Is a Trading Subsidiary Right for Your Charity?

For most charities, generating income is key to achieving their mission. Donations and grants help, but trading can provide extra funds. A trading subsidiary might be a good way to raise money. But is it right for your charity?

This guide explains what a trading subsidiary is, why charities set them up, and what to consider before moving forward.

What is a Trading Subsidiary?

A trading subsidiary is a separate legal company fully owned by a charity. It carries out commercial activities, often non-charitable, to raise income for the charity and manage risk. These activities happen within a limited liability company, protecting the charity’s core assets.

Why Set Up a Trading Subsidiary?

Charities set up trading subsidiaries for several reasons:

• Manage Taxable Trading: Non-primary purpose trading can lead to tax liabilities. A subsidiary can manage those liabilities more efficiently.
• Exceed Small Trading Exemptions: Charities can only generate non-charitable trading income up to specific limits without paying corporation tax: £80,000 for those with income over £320,000, 25% of income for charities with income between £32,000 and £320,000, and £8,000 for charities with income under £32,000.
• Protect Charity Assets: A subsidiary separates financial risks from the charity’s main assets, keeping them safe.
• Unrestricted Trading: Trading subsidiaries have no restrictions on their ability to trade in support of the charity, offering flexibility for charities with additional income streams.
• Administrative Convenience: A subsidiary simplifies the management of commercial activities by separating them from the charity’s core mission.

Drawbacks of a Trading Subsidiary

While there are several advantages to setting up a trading subsidiary, it’s important to consider the possible drawbacks:

• Additional Costs: Setting up and running a separate company can involve additional administrative costs.
• Loss of Tax Benefits: The charity may lose access to certain tax benefits for activities conducted through a trading subsidiary. For example, business rates relief and exemption from stamp duty land tax typically apply to charitable activities but may not extend to commercial trading operations or transactions.
• Increased Complexity: Operating a subsidiary adds complexity in terms of governance, compliance, and financial reporting.
• Ongoing Oversight: Trustees must regularly monitor the subsidiary’s activities to ensure it aligns with the charity’s mission and complies with relevant laws.
• Risk of Confusion: Having a separate entity may confuse donors or the public about the charity’s activities, especially if the trading subsidiary’s name or activities closely resemble those of the charity. Choose the trading subsidiary’s name carefully to avoid confusion.

Example: Museum Case Study

A museum sells tickets to members of the public. Ticket sales are usually tax-exempt as they directly support the museum’s charitable purpose. However, a café or gift shop inside the museum may sell items that are taxable because they are ancillary to the purpose. Such institutions will usually have a trading subsidiary to manage the tax issues properly.

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What to Consider Before Setting Up a Trading Subsidiary

Before setting up a subsidiary, senior leadership need to think about five key factors:

1. Clear Purpose and Governance: Confirm the charity has the power to create a trading company. The subsidiary must support the charity’s charitable purpose. Trustees should also decide on the subsidiary’s board, including managing conflicts of interest, and how shared resources will be managed.
2. Business Planning and Financial Projections: Develop a solid business plan with clear objectives and financial projections. Identify income streams, risks, and profitability timelines.
3. Tax Considerations and VAT: Consider the tax implications of the trading subsidiary’s activities, including corporation tax (reduced via Gift Aid donations to the parent charity), VAT registration if turnover exceeds £90,000, and tax planning to maximize exemptions and efficiently manage taxable trading.
4. Resource Requirements and Risk Exposure: Running a subsidiary requires resources and risk management. Trustees should ensure the charity can provide support and isolate risks in the subsidiary., while retaining oversight.
5. Legal and Compliance Issues: Set up formal agreements to govern the relationship between the charity and the subsidiary, covering profit distribution, loans, and shared resources. The Charity Commission provides detailed guidance on charities and their trading subsidiaries.

Steps for Setting Up a Trading Subsidiary

Once you decide a subsidiary is the right choice, follow these five steps:

1. Develop a Business Plan: Create a thorough plan that clearly defines the subsidiary’s goals, activities, expected outcomes, and management structure. This ensures the subsidiary aligns with the charity’s needs.
2. Seek Legal and Tax Advice: Consult professionals to understand the legal and tax implications of setting up a subsidiary and managing its governance. It’s crucial to seek ongoing legal and tax advice to ensure that the subsidiary’s activities continue to comply with charity law and relevant tax regulations as they evolve over time.
3. Register the Company: Once legal and tax advice has been sought, the charity’s board requires a resolution to establish the company. Register the subsidiary as a separate legal entity with Companies House. Typically, this means forming a limited company by shares. Though some may choose a company limited by guarantee or a community interest company.
4. Appoint Directors and Set Governance: Appoint directors to the subsidiary’s board, ensuring some, preferably most are independent of the charity. Directors oversee the subsidiary’s commercial success while maintaining a clear separation from the charity’s board.
5. Set Up Accounting and Financial Systems: Implement accounting systems to track the subsidiary’s finances separately from the charity. Ensure these systems comply with tax and VAT regulations and set up procedures for Gift Aid payments to ensure tax efficiency.

Key Tax and Legal Considerations

• Corporation Tax: Trading subsidiaries pay corporation tax on profits. However, profits can be passed to the charity via Gift Aid, reducing the tax burden. Ensure timing aligns with tax requirements.
• VAT Registration and Relief: If the subsidiary’s taxable turnover exceeds the VAT threshold of £90,000, it must register for VAT. Be aware of VAT reliefs for specific charity trading activities, like fundraising or selling donated goods. VAT and property in relation to charity activities requires careful planning.

• Non-Primary Purpose Trading: Activities not related to the charity’s mission, such as running a café in a museum or selling t-shirts with your cause on it, may incur tax charges if not considered ancillary. Structuring these activities within a subsidiary ensures compliance with tax regulations and minimises tax risks.

• Loans and Profit Distribution: Loans to the subsidiary must be properly documented. Charity funds should not be used to support a struggling subsidiary. The subsidiary can only distribute profits that are legally available for distribution under company law, ensuring all financial obligations and legal requirements are met first.
• Legal Compliance: Trustees must ensure the subsidiary follows charity law and company law, including rules around non-primary purpose trading, tax exemptions, and governance.

Conclusion

Setting up a trading subsidiary is an effective way for charities to raise income, but it requires careful tax and legal planning.

Trustees must ensure all trading activities comply with charity law, company law, and tax regulations. Ongoing professional advice is crucial to manage complex rules and avoid unintended tax liabilities.

How We Can Help
At gunnercooke, we can guide you with the set up a trading subsidiary. From legal setup to tax planning, we’ll assist you every step of the way.

Get in touch to get started:

• Michele Price, Charity and Philanthropy Partner:

[email protected]

• Neeraj Nagarkatti, Tax Accountant & Associate Operating Partner: [email protected]