Keep it legal: Trading activity

The purpose of trading activity is to generate profit. This conflicts with the objectives of a charity, which must be charitable by definition.

If trading activity becomes substantial, there is a risk that it can come to dominate the activities of a charity to such an extent that the organisation is no longer fulfilling its charitable purposes. If a charity allows this to happen, trustees are in breach of their duties and at personal risk of having to make good any loss to the charity.

A prudent investment?

The common solution to this problem is to anticipate it and to give a charity constitutional power to invest in a trading subsidiary. Trustees must still consider whether investment in a subsidiary is reasonably prudent and ensure that a practical written business plan and financial projections are in place.

The finances and activities of the charity and its subsidiary must, of course, be kept separate. The trading company will typically be established as a company limited by shares, with the charity owning the shares. The trading company must be sufficiently disassociated from the charity to ensure that trade creditors do not think they are dealing with the charity itself.

The company can be supported financially by the charity. Some start-up funding will normally be needed, which can be provided by the charity - probably by way of a loan, as well as capital funding.

Putting it to the test

The test of trustees' actions will always be what a prudent commercial investor would do in the same circumstances. Trustees who do not observe that test are at risk of a loss of their charity's tax reliefs, or at least a restriction to them. Loans should be on arm's-length terms. If a loan is not repaid with commercial rates of interest, there is a risk the trustees will be held personally liable for the loss to the charity.

Once the subsidiary starts making a profit, it will be taxed on funds that are not donated to the charity. The traditional and best practice is for the trading subsidiary to covenant to pay its profits to the charity, but Gift Aid payments are an alternative.

- Simon Leney is a partner at Cripps Harries Hall LLP.

 

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