1. DTAS Annual Conference 2013 TRADING AND CHARITABLE STATUS
Aberdeen Edinburgh
Glasgow
DTAS Annual Conference TRADING AND CHARITABLE STATUS
Stephen Phillips
Head of Third Sector Team
2 September 2013

2. Trading and charitable status
Key principles
Using a subsidiary company
Making the decisions

3. Key principles Understanding the key principles round charity trading:
avoids unnecessary tax exposure
avoids risk of potential criticism/action by OSCR
allows the development trust to move forward with new income-generating opportunities – tailoring a legal structure to fit

4. Key principles Main tax exemptions relevant to development trusts:
primary purpose trading
trading where the work is mainly carried out by beneficiaries
small trading exemption
plus
rates relief
SDLT (stamp duty) on transactions relating to land/buildings

5. Key principles Charitable status is important for development trusts:
maximises range of potential sources of funding
builds confidence/trust among the local community, funders, partner organisations, businesses
tax reliefs maximise the cash that can be recycled:
to develop the activities of the development trust
to support projects and initiatives that benefit the local community
But the rules round tax relief - and wider charity law principles round trading - need to be respected

6. Key principles Primary purpose trading
Applies where the trade is carried on in the course of the actual carrying out of a primary purpose of the charity
Not enough that the profits are used for charitable purposes of the development trust; focus is on the trading activity itself
Easy example – arts organisation, profits from sale of tickets for a performance
Can be uncertainty round what is included within the boundaries of each charitable purpose esp for development trusts

7. Key principles Primary purpose trading (cont)
May be a need to adjust articles/constitution to add in a further charitable purpose (with OSCR’s prior approval)
If a trading activity falls within the primary purpose exemption, there is no upper limit on the profits that can be earned, tax free

8. Key principles Work mainly carried out by beneficiaries
Applies where the work in connection with the trade is mainly carried out by beneficiaries of the charity
Easy example – Cafe which is mainly staffed by people with learning difficulties
No clear definition of “mainly”
Need to continue to satisfy the “mainly” test reduces flexibility as regards future changes to the staffing structure (eg if financial viability becomes challenging)
No upper limit on tax-free profits

9. Key principles Small trading exemption
Applies where neither of the two main exemptions apply
Exemption from tax where all turnover (turnover, not profits) from all trading activities outwith the two main exemptions is less than:
25% of the charitable development trust’s overall income;
but on the basis that even if the development trust has income of over £250k, the maximum allowed will be £50k.
Useful for small pilot trading initiatives, or for small-scale sources of trading income
Charity law issues should be borne in mind – a charity should not put its assets at risk in supporting non-charitable activities

10. Key principles Other points
Certain activities may fall within the primary purpose exemption as an ancillary trade eg a cafe within a museum with no direct access from the street
Income from a lease (where minimal landlord services are supplied) is not trading income, and falls with the charities tax exemptions
But income from hiring out rooms (unless primary purpose) will not fall within the charities tax exemptions – other than (possibly) the small trading exemption

11. Key principles Other points (cont)
Charities are exempt from capital gains tax
But that exemption will not apply where the charity is essentially acting as a commercial property developer
Sale of donated goods is normally not a trade, so usually exempt from tax
Special rules apply in relation to fundraising events
Sponsorship arrangements may or may not be exempt from tax – depending on what benefits are received by the sponsor

12. Key principles Further issues
A trading activity that makes a loss can raise questions under charity law – use of charity funds to support non-charitable activities
Expenditure by a charitable development trust in setting up a trading activity outwith the two main tax exemptions could (in theory) attract a tax charge on an equivalent amount of income
VAT implications should be checked out in each case
There may be advantages – over and above tax reasons – that make a subsidiary company attractive

13. Subsidiary company
A subsidiary company can carry on trading activities that the development trust (due to charitable status) is unable to carry on itself
Board of subsidiary is normally smaller than main board, and made up mainly of people with commercial expertise
Subsidiary can be a separate focus for funding and security arrangements
There are checks and balances in the corporate structure of the subsidiary which bolt it to the development trust

14. Subsidiary company
Subsidiary’s own board has primary responsibility for the subsidiary company’s operations
Development trust retains ultimate control, as it holds 100% of the voting shares in the subsidiary eg:
power to appoint/remove the directors of the subsidiary
power to alter the subsidiary’s articles of association
Typically, the subsidiary’s annual business plan requires to be approved by the board of the development trust

15. Subsidiary company
Subsidiary’s profits would normally be taxable – but gift aid is used to draw off profits to the development trust
If subsidiary has eg £100,000 profits:
gift aid payment to development trust of £95,000
subsidiary pays tax on balance of £5,000
development trust has £95,000 to use for its charitable purposes

16. Subsidiary company Points to note:
Subsidiary needs to pay development trust for use of development trust’s staff, premises, equipment etc
Development trust should not take on loans, grant securities etc to fund the subsidiary’s trading operations
Payments by the development trust to the subsidiary could cause tax issues (as well as being problematic under charity law) unless:
they can be justified as a sound investment, with a reasonable return and proper security or
they are specifically earmarked for projects/initiatives which directly further the development trust’s purposes (and with outcomes being in line with amounts paid)

17. Making the decisions Identify each income-generating activity
For a steering group setting up a new development trust or a board of an existing development trust considering a new trading operation.....
Identify each income-generating activity
Check against the two main exemptions – primary purpose/work mainly by beneficiaries
If neither, then consider if the anticipated income will fall below the small trading threshold (after adding in the income from other trading activities that fall outwith the two main exemptions)
If none of the above three exemptions apply, then consider use of a non-charitable trading subsidiary (or possibly an independent trading company ?)
Take advice if not clearcut – and including accounting and VAT issues