What’s the issue?
Lots of charities carry out some sort of trading (ie selling goods or services) to help raise funds to pursue charitable objectives. A charity might sell items in a gift shop or rent rooms in its property, for example. The problem is that, unless this is monitored carefully, profits earned from trading could result in a corporation tax charge for the charity.
The limits
All charities are permitted to make money from “primary purpose trading”. This is trading linked to the primary purpose specified in the charity’s governing document. For example, a museum or art gallery is permitted to charge fees for tickets.
Charities are also allowed to be involved in other sorts of trade not directly linked to the primary purpose. For example, an educational charity may rent rooms to students (primary purpose) and also to the general public during holidays (not primary purpose).
It is this non-primary purpose trading that can result in a tax bill. There is an exemption available for small trading. If your charity’s non-primary purpose trading income is £80,000 or less then the exemption should be available, as long as the trading income is not more than 25% of the charity’s total income.
But if the exemption limit is exceeded then the charity may wish to look at ways to structure things so that trading activity doesn’t result in a tax charge.
A solution
Many charities decide to deal with this issue by setting up a trading subsidiary. This separate company carries on the trading activity and (hopefully) generates a profit. The trading subsidiary then makes a gift aid donation each year, passing over the profits it has earned to the charity. This usually reduces the tax charge to zero.
Some complexities to consider before choosing to put this structure in place
This can be a complicated area, so generally charities only decide to set up a trading subsidiary if absolutely necessary. Some of these complexities may include:
- Gift Aid payment. The trading subsidiary is required to make its gift aid donation within nine months of the year-end, and this must be an actual payment rather than an intercompany offset.
- Administrative overhead. A trading subsidiary will incur additional costs, for example for accounts preparation and tax returns. The parent charity will also need to start preparing consolidated accounts, to properly include the results of the subsidiary.
- Subsidiary losses. If the subsidiary makes a loss, it will need to be careful about not making a gift aid donation which exceeds its distributable reserves. The charity should also consider whether supporting ongoing losses in the subsidiary could conflict with its charitable objectives.
- Cost split. In an ideal world, all costs related to trading would be invoiced directly to the trading subsidiary, so they match up with the income earned. In practice, however, things are likely to be more fiddly than this. Some costs may apply partly to the charity and partly to the subsidiary. Management will need to set a cost-sharing or recharge policy whereby it uses a reasonable basis to split costs between the charity and its subsidiary.
- VAT. The trading subsidiary is likely to need to be VAT registered and raise VAT invoices. Only the entity that receives a taxable supply and holds a valid VAT invoice in its own name is entitled to recover VAT on its purchases. Therefore, it may be necessary for the charity to be VAT registered as well, if it continues to incur some trading costs. It could then reclaim VAT by making a taxable supply to the subsidiary through the recharge.
- Staff costs. Staff costs should be recorded in the first instance in the entity which has the contract of employment. If some staff costs relate partly to the charity and partly to the subsidiary, a portion may need to be re-allocated through a management recharge. If staff have joint contracts of employment with both the charity and the subsidiary, then for VAT purposes there would be no taxable supply in relation to the recharge.
This is a complex area and charities will need to obtain specialist advice before making the decision to set-up a trading subsidiary. Please contact us if you are interested in obtaining further assistance on this.