CC35 – TrusteeS, trading and tax

How charities may lawfully trade

This guidance is mainly about trading for the purpose of raising funds, rather than trading to carry out the charity’s objects.

Terminology and Definitions

Ancillary trading.  Trading ancillary to a charity’s primary purpose, legally part of the charity’s ‘primary purpose trading’.

Non-primary purpose trading.  Trading which is not primary purpose trading.  In practice this will mean that the trading is carried on with the main or sole aim of raising funds for a charity.

Primary purpose trading.  Trading that is carried on by a charity in the course of carrying out a primary purpose of the charity.

What is trading?

The following activities are not generally regarded as ‘trading’, and the income derived from them is not regarded as trading profits:

• the sale or letting of goods donated to a charity;
• the sale of investments;
• the sale of assets which the charity uses, or has used, for its charitable purposes; and
• the letting of land and buildings where no services are provided to the user.

When a charity lets property, the trustees will normally need to obtain the advice of a qualified surveyor regarding a proper rent for the property.

What kind of trading may charities carry on?

Charity law allows charities to trade provided that the trading falls into one of the following categories:

• ‘primary purpose trading’;
• ‘ancillary trading’;
• ‘non-primary purpose trading’ that does not involve significant risk to the resources of the charity.

‘Non-primary purpose trading’ is normally understood to include:

• the conduct of lotteries, subject to conditions;
• trading within the terms of the ‘small scale exemption’.

Sales of donated goods are zero-rated if the goods are sold through charity shops, or through charity auctions of similar events, to the general public, disabled people, or people receiving certain specified benefits, or are exported.

Do charities have to pay tax on trading profits?

Charity trading profits are exempt from corporation tax where the trading is:

• ‘primary purpose trading’;
• ‘ancillary trading’;
• within the terms of the ‘small scale exemption’;

a lottery; and

• connected with certain fund-raising events.

Do charities have to charge VAT on sales?

There are special treatments for certain items:

• the sale or hiring out of goods donated to charities for that purpose is zero-rated for VAT;

and

• the sale of goods or services at certain charity fund raising events is exempt from VAT.

The area of VAT is a notoriously complex one.

What is ‘ancillary’ trading?

‘Ancillary trading’ contributes indirectly to the successful furtherance of the purposes of the charity.  This is treated as part of ‘primary purpose trading’ for both charity law and tax purposes.

An example of ancillary trading is the sale of food and drink in a restaurant or bar by a theatre charity to members of an audience.  The level of annual turnover in trading which is said to be ancillary may have a bearing on the question whether the trading really is ancillary, but there is no specific level of annual turnover beyond which trading will definitely not be regarded as ancillary.

What is ‘non-primary purpose trading’?

Charity law permits charities to carry on non-primary purpose trading in order to raise funds, provided that the trading involves no significant risk to the assets of the charity.

What if trading comprises both ‘primary purpose’ and ‘non-primary purpose’ elements?

For tax purposes this type of mixed primary and non primary purpose trading activity must be treated as two separate trades.  There must be a reasonable apportionment of expenses and receipts between the notionally separate trades.

Does running a lottery count as ‘trading’?

Conducting a lottery is trading.  However, subject to conditions, charities are allowed to hold lotteries and the profits from such lotteries are exempt from tax.

What is the small scale exemption?

It applies only where all the relevant profits or income are applied for the charity’s purposes.

In order to qualify for the small scale exemption within a given chargeable period, either;

• the annual turnover of the relevant non primary purpose trading of the charity, plus the ‘incoming resources from miscellaneous activities’ potentially qualifying for exemption, must not exceed the ‘relevant threshold’ during the chargeable period; or
• if it does exceed the ‘relevant threshold’, the charity must have had a reasonable expectation at the start of the chargeable period that it would not do so.

What tax privileges apply to charity fundraising events?

The supply of goods or services at or in connection with a wide range of fundraising events is exempt from VAT, and the trading profits are exempt from corporation tax, subject to strict conditions:

• trading is not being undertaken through a series of events;
• there may be no more than 15 events of the same kind in a charity’s financial year at any one location of a charity.

What happens if a charity loses money from non-primary purpose trading?

If a charity incurs losses in non-primary purpose trading which it has carried on, the charity’s tax exemptions on other income may be at risk, and the trustees may be liable for breach of trust.

If a charity incurs a loss from its non-primary purpose trading, the loss in connection with the trading will be regarded as ‘non –charitable expenditure’.

The Commission’s view is that incurring such a loss would only amount to a breach of trust if the loss had been incurred irresponsibly.

However, tax exemption is at risk whether the loss has been incurred irresponsibly or not.

What is a ‘trading subsidiary’, and when must a trading subsidiary be used?

A trading subsidiary must be used in any case where there would be a significant risk to the assets of the charity, if it were to carry on non-primary purpose trading itself.

The fact that the trading profits would have been exempt from tax if the trading had been carried on by the charity itself does not necessarily mean that it is appropriate for the charity to carry on the trading.

The provision by a charity of advertising and other promotional services in return for business sponsorship is an example of trading which is unlikely to present significant risk.

The use of a trading subsidiary may be disadvantages in that some benefits which charities enjoy may not be available, e.g. charity rate relief and exemption from stamp duty land tax.

How can a trading subsidiary pay funds to its parent charity?

Funds are now rarely, if ever, paid to the parent charity by way of share dividend.

Where a parent charity provides loan capital to a trading subsidiary, the trading subsidiary must, of course, make interest payments and repayments of principal in accordance with the terms of the loan.

It is possible that the trading subsidiary may prefer to acquire the resources needed to make the full Gift Aid payment out of funds borrowed from the parent charity.  However HMRC Charities take a critical view of any apparently circular arrangements.

The trading subsidiary will usually require more than a nominal amount of capital in order to operate effectively.

The parent charity’s trustees must be able to justify financial support for a trading subsidiary as an appropriate investment of the charity’s resources.

Trustees might wish to provide a trading subsidiary with an interest-free loan, or a loan which is secured only by the contractual undertaking of the subsidiary, and not by a charge over assets of the subsidiary.  However HMRC Charities takes a critical view of loans which are not made on proper commercial terms.

What other tax implications need to be considered when investing in a trading subsidiary?

To avoid treatment as non-charitable expenditure, the trustees must be able to satisfy HMRC Charities that the investment in the trading subsidiary was made purely for the benefit of the parent charity, and not for the avoidance of tax.

It is important for trustees to keep a record of the deliberations which preceded any decision to make an investment in a trading subsidiary, and to be able to demonstrate the HMRC Charities that the investment duties described briefly above have been properly discharged in relation to the making of that investment.

Does a trading subsidiary enjoy the tax privileges accorded to its parent charity?

A trading subsidiary enjoys some, but not all, of the VAT privileges of its parent charity, provided that certain conditions are met:

• the zero-rate of VAT on the sale of letting of donated goods;
• the VAT exemption on sale of goods and services by a trading subsidiary in connection with fundraising events.

Trading subsidiaries have no absolute right to rate relief in respect of the properties which they occupy.  However the rating authority may grant rate relief at its discretion.

Governance issues

As a matter of good governance, there should be both:

• at least one person who is a trustee, but not a director or employee of the trading subsidiary; and
• at least one person who is a director of the trading subsidiary, but not a trustee or employee of the charity.

Trustees must always put the interests of the parent charity first.

Trustees must routinely monitor the performance of all trading subsidiaries.

Can a charity guarantee the liabilities of a trading subsidiary?

Such guarantees, if given, will often be unenforceable against the charity and may expose trustees to personal liability.

The registration of a ‘VAT group’ comprising a charity and its trading subsidiary or subsidiaries means that each entity within the group guarantees the settlement of the VAT liabilities of the other entities within the group.  There is no objection in principle to the registration of a charity as part of a VAT group.  But before doing so trustees need to satisfy themselves that the overall benefits of group registration outweigh the risk of loss to the charity’s assets.

Guaranteeing the liabilities of trading subsidiaries can be a complex area.

Can a parent charity and its subsidiary consolidate their bank accounts?

There is no  objection in principle to the consolidation of bank accounts in order to obtain better terms of business from the bank.

Can a trading subsidiary use its parent charity’s land and buildings?

Any use of the parent charity’s land and buildings by a trading subsidiary should be covered by a formal lease or licence of the property concerned from the charity to the subsidiary.  The trading subsidiary must pay a rent of fee which is comparable to that which would be payable for letting the property on the open market.

Charities enjoy an exemption from stamp duty land tax on their purchases of land (which includes buildings).  However the relief does not apply to purchases by trading subsidiaries..

Can a charity invest indirectly in a trading subsidiary?

The charity must charge the subsidiary, at fair value, for such services and use of facilities.

Such charges should not normally go beyond the reimbursement of the charity’s costs; it they do, they will be considered to be a receipt of trading carried on by the charity.

Where staff are employed exclusively on the trading subsidiary’s business, the trading subsidiary should employ the staff.