Example1:
A sports charity receives money from corporate sponsorship, and it publishes the sponsors’ names and logos on its website, with a link to the sponsors’ own websites. While HMRC say that these are indicators of trading, they are not conclusive. (See Chapter 3). To avoid any risk of a tax liability arising it may be advisable to put the activity through a trading subsidiary.
Example 2:
An arts charity has entered into website shopping arrangements with retailers, so that the charity’s supporters can click through to the retailers’ websites when making purchases. The charity receives a tiny fraction (1/4%) of the amount spent by the supporters. The amounts here may well be small, but the charity will have no idea in advance of how much will be earned from this activity. Again, it may be safer to put this through a trading subsidiary.
Example 3:
A major animal welfare charity has a network of local branches and supporters groups, many of which carry out small scale trading activities. For instance, one group recently made £5,000 by selling items on eBay. Head office don’t always find out about these activities until after they have taken place. In this case it would seem sensible for the charity to put all the non-charitable trading activities of which Head Office are aware through the trading subsidiary, so that the £50,000 limit is used to mop up sundry small scale activities. And of course Head Office needs to provide guidelines and training for the branches!
4.2
OTHER REASONS TO USE A TRADING SUBSIDIARY
Section 2.12 discussed circumstances when it mightbe appropriate to use a trading subsidiary. The main one of these was to avoid direct tax, given that non- primary purpose trading was not a charitable activity. At the risk of repetition, this section highlights other reasons for using a subsidiary.
Risk
Trading is by its nature risky and the charity could make losses instead of profits. A subsidiary can be used to reduce the charity’s exposure to losses from a non-charitable trade.
However, in practice the reputation risk of allowing a closely linked trading subsidiary to fail owing money to others often means that the risk shelter argument is questionable.
VAT savings
Some VAT exemptions depend on the status of the organisation delivering the service. In certain cases if income generation is through the charity the income may be exempt from VAT. As discussed in Chapter 1 this means that input VAT recovery is restricted. In some cases it may be advisable for the income to be standard rated for VAT so that input VAT can be reclaimed. This is usually worth doing when the recipient of the services can recover the VAT charged. For instance, welfare services (as defined) supplied by a charity are exempt from VAT. Welfare services supplied by a trading company are only exempt from VAT when the trading company is required to be state- regulated. When the supplies are to a body such as a local authority that can reclaim all its VAT, it makes
sense for the subsidiary to provide these services and charge output VAT on them so that it can recover input VAT on its costs. Therefore it would make sense to use a trading company although the income is likely to be primary purpose trading and not liable to direct tax. Certain other services gain exemption when they are delivered by an “eligible body”. These services are supplies of education, cultural services, sporting services and fundraising services. There are variations in the definition of eligible body for each category affected but the general principle is that the
organisation cannot and must not distribute its profits. (Gift Aid is not viewed as a distribution of profits for this purpose.)
As a company limited by shares can usually distribute its profits, such a company may not satisfy this criterion and therefore a company limited by guarantee may be necessary in order to obtain VAT benefits. Different types of company are discussed in Section 4.3.
Is the activity making profits?
The reason for having a trading subsidiary is to save the charity paying direct tax on non-charitable profits. This raises the question of whether the charity will actually be making taxable profits. It is of fundamental importance that the trustees prepare a budget for the trading activities, including all direct and indirect costs, to decide whether to set up a trading subsidiary. As noted in Section 2.12 above, if a trading activity is projected to make a loss after allocation of all costs, (even if it makes a contribution to fixed costs), using a trading subsidiary may not be the answer.
4.3
WHAT FORM OF COMPANY SHOULD BE USED?
There are a number of different possible structures for asubsidiary trading company.
Company limited by shares
The most common vehicle is a company limited by shares. This is the standard form for a commercial trading company. The share structure means that dividends can be declared easily, and each
shareholder’s voting rights can be precisely calculated according to the number of shares that they hold. Shareholders also have rights to the company’s assets in a winding up. In most cases the charity or its nominees (if the charity is not incorporated) will be the sole shareholder or shareholders.
If the charity is a company, a subsidiary limited by shares will be a member of a corporation tax group with the charity and any other subsidiaries. This means that group relief is available for losses and assets can be transferred between group members without tax liabilities arising.
It should be noted that a company limited by shares may not be an eligible body for VAT purposes, and a company limited by guarantee or a Community Interest Company (CIC) may be more appropriate in such cases.
It is also possible for a corporate charity to form a VAT group with one or more of its subsidiaries. A charity which is a trust cannot be in a VAT group.
Company limited by guarantee
A company limited by guarantee may sometimes be used as a subsidiary. This can have VAT advantages (see Section 4.2 above). The members are usually the directors, and they do not own any capital, although they guarantee to contribute a sum of money, often no more than £1 each, if the company is in difficulties. Typically members have no rights to dividends or to a share in the assets of the company. If this structure is used the charity would be the sole member and would thus have all the voting rights. The charity would be able to appoint and remove the directors, who would not be members.
A subsidiary limited by guarantee would not be part of a corporation tax group, and so would lose some tax advantages on loss relief and intra-group transfers. It could still, however, be VAT-grouped with a corporate charity.
A company limited by guarantee must have provisions in its Memorandum or Articles of Association that “every person who is beneficially entitled to participate in the company's profits, or share in the net assets at a winding-up is or must be a charity or a company wholly owned by a charity” (Section 339 (7AA) ICTA 1988).
Without this provision a subsidiary limited by guarantee would not be able to benefit from the nine month extension to the Gift Aid payment deadline (see Section 4.7 on Gift Aid).
Community Interest Company (CIC)
The subsidiary can be a CIC. CICs are limited companies which have special additional features that can make them attractive where a charity wants to demonstrate clearly that the business or other activity is for community benefit. This is achieved by a
"community interest test" and "asset lock", which ensure that the CIC is established for community purposes and the assets and profits are dedicated to these purposes. Registration of a company as a CIC has to be
approved by the CIC Regulator who also has a continuing monitoring and enforcement role.
CICs can be limited either by shares or by guarantee. Although they are set up for community benefit CICs do not have the tax exemptions that are available to charities.