WHAT IS A TRADING SUBSIDIARY?
It is an independent commercial body, quite distinct from the charity. Its legal structure will usually take the form of a non-charitable company limited by shares or a non-charitable company limited by guarantee.
Although the trading subsidiary does not enjoy the advantages of charitable status, it is not burdened with the stringent trading restrictions that a charity must comply with. It will therefore be able to undertake trading activities which the charity cannot.
WHY USE A TRADING SUBSIDIARY?
- trading subsidiaries offer greater flexibility and fashion the opportunity to generate greater sums of money for the charity.
- The trading subsidiary will be able to carry out non-primary purpose trading on a larger scale and obtain tax relief through the gift aid scheme. If a trading subsidiary gives all or part of its profits to the parent charity then it will not have to pay any tax on those profits. This can result in very significant savings for the charity through the reduction or elimination of tax liabilities. Where the non-primary purpose trading does involve a significant risk the Charity would have to establish a trading subsidiary if it wished to continue that form of trading.
- To protect the charities assets from the risk of trading. If the trading is carried out within the trading subsidiary then the risks associated with any losses will be ring-fenced within the subsidiary itself.
- To protect the trustees of a charity from personal risks & liabilities.
- The directors of a trading subsidiary may be paid for their work unlike their trustee counterparts. Therefore a more commercially savvy person may be attracted to run the business. It must be noted though that the establishment of a trading subsidiary should not be used as a backdoor method of paying charity trustees.
It is important to remember that it is not only where non-primary purpose trading is undertaken that a subsidiary may be established. A charity may set up a trading subsidiary for the purpose of primary purpose trading if it so wishes.
DISADVANTAGES OF SETTING UP A TRADING SUBSIDIARY
Where the establishment of a trading subsidiary is not essential the benefits enjoyed must be balanced with the drawbacks that such a move would entail.
The disadvantages may include:
- The tax benefits may not outweigh all the extra costs associated with setting up and running a subsidiary.
- The additional administrative burden of a legal entity, quite separate from the charity.
- Difficulties that can emerge concerning the financing of a subsidiary.
- Possible cash flow problems for the subsidiary if all of the profits are donated back to the parent charity.
- The possible conflicts of interest arising where trustees of charities sit on the board of the subsidiary as directors.
These potential drawbacks will not be relevant in every case but trustees must be careful to avoid having their positions compromised.
In Parts 3/4 I will take a look at the financing of a subsidiary. This is often a difficult proposition given the numerous constraints placed on charities but it is essential that trustees are alert to the potential pitfalls.
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