1 August 2017

Do you need a trading subsidiary?

We look at the tax benefits that can be derived by a charity setting up a trading subsidiary.

It is often assumed that charities are not subject to corporation tax, when in fact they are. There are, however, a series of tax exemptions from which they can benefit.

As a basic rule, trading income does not qualify for tax relief and is generally liable to tax. That said, if the trading income has been derived from one of the following sources it will be exempt from tax:

  • Primary purpose trade;
  • A trade that is ancillary to a primary purpose activity;
  • Trades where beneficiaries of the charity carry out the work.

Trading income that does not fall within the above categories may give rise to a tax charge. While HMRC allows charities to earn some trading income, a charge will arise if the total non-exempt income exceeds £50,000 per annum (if your turnover exceeds £200,000). Even if the trading income and correlating expenditure results in a loss, the charity’s exemptions will be at risk.

Specific areas of income that may result in corporation tax issues include income derived from:

  • Sponsorship: where a sponsor receives more than just a simple recognition for their contribution, the income becomes taxable.
  • Shops: any merchandise that is not sold as part of achieving the charities objectives will generally be treated as taxable.
  • Cafes and restaurants: the rules surrounding cafes and restaurants are considerably more complex and, more often than not, they give rise to tax implications within the charity. Consideration needs to be given to whether you or another company run the establishments and who uses them.
  • Rent: Rent should not result in any corporate tax implications where no additional services are provided, such as cleaning or the hiring of equipment. However, if additional services are provided, corporation tax may apply.

When it comes to tax, charities that participate in any of these activities may benefit from setting up a trading subsidiary. The sources of income mentioned above would then be moved into a trading subsidiary and treated the same as any other company for corporation tax purposes.

A benefit of setting up a trading subsidiary is that it can gift aid all of its profits to the charity, as long as it has the available reserves. This would remove any corporation tax charge arising in the subsidiary. The trading subsidiary has up to nine months to make the gift aid payment to the charity, which allows the trading company to finalise their accounts and tax position before having to make the charitable donation.

That said, coming to a decision on whether your charity needs a trading subsidiary should not be taken lightly. Running a separate entity will involve additional costs and you need to weigh this up against the charity paying some tax on the non-exempt income.

If you are considering setting up a trading subsidiary and you would like some more advice, please do not hesitate to contact Kirsty Murray or Catriona Macleod on 0131 473 3500.

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