than the repayment of loans).
Return to Contents
56. Trustees should ensure that loans which they make are properly serviced by the subsidiary trading company. This means that interest payments should actually be made to the charity (and not simply be rolled up with the outstanding principal of the loan). The loans will need to appear in the charity's accounts. A programme for the repayment of capital should exist. Please see paragraphs 55, 62, 71 and 72.
Return to Contents
Unsecured loans and interest-free loans
57. Charities should not normally make unsecured or interest free loans to subsidiary trading companies. Such loans are not compatible with the proper discharge of the duties and responsibilities of charity trustees. If the subsidiary trading company fails the trustees may find themselves personally liable for any losses to the charity's funds if they have acted in breach of trust (see paragraph 5 above).
Are there any tax implications for investing in a subsidiary trading company?
58. Yes. There are special rules in Schedule 20 to the Income and Corporation Taxes Act 1988 which apply to investment of a charity's funds in a trading company. If these rules are not followed the charity will risk losing some or all of its tax exemptions. The Inland Revenue booklet CS2 gives further information on this.
Return to Contents
Continuing funding by charities
59. There is an inevitable conflict surrounding the continuing funding of a subsidiary trading company by a charity. The situation often arises where, to be tax efficient, the subsidiary trading company covenants the whole of its profits to the charity (ie whole profit-shedding) leaving no funds for internal investment and, therefore, creating cash flow difficulties etc. In this case it is little more than a shell and it is usually necessary for the charity to make a return investment (ie lend cash) to the subsidiary trading company to enable it to continue. Such payments or loans must be considered as investments but, as the subsidiary trading company has little or no substance (if it can retain no profits), the charity cannot often justify the investment under trust law.
60. Recognising this, some charities may prefer to accept the tax consequences of a measure of profit retention by the subsidiary trading company. This can enable the subsidiary trading company to function in a normal commercial way, and reduce or eliminate the need for the charity to invest (and risk) its own money in the subsidiary trading company
61. As with all other forms of investment, the arrangements for the transfer of profits should be reviewed periodically and charities should not restrict themselves to only one of the options.
Return to Contents
Advice for whole profit-shedding
62. Where the whole profit-shedding option is adopted, we recommend that trustees give careful and objective consideration (after taking their own legal and accountancy advice) as to:
63. The trustees will also need to recognise that if the subsidiary trading company fails, there is a "pecking order" in liquidation with unsecured creditors coming second to last, and the shareholders coming last of all.
Return to Contents
64. Where a subsidiary trading company is planning to adopt the option of retaining profits notwithstanding the tax consequences, it should not make unnecessary retentions. This is because retained funds would reduce the relief from tax which the company is able to obtain and hence decrease the payments available to the charity. In particular, trustees should note that VAT zero-rating on the sale of donated goods by a subsidiary trading company (in those circumstances where zero-rating is applicable see paragraph 26) only applies where the subsidiary covenants 100 per cent of its profit to charity. The fund-raising events exemption from VAT only extends to trading subsidiaries which are wholly owned by a charity, and covenant all of their profits to the charity.
Return to Contents
65. Non-financial support of a subsidiary trading company can be as important to its viability as loans and other investments made by the charity. Such non-financial support often takes the form of the use of the charity's land or staff and equipment: trustees need to ensure that a business relationship between the two bodies is maintained in this respect.
Use of the charity's land by the subsidiary trading company
66. Such use should be covered by a formal lease or licence of the property concerned from the charity, to the subsidiary trading company. The subsidiary trading company should 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 a licence may) constitute a disposition of the charity's land. Any such disposition will need to be authorised by Order from the Commission under section 36(1) of the Charities Act 1993 (because the trading company is a "connected person" in relation to the charity within the meaning of schedule 5 to the 1993 Act). See our publication Disposing of Charity Land (CC28).
Return to Contents
Shared use of staff and/or equipment
67. The costs of this should be apportioned on a pro-rata basis between the charity and the non-charitable subsidiary trading company. Equipment used exclusively by the subsidiary trading company should be purchased by it.
Points to consider when establishing and funding a subsidiary trading company
68. Based on our experience of cases, where substantial amounts of a charity's money have been lost as a result of ill-considered investments in subsidiary trading companies, we recommend
that trustees bear in mind the following points of good practice before agreeing to fund such a company:
Return to Contents
69. We advise that proper consideration should be given to the possibility of the financing of subsidiary trading companies through commercial funding, as an alternative to funding by the charity. This is on the grounds that the involvement of a commercial lender will ensure:
70. The additional cost of commercial lending, as compared with lending by the charity, may be regarded as a reasonable price to be paid for the acceptance by the commercial lender, rather than the charity, of the risk of loss. Return to Contents
71. Arranging external funding can cause practical difficulties in some cases. Given that all the profits of the subsidiary trading company, after any loans have been serviced, are often transferred to the charity each year, the trading company itself may remain a shell with little substance. In these circumstances, commercial lenders may wish to secure loans to the trading company on the charity's own assets.
72. Whether such security takes the form of an indirect loan arrangement, a guarantee, or a charge over charity property, it essentially has the effect of re-exposing the charity's assets to the financial risks of the business. This negates the effect of involving the commercial lender at all and we would not normally regard the giving of such security as being in the best interests of the charity. Accordingly, we would not ordinarily be prepared to authorise entry into a transaction of this nature, or to give consent which may be required under section 38 of the Charities Act 1993
73. Where commercial funding is not possible, the
charity may need to accept that a viable trading company cannot be established. However, it is sometimes possible to find one, or more, "wellwishers" who are prepared to fund the trading company by giving it money, or lending to it on favourable terms.
Return to Contents
74. The profits of a charity's subsidiary trading company are, like the profits of any other trading company, taxable. However, gifts by the company to the charity out of the profits can, if properly structured, effectively avoid any tax liability. Information on how to achieve this is contained in the Inland Revenue booklet CS2. Return to Contents
75. It will he necessary for the trustees to review regularly the relationship between the charity and the subsidiary trading company. The purpose of establishing such a company is to raise funds for the charity, and its effectiveness in doing this, should be monitored. Any investments which the charity has made in its subsidiary trading company should also be reviewed regularly.
The address of the Financial Intermediaries and Claims Office (FICO) of the Inland Revenue is set out below.
Financial Intermediaries and Claims Office
Tel: 0151-472-6043/6046
The address of the Gaming Board:
Gaming Board for Great Britain
Tel: 0171-306-6200
Extra-statutory concession C4
Where a trading activity is NOT caught by the statutory exemptions, the Inland Revenue exercises a Concession which does not seek to tax the profits of some small scale events (such as jumble sales, firework displays and concerts) arranged simply to raise funds for charity. The Concession states:
C4. TRADING ACTIVITIES FOR CHARITABLE PURPOSES
"Bazaars, jumble sales, carnivals, firework displays and similar activities arranged by voluntary organisations or charities for the purpose of raising funds for charity may fall within the definition of "trade" in section 832, Income and Corporation Taxes Act 1988, with the result that any profits will be liable to corporation tax. Tax is not, however, charged on such profits provided all the following conditions are satisfied:-
Questions relating to the application of the Concession to any specific event should be directed to the Inland Revenue at the address given in Annex A.
CC14 Investment of Charitable Funds: Basic Principles CC20 Charities and Fund-raising CC27 Providing Alcohol on Charity Premises CC28 Disposing of Charity Land CC29 Charities and Local Authorities
For a complete list of all of our publications, audio-cassettes and video, please ask for:
CC1 Charity Commission Publications
To obtain copies of any of the above publications you can either: Gift Aid - A guide for donors and charities (IR113) Deeds of Covenant: Guidance for Charities (CS1)
Click for the top of this file
or for Inland Revenue booklet CS2.
(i)
a particular investment in a trading subsidiary is beneficial to the charity; and
(ii)
it is not connected with tax avoidance, it may well have difficulty in avoiding a restriction of its charity tax reliefs.
voting powers;
appointment of directors;
remuneration; and
dividends.
Points to consider when establishing and funding a subsidiary trading company. Commercial funding
Problems with commercial funding
The tax treatment of trading profits
Reviewing the relationship between the charity and the subsidiary trading company
Charities Technical
St John's House
Merton Road
Bootle
Merseyside
L69 9BB
(charity trading enquiries)
0151-472-6036 (general enquiries)
Lotteries Section
Berkshire House
168-173 High Holborn
London WC1V 7AA
Further reference
For further information you may find it useful to refer to the following Charity Commission publications:
Inland Revenue Booklets
Trading by Charities - Guidelines on the tax treatment of trades carried on by charities (CS2)
HM Customs and Excise leaflet
Value Added Tax - Charities (VAT Notice 7O1/1/95)