A charity can be set up for any number of reasons, but depending on your aim, remit and resources, trading under your charity might not be your best bet - or even allowed.
Where trading is to raise funds (rather than being in pursuit of your charitable objectives) and involves significant risk to a charity’s assets, it must be undertaken by a trading subsidiary.
This is by far the most common reason a charity might choose to operate through a subsidiary as it manages and mitigates the risk to your charity’s assets and ensures that trustees are not in breach of rules or - worse still - personally liable.
Even if it doesn’t involve significant risk, there are reasons you might choose to trade through a subsidiary company. It will predominantly come down to risk management, complying with charity regulations or possible tax issues - but where do you begin?
In general, your charity won’t be expected to pay tax on profits it makes on trading if it falls under your principal aims and objectives, known as ‘primary purpose trading’ or ‘ancillary purpose trading’.
You also won’t need to pay tax if your level of trade (that is ’non-primary’ purpose) falls below the charity’s small trading tax exemption limit - which can be up to £80,000 annually depending on your income. If it does exceed the limits and is not otherwise exempted, profits are subject to tax.
Importantly, however, you can potentially achieve greater tax efficiency on non-primary purpose trading profits if you put this trade through a subsidiary trading company - which is another reason that it could be a big boost to your charity, if properly implemented.
In a subsidiary trading company, profits from trading are subject to corporation tax unless specifically exempted. If not exempted, there is the opportunity to subject any profits which are liable to corporation tax to greater tax efficiency - by gift aiding the profits to the parent charity. Further advice would need to be sought, and due consideration given, to the amount and timing of any gift aid donation.
Setting up a subsidiary requires time and will incur additional costs in order to ensure compliance - that is true - but it can ultimately save your charity funds, safeguard your VAT and corporation tax exemption(s) and help to avoid a long list of legal pitfalls.
To know whether it is appropriate for your charity to trade, first we address the obvious question: what is trading?
It might seem like an obvious question, but when it comes to charities, this isn’t as clear-cut as you might think. In fact, according to the Charity Commission for England and Wales “there is, unfortunately, no short answer.” The selling of goods and services is broadly accepted in most contexts as being the definition of ‘trade’, but with charities, this can be complex and there are a number of variables. In general, the following activities are not classed as trading for this sector:
Careful consideration should be given to the appropriateness of undertaking any planned trading activity and its financial viability. There are other considerations too, so do seek advice when considering setting up a trading subsidiary.
The Charity Commission’s advice states that ‘where trading (other than trading in pursuit of its charitable objects) involves significant risk to a charity’s assets, it must be undertaken by a trading subsidiary.’
But what qualifies as a significant risk? Essentially, this is a trade that could negatively impact the charity’s ability to function - such as a transaction which, when carried out, could result in your turnover being insufficient to meet your primary aim or which results in the difference needing to be financed from charity trustees or stakeholders directly - which is not optimal.
As the term suggests, however, ‘significant risk’ always comes down to individual discretion and each charity could interpret this differently, depending on its size, assets and remit.
If you are operating a charity and want to safeguard your assets, it can make complete sense to set up a subsidiary to trade as a safeguarding mechanism - but do bear in mind that this in itself involves additional costs and compliance measures that will need to be implemented.
If you have questions and are seeking clarity, you can speak to our dedicated charities team today to ensure that your organisation thrives with good governance and compliance.