Trading Subsidiaries – should a charity have one?

The purpose of trading subsidiaries of charities is simple. The wholly owned trading subsidiary undertakes the commercial trading activities that do not fall within the objects of the charity. The subsidiary will be taxable in exactly the same way as for a normal company but with careful planning can gift the majority of its profits to its parent charity and reduce its corporation tax liabilities to virtually zero. Typically therefore trading subsidiaries will not pay dividends.

Regulatory issues.

The Charity Commission and HMRC view the nature of the relationship between a charity and
its commercial trading subsidiary as an investment activity. This means charities need to have appropriate powers in their constitution in order to make the investment. It is essential for charity law and tax purposes that there is an appropriate “arms-length” relationship between the two entities. For example, the subsidiary should be charged on a commercial basis for services and facilities supplied by the charity. A formal cost-sharing agreement should be drafted to cover this point.

A licencing agreement will normally be used to provide clarity over the use of charity
assets and resources by the subsidiary. For operational matters other formal documentation would be useful to spell out the relationships.

How can a trading subsidiary be funded / provided with assets?

Often the charity setting up the trading subsidiary provides funding to the trading subsidiary by way of a loan or purchase of share capital, and perhaps assets as well. However the Charity Commission does not favour significant investment in trading subsidiaries by way of share capital as there is less security for the charity should the subsidiary’s business fail. The normal approach is for loan funding to be provided by the parent charity. There is a duty on trustees to only lend to the trading subsidiary at arms length (i.e. at a commercial rate of interest) and to obtain security for the loan. The trustees ought therefore to have a formal loan agreement.

It is important to recognise that in order to finance the repayment of any loans the subsidiary will need to retain profits, and a tax liability is therefore likely to be incurred.
If the charity purchases share capital – it will likely need external professional advice about the appropriateness of such investment in the subsidiary and the terms of that investment – for example, the return on amounts invested, the risks of default and so on.

Disadvantages to setting up a trading subsidiary

Additional management is required and preferably some independent directors as well and generally there will be more administration and tax implications to be considered.

For these reasons, charity trustees are advised to weigh up carefully whether they require a trading subsidiary.

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