A trading subsidiary is a company wholly owned by a charity, which is run to generate the charity unrestricted funds. Many charities have one or more such investments, however is this something your charity should be considering?
Primary Purpose Trading
A charity’s primary purpose is defined within it’s governing document. Any activity which generates a surplus that is part of your charity’s primary purpose, or which helps the primary purpose will not be taxable.
Examples include: a care home charging residents for accommodation and care (primary purpose) or a museum running a café for visitors (helps the primary purpose).
When might a charity pay tax?
The only time that a charity may be expected to pay Corporation Tax is on profits arising from a trade that has nothing to do with its primary purpose.
To illustrate when this might arise, lets use the example of the museum. Instead of the café being located within the museum, the café is instead located on a high street. In this instance, the running of the café is completely unrelated to the primary purpose of the charity and therefore would be taxable.
There are some exceptions though, providing all profits go the charity’s primary purpose.
- Workers who benefit – for example disabled staff of a café run by a charity that helps people with disabilities. Not all workers need to be beneficiaries of the charity, but the majority must be.
- Fundraising and lotteries – in addition to all profits going to the charity’s primary purpose, the event needs to qualify for exemption from VAT under the rules, and the charity must have an operating licence for any lotteries run.
Small trading tax exemption
Even if a charity starts generating taxable profits, it may still be possible to avoid a tax charge. This is where the small trading tax exemption may help.
A set amount of trading, which does not relate to your charity’s primary purpose, is permitted before tax is payable.
This table shows how the exemption limits are applied depending upon the size of your charity:
|Charity’s gross annual income||Maximum permitted small trading turnover|
|£32,001 to £320,000||25% of your charity’s total annual turnover|
How can having a trading subsidiary help?
If trading profits begin to exceed the permitted amounts, then Corporation Tax becomes payable. Naturally, this will reduce the amount of profits which are available for use by the charity.
One option to resolve this issue, is for a charity to establish a wholly owned trading subsidiary to undertake the trade.
The subsidiary will then donate its profits to the charity each year under gift aid tax relief, which exempts the donation from Corporation tax.
Additionally, if the trade was to fail for any reason, the charity can benefit from limited liability, which will likely be restricted to the value of the investment made in the subsidiary.
A key issue to consider
A significant drawback to utilising a trading subsidiary is the additional administration and compliance. As a separate legal entity from the charity, it is important that there are clear boundaries established between the charity and the company.
This will involve keeping separate financial records for the company, ensuring all transactions between the company and the charity are recorded in each entity, and complying with Companies Act requirements including minuting meetings of the board of directors
It is also likely that other compliance fees such as those for audit and tax fees, will also increase as two organisations require review instead of just one.
After the additional costs have been considered, the savings on corporation tax payments may actually be small.
A trading subsidiary can be a useful tool to protect the charity, and create an opportunity to develop a reliable source of income to support the charity’s primary purpose.
However, there are additional costs that the charity that need to be fully considered.