Trading subsidiaries: when does a charity need one?

Trading subsidiaries might be established and operated by charities for a variety of reasons. Often, they are used to carry out non-charitable trading in order to raise funds for the charity, but they are also sometimes used to carry out charitable activities in a ring-fenced vehicle, to avoid risk to the charity’s assets.

What is a trading subsidiary?

The term ‘trading subsidiary’ is, in most cases, used to refer to a wholly owned subsidiary company of a charity. Whilst various trading structures are available, a non-charitable company limited by shares is the most common due to the group tax reliefs generally available.

A trading subsidiary will have a minimum of one director, but in practice there are usually several directors. The charity will often have a right to appoint and remove directors, in order to keep a level of operational control.

It is also advisable for the trading subsidiary board to comprise a mixture of some (but not all) of the charity’s trustees, and some ‘independents’ who bring relevant expertise and help manage conflicts of interest.   It is not normally possible for a trustee of the charity to be paid for their time serving on the trading subsidiary’s board.

What is the tax position of a trading subsidiary?

Charities enjoy certain tax advantages, but these are not generally shared by a trading subsidiary. For tax purposes, the trading subsidiary is a normal commercial company, but with careful planning can gift the majority of its profits to its parent charity and reduce its corporation tax liabilities to virtually zero.

Great care is needed as regards tax and the relationship between the parent charity and its trading subsidiary.

How can a trading subsidiary be funded / provided with assets?

Often the charity setting up the trading subsidiary provides funding to the trading subsidiary by way of a loan or purchase of share capital, and perhaps assets as well.

However, the charity tax implications of any contribution by the charity to the setting up of the trading subsidiary will need to be considered carefully. If the support does not represent an approved charitable investment or approved charitable expenditure by the parent charity, the charity may have to pay tax on its contribution, and the trustees may be in breach of trust.

The charity will likely need external professional advice about the appropriateness of any investment in the subsidiary and the terms of that investment – for example, the return on amounts invested, the risks of default and so on.

Are there any disadvantages to setting up a trading subsidiary?

Trading subsidiaries do have some drawbacks:

  • they require additional management and so incur related costs;
  • they can result in some tax leakage; and
  • they can be time consuming due to the additional administration.

For these reasons, charity trustees are advised to weigh up carefully whether they require a trading subsidiary as the disadvantages may in some cases outweigh the benefit.

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