Five things to consider before setting up a trading subsidiary

Your church or charity might want to undertake trading activity, for example running a café or events business, providing supported employment for vulnerable individuals or offering paid consultancy and training services.

But what is the best legal structure for this commercial activity?

A charity would usually have to pay tax on the profits of its commercial activity and so may instead choose to set up a 'trading subsidiary'. A trading subsidiary is an ordinary non-charitable company or Community Interest Company which is owned by the charity and carries out the commercial activity.  Using a trading subsidiary can maximise tax efficiency and protect the charity from financial or reputational damage if a commercial venture fails, but there are some important questions to consider before you start.

1. Do you actually need a trading subsidiary?

Your church or charity will not pay corporation tax on profits from trading which is part of its primary charitable purpose.  For example, a charitable Christian school does not pay tax on any profits from providing tuition and Stewardship does not pay tax on any profits from providing its Accounts Examination Service.

In addition, profits from trading which do not relate to your charity’s primary purpose may be exempt from tax if the turnover is below the small trading tax exemption limit. For a charity with gross annual income of £32,001 to £320,000, the maximum permitted small trading turnover is 25% of the charity’s total annual turnover.  Note that this limit refers to turnover, not just the profits of the activity. However, it may still be enough to cover the income from activities such as letting out the church hall.

2. How will you fund the subsidiary?

Your subsidiary may need start-up capital or other financial support.  Even if it is wholly owned by your charity, your charity cannot simply give funds to the subsidiary, as this would constitute taxable non-charitable expenditure.  So a charity cannot subsidise the operations of its trading subsidiary.

Before making any loan or other investment in the subsidiary, your charity trustees must consider their investment duties and the alignment with their investment policy.  Funding should be provided on arm’s length terms which are set out in writing.  Your trustees should record the basis for their decision-making, for example consideration of the subsidiary’s business plan and cashflow forecast.

3. Who will be the directors?

You’ll want to recruit directors with skills and experience relevant to the commercial activity of the subsidiary, for example business strategy or HR.  It’s usually wise to have at least three directors.

Whilst there may be some overlap between the subsidiary board and your charity’s board/staff, the charity and the subsidiary must each have a quorum of directors who are fully independent of the other entity.  This is to ensure that the charity and the subsidiary can manage any conflicts of interest and negotiate the sharing of financial or other resources on an arm’s length basis. 

4. Will the subsidiary share your staff, premises or branding?

Your charity’s resources can only be used to further its charitable purpose.  If you wish to permit the subsidiary to share your premises, branding or other assets, the subsidiary must pay an open market fee, and the terms should be formally documented.  If charity staff undertake duties for the subsidiary, the subsidiary should pay the charity a fair apportionment of employment costs.  The two entities should have separate accounts and financial records, with any transactions between them carefully considered and recorded.

5. What will happen to the profits?

A trading subsidiary is subject to corporation tax on its activities and must register for VAT if it exceeds the threshold.  However, the trading subsidiary can donate its trading profits to your charity under the corporate Gift Aid scheme and so avoid its trading profits being subject to corporation tax.  In addition, a trading subsidiary’s VAT recovery may be more efficient than your charity’s VAT recovery if the subsidiary makes taxable supplies.

Recommendation: take advice first!

In conclusion, setting up a trading subsidiary can be an effective way to expand your charity’s work or raise funds.  However, it is a complex area and there are significant legal, governance and tax risks which need to be managed.  We’d therefore recommend that you seek professional advice at the outset.

Setting things up correctly will require an investment of time and money, but in our experience will be cheaper and easier than trying to amend a structure which was established without due consideration of these risks.

For more information, please see the Charity Commission’s guidance at guidance for charities with a connection to a non-charity.