Charities trading, tax & subsidiaries
Many charities trade, either as an integral part of their charitable activities or to raise funds. Some charitable groups/organisations set up a subsidiary ("business" or "trading arm") as a way to generate income on a more substantial or permanent basis, which is a non-charitable trading company. These are often set up as a social enterprise or community business.
Trading is normally defined as involving the provision of goods or services to customers or clients (for profit). If your group or organisation carries out any type of trading activity, find out about any tax requirements that apply. Even one-off or occasional ventures may be treated as a trade for tax purposes if it involves the sale of goods or the provision of services for profit. For charities, the profits made from trading are generally exempt from tax provided that certain conditions are met.
The current annual turnover limit is £5,000, or if the turnover is greater than £5,000, 25% of the charity's total incoming resources, subject to an overall upper limit of £50,000. The table below illustrates the application of these rules.
|Total incoming resources in a tax year||Maximum permitted turnover in a tax year|
|£20,001 to £200,000||25% of charity's total incoming resources|
For the purpose of this limit, "total incoming resources" means the total receipts of the charity for the year from all sources (grants, donations, investment income, all trading receipts etc).
Your accountant will be able to advise you on the aspects of tax and trading. It is also advisable to seek guidance from HM Revenue & Customs.
Taxation of Charity Trading
All charities need a regular source of income. As there is little or no control over donations and legacies being received, inevitably trustees often decide to be proactive and increase revenues through trading activities. The development of trading activities is becoming increasingly essential for many charities.
However charity law does not permit charities to trade simply for the purpose of raising funds. This is because of the general expectation that contributions made to a charity will be used to meet its charitable purposes or invested prudently, rather than being risked in trading activities. Also if a charity trades simply for the purpose of raising funds, it may not only be in breach of charity law, but may also incur tax liabilities on trading profits.
It's therefore worth looking at what a voluntary organisation can and cannot do, and when charities may engage in trading activities for fundraising purposes, and also when a separate subsidiary trading company should be established to carry out those activities.
Charity law is very clear in that charities can trade in carrying out their charitable objectives or in connection with the primary purpose of the charity. For example, a charity set up for the promotion of religion can sell religious literature; an independent school charity which provides its educational services in return for fees; the provision of residential care services by an almshouse or similar charity in return for payment; art exhibitions at a gallery; or stage productions by a theatre can all be charged for.
Charities wanting to trade on a substantial or regular basis for the main purpose of raising funds, can separate out those trading activities to a subsidiary non-charitable trading company - a private limited company. This protects the charity and its assets from the risks and liabilities of the trade.
There may also be tax advantages for the charity in establishing a subsidiary trading company to carry out the primary purpose trading of the charity. Also, any profits of a non-primary purpose trade which is carried out directly by a charity will often be taxable, which is why many organisations choose for simplicity sake to separate the activities of the charity and a subsidiary trading company which covenants its net profits to the charity every year.
It is essential to bear in mind that if a subsidiary trading company is formed as a method of raising funds for the charity, funds should flow in one direction only: from the subsidiary trading company to the charity.
Also, where trustees are to be appointed as directors of the subsidiary trading company, the trustees need to bear in mind the potential for conflict of interest; and that the appointment of trustees as directors cannot be used as a method of paying trustees "by the back door".
What they don't tell you about working for a charity is that what constitutes a "trade" for tax purposes is primarily a matter for HM Revenue & Customs, but the fact that all profits or surpluses are to be used for charitable purposes is irrelevant.
However, income from the sale of donated goods is generally not regarded as trading income which is why charity shops relying on second-hand goods as such a welcome and established source of revenue for many organisations.
HMRC can advise trustees about the tax implications of primary purpose trading, but trustees may also decide to consult their own legal and accountancy advisers as well.
- Trading by Charities - guidelines on the tax treatment of trades carried out by charities
- VAT for Charities
- Using a trading company
Also check out the Charities and Donors section of the HMRC website
Charity Commission for England and Wales pamphlet CC35 Charities and Trading and Tax
There are two other important restrictions to consider:
(1) Charities cannot have ‘trading' per se as an object of the charity
(2) A Charity wishing to enter into any form of trading activity must have power to do so in its governing documents
Non-charitable Trading Subsidiary
Charities can set up subsidiary companies to carry out trading on their behalf. A trading subsidiary is a company owned and controlled by one or more charities, and is usually set up to generate income for the charity. The advantage of using subsidiary companies is that they don't have the restrictions on their trading activities that charities have.
The subsidiary company can donate part or all of its profits to its parent charity and get relief from Corporation Tax for the payments. As long as the charity uses the income for charitable purposes, it doesn't have to pay tax on it.
HM Revenue and Customs (HMRC) treats subsidiary trading companies owned by the charities as normal commercial enterprises for VAT purposes. So your charity's trading subsidiary won't get most of the VAT reliefs that your charity benefits from. But there are two exceptions that apply to trading subsidiaries:
- selling donated goods can be zero-rated in most circumstances, as long as your trading subsidiary is donating its profits to your charity.
- certain charitable fundraising events are exempt from VAT when they're undertaken by your charity's subsidiary trading company on behalf of your charity.
There is information and advice available about what a particular charity can and cannot do in the way of trading from:
NICVA's Governance and Charity Advice Service
Tel. 028 90877777
More on Setting up a social enterprise