Contrary to some views, charities may
conduct trading but only on certain terms. Otherwise, a trading company should be used.
When to use a trading company
The most common reasons for a charity to set up a trading company are:
- to carry on trading which does not directly fulfil the charity’s purposes
- to protect the charity from risk
- to separate significant specialist work.
We recommend trustees familiarise themselves with the Charity Commission’s published guidance, Charities and trading
, which has recently been updated.
The Commission emphasises a trading subsidiary should be used where there would be a significant risk to the assets of the charity if it were to carry on non-primary purpose trading itself. However, be aware the trading subsidiary must be set up correctly in order to protect the charity and its assets from the risks involved in trading. A parent charity can inadvertently be liable for its subsidiary’s losses or liabilities. In certain cases trustees may find themselves personally liable if the assets of the charity are put at risk for the benefit of the trading subsidiary.
Additionally, risk is not the only factor: a charity should not conduct non-charitable trading, unless small scale, even if there is no great risk because a charity must only trade in direct fulfilment of its objects.Primary purpose trading & non-charitable trading
There are no limits on the extent to which a charity may carry out primary purpose or charitable trading activities or trading which is ancillary to this. This includes trading which is:
- Primary purpose trading i.e. a direct means to further the charity’s charitable purpose/s (set out in the objects of the governing document);
- Ancillary trading which is supportive of the charitable purposes, such that those are furthered indirectly; the term ‘ancillary trading’ tends no longer to be used by the Commission but it talks instead of trading which helps a charity’s main purpose, such as a café for a museum’s visitors
- Trading carried out mainly by beneficiaries
for example the sale of items made by disabled persons who are beneficiaries of a charity which supports them.
The profits from such trading are exempt from corporation tax (or income tax in the case of a charitable trust).
There is also a small trading exemption, below which HMRC will not charge tax even if the trading is non-charitable. The current limits are:
Charity’s gross annual income
Maximum permitted small trading turnover
£20,001 to £320,000
25% of your charity’s total annual turnover
Fundraising and trading are very similar but the law can treat them differently. Trading raises funds of course. However, the term fundraising is very wide and includes trading, inviting donations, and fundraising events of all sorts.
The scope of this short article is not sufficient to cover all the rules on fundraising, but please note data management (including the General Data Protection Regulation and the Privacy and Electronic Communications Regulations) as well as the requirements of the Information Commissioner and The Fundraising Regulator are all relevant.Advantages and disadvantages of using a trading company
The advantages of using a trading company include:
- Protection: using a trading company protects the charity’s assets from the risks of trading, although care must be taken that the charity does not in fact become liable explicitly or impliedly
- Wider trading scope: using a trading company allows the charity to benefit from the profits of broader, non-charitable trading
- Specialisation: a trading company can have a board and senior staff selected for particular work undertaken within that company, which may be quite different from the charity’s work
- VAT savings: when undertaking certain construction projects, significant VAT savings can be made by careful use of a trading company (a mechanism endorsed by HMRC)
- Joint ventures: a trading company can be used by more than one charity, and also non-charities, as a joint venture and a formal way of managing the relationships and risks of such an enterprise.
The disadvantages of using a trading company include:
Structure of the trading company and relationship with the charity
- Costs: the additional cost of setting up and running a separate company, including internal cost as well as professionals’ fees
- Administrative burden: separate accounting and governance is required, including meetings and all associated paperwork and communications; the resource for this must be planned for
- Governance and recruitment: connected with the last point, it can be difficult to recruit directors for a trading company
- Tax implications: the tax benefits of the charity may be affected if the trading company’s work is extensive and for example if the two organisations share premises there may be an impact on business rates and stamp duty land tax.
A trading company is usually established as a company limited by shares, although sometimes it is more appropriate to use a company limited by guarantee or a community interest company. For wholly owned trading companies, the charity will usually own just a single share (which will be the only one issued). If a guarantee company is used (including a CIC type) then the charity will be the sole member.
Joint venture trading companies will have the joint venture ‘partners’ each owning shares (or being members) with rights set out in a JV agreement.
The relationship between a parent charity and a trading company should be structured in such a way that the governance, finances and operations of two entities are as separate as possible. This includes the management of any potential conflicts of interest, management accounts and bank accounts, project management and meetings of staff and boards. The relationship must be kept commercial or ‘at arm’s length’, in order to preserve the charity’s independence.
A charity must (in most circumstances) not subsidise the trading company because otherwise the charity’s resources are vulnerable to non-charitable use. Thus, any services, facilities or other resources used by the trading company should be charged for by the charity at a commercial rate. The working arrangements should be set out in a formal agreement and the arrangements reviewed regularly.
If you would like to discuss charities and trading and the use of trading companies in more detail, please get in touch
with a member of our Charities Team.