Charities & Trading Subsidiaries Part 3

Part 3

FINANCING A SUBSIDIARY

A trading subsidiary like any newly formed business will require starting capital in-order to finance its activities before a profit is ever realised. Given the nature of the relationship between the charity and trading subsidiary it is normal to assume that the charity may wish to invest monies into the subsidiary. There are special rules that apply when a charity wishes to invest funds in a trading subsidiary which must be adhered to.

Firstly any trustees wishing to invest should insure that they have the requisite power to do under the charities constitution.

Any investment made in the trading subsidiary must be deemed a 'qualifying investment' for HMRC purposes. if it does not qualify then HMRC will view the investment as 'non-charitable expenditure@. This can be defined as expenditure on things that are not for the charitable purposes as set out in the charity's governing documents or any investments and loans made by the charity which are not qualifying loans or investments as detailed by HMRC regulations.

Any non-charitable expenditure may result in the charity losing its tax exemption on all or part of its income or gains. the amount is taxable at the same amount of non-charitable expenditure.

For example: A charity receives gross gift aid income of £40,000. the charity would normally be entitled to tax relief of £40,000. If £30,000 was spent on charity grants and administration and £10,000 on a non-charitable loan then the charity would lose tax relief on the same amount of the £10,000 loan.

The list of qualifying investments does not include investments in or loans to subsidiary companies per se. there is provision however that a charity can make a claim to HMRC to treat such investments as qualifying.

To satisfy this provision the charity must show that it was made for charitable purposes and that it is for the benefit of the charity, and not to avoid tax.

In order to achieve this, the investment should be commercially sound and the charity should ensure that the investments are secure, carry a fair rate of return and in the case of loans, provide for recovery of the amount invested in due course.

The trustees must be able to justify financial support for a trading subsidiary as an appropriate investment of the charities resources. The Charity Commission for England & Wales has stipulated the following guidance for trustees when considering the investment of charities resources, both in general and in the particular context of a proposed investment in a trading subsidiary which is used to carry on a non-primary purpose trade.

- be certain that the investment is within the charities investment powers;

- exercise such care and skill in the investment process as is reasonable in the circumstances;

- have regard to the suitability to the charity of investments of the same kind as the particular investment which it is proposed to make;

- have regard to the suitability of the particular investment in question, as an investment of the kind which it seems appropriate to make;

- have regard to the need for diversification of investments, as appropriate to the circumstances of the charity; and

- ordinarily obtain and consider advice about the investment from a person reasonably believed by the trustees to be qualified to give it by his or her ability in and practical experience of financial and other matters; the advice needs to have regard to the suitability and diversification points mentioned above;

- the trustees must reasonably consider that it is in the charities interests to make the investment, after making a fair comparison of this form of investment with other forms of investment which might be selected;

- this fair comparison must involve an objective assessment of the trading subsidiaries business prospects;

- the trustees must be satisfied as to the financial viability of the trading subsidiary, based on its business plan, cash flow forecasts, profit projections, risk analysis and other available information; and

- the trustees must ordinarily take appropriate advice on the investment, and the financial viability of the trading subsidiary. What is appropriate will depend on the circumstances: the cost of taking the advice is a relevant factor, and the cost should be commensurate to the size of the proposed investment.

- pay attention to the length of time over which funds may be tied up in an investment in a trading subsidiary, since funds needed in the short to medium term may not be easily realised when invested in this way;

- consider, and take suitable advice on, the possibility of obtaining independent funding as an alternative to funding by the charity.