1. Charity trading
Some may think that charities cannot trade and others may think that charities are not subject to tax in respect of any trading which they do carry on. Whilst both these propositions can be true in particular cases, they are not universally applicable and charities need to know their true situation.
1.2 What is trading?
First of all, what counts as trading? It involves buying goods or services or the benefit of a right which the charity has. This will cover many things from selling Christmas cards to selling goods in a charity shop to charging for the charity’s services and to licensing the use of the charity’s name or logo.
1.3 Can a charity lawfully carry on trading?
The answer lies in the charity’s governing document. The question is whether the charity’s governing document (trust deed, Constitution or articles (if any company)) permits expressly or impliedly the carrying on of the trade in question.
1.4 Primary purpose trading
The carrying on of the particular trade may be authorised as part and parcel of carrying out the purpose of the charity. For instance, an educational charity may have power to charge fees for the educational courses which it provides. The very purpose of the charity is education and so when it charges for providing those educational services it is trading, but it is what is known as “primary purpose trading”, i.e. trading in the course of carrying out the purpose of the charity.
1.5 Non-primary purpose trading
On the other hand, if the charity wants to raise funds by selling bought in goods or, for example, by holding a dance for which tickets are sold, then such trading would not be in furtherance of the purposes of the charity but would rather be fund raising and would be regarded as what is known as “non-primary purpose trading”. Again, the charity must have power within its governing document to do that. Such authority could be read into a power to raise funds provided for in the governing document or some general clause such as a power to do all such other lawful activities as shall be in furtherance of the objects.
1.6 Breach of trust
If a charity does not have the appropriate power to trade, the trustees run the risk of being in breach of trust by trading without authority. We are able to review your charity constitution for you.
1.7 Is there a limit under the law to charity trading?
There is no limit for primary purpose trading but in other cases where there is non-primary purpose trading the Charity Commission’s advice is that a charity can carry on such trading so long as there is no significant risk of loss. In general terms, small scale trading will not involve significant risk. Small scale trading is regarded by the Commission as trading where the annual total turnover does not exceed:-
(i) £5,000, or
(ii) 25% of the charity’s total incoming resources subject to a limit of £50,000.
Thus, if a charity’s income from all sources including donations, trading and investments is £200,000, £50,000 of that may be trading income so long always, as the charity has power to carry on the trade in question in its governing document.
The Charity Commission do however qualify this test for small scale trading by saying that various other factors such as the size of the charity, the nature of the business, the expected outgoings and turnover projections, should all be taken account of in assessing risk.
1.8 What if the income from non-primary purpose trading exceeds the limit of 25% or £5,000 referred to above, or is regarded as involving significant risk from the outset?
The usual answer is that the charity should establish a wholly owned non-charitable subsidiary company which will carry on the trade and donate its profit from the trading activity to the charity, thus avoiding the charity trading problem and avoiding tax on the profit by the gift aid scheme. More guidance on the trading subsidiary solution is given later in this note.
2. Taxation of trading profits made by charities
2.1 General rule
As a general rule, profits from a trade carried on by a charity are taxable unless an exemption or concession applies. Thus, if a charity sells new goods in its shop, the profit from the sale of those goods is liable to be taxed. However, there are a number of important exemptions and concessions which charities can take advantage of.
2.2 Primary purpose trading
The most important exemption is that where a charity carries on a trade in the direct fulfilment of its charitable purposes such an educational charity or a hospital established as a charity, and charges fees for its services, that income arises from the trade and the profit (without limit) will not be taxable. Similarly if the charity, for example, supplies literature for sale in the course of its charitable activity, such as a religious charity selling religious books, the profit from that activity will not be taxable so long as it is applied for the purposes of the charity.
2.3 Trading work by beneficiaries
There is another exemption for trading profit where the work is carried on by beneficiaries of the charity. This would apply, for example, to goods made or assembled by handicapped people where the charity is set up to help handicapped people. Another example would be the sale of handicraft goods made by people in a project set up by a charity to relieve poverty by training and developing their skills. Such people would be the beneficiaries of the charity and so the sale of the produce would follow from the purpose of the charity.
2.4 Ancillary trading
Where the trade in question is ancillary to the primary purpose trade, that too is exempt from tax on the profit. Examples of ancillary trading which is exempt from tax include the sale of refreshments in the course of a charitable service such as a hospital, museum, gallery, theatre or college. The ancillary trade must be ancillary to the primary purpose trade and so if it is available to the public generally without being exclusive to those availing themselves of the primary purpose trade then it would not qualify as ancillary trading. Thus, a café at a museum which is available to any member of the public, whether or not visiting the museum, that may not be ancillary trading and the result would be that the profit from it is, in principle, taxable.
2.5 Small scale trading
Small scale trading has been described above and in addition to being regarded by the Charity Commission as permissible for charities, it is also the subject of a special exemption from tax for both charitable trusts and charitable companies. It must be remembered that the exemption applies to turnover and not to profit. For the exemption to apply the annual turnover limit of non-exempt trading must not be exceeded. As referred to above, the annual turnover limit is:-
(i) £5,000, or
(ii) if annual turnover of non-exempt trading activity is more than £5,000 and is 25% of a charity’s total incoming resources subject to a maximum of £50,000.
For example, if a charity’s non-exempt trading income is £40,000 and its total income in every form is £200,000, its £40,000 of non-exempt trading income is exempt from tax as it is less than 25% of the total incoming resources and is less than £50,000.
In referring to non-exempt trading here it is intended to refer to trading income which is exempt under one of the other exemptions such as primary purpose trading, sale of donated goods or fund raising event sales which are referred to below.
2.6 Sale of donated goods
A number of well-known charities sell goods which are donated to them by their supporters. This is often done through charity shops. This looks like non-primary purpose trading as it is done for fund raising purposes and not as part of the charitable purpose of the charity. However, neither HMRC nor the Charity Commission regard the sale of donated goods by charities as trading and so the profits from it are not taxable. There is no limit on the volume of donated goods which charities may sell. It is regarded as the conversion of a gift into cash and not trade.
Note however that if donated goods are improved or altered by the charity, their onward sale may not be regarded as within the exception because the goods have become something more than what was donated. Cleaning or repairing the donated goods will not count as improvement or alteration.
2.7 Fund raising events
There are many ways, often ingenious by which charities raise funds. Sometimes the methods used to raise funds are trading and in turn may or may not be exempt from tax under one of the exemptions described in this note. Other methods of fund raising may not be trading and so not taxable at all. Examples of those methods (which would not count as trading at all) are public appeals for funds, sponsored walks, public or door to door collections and soliciting legacies. However, events such as dances, jumble sales, car boot sales, quiz nights, dinners, fetes and concerts can be trading which is not primary purpose trading, nor ancillary trading, nor small scale trading, nor the sale of donated goods. These methods of fund raising may therefore be taxable unless they can come within the available exemption for fund raising events.
The exemption for fund raising events applies to an event organised by a charity, the primary purpose of which is to raise funds for the charity and is promoted as such. Thus, for example, dinner dances, barn dances, discos, concerts, plays, festivals, exhibitions, jumble sales, car boot sales, games, quizzes, firework displays, dinners, lunches, barbeques, garden produce shows, film shows and sports events can all be within the exemption if organised as fund raising events for the charity and are promoted as such so that those attending are aware of the true nature of the event.
There should not be more than fifteen events of the same kind at the same location organised by the charity in any financial year.
Challenge events such as the London Marathon which are organised by a commercial operator involving the payment of a registration fee by participants do not come within the exemption because they are not organised by the charity. However, if a participant obtains gifts from sponsors, those gifts will not be taxable and could qualify for gift aid.
As a foot note to this tax exemption, it is sometimes the case that events are arranged by charities and, whilst there is no entrance fee, persons attending have a facility to make voluntary donations. Such voluntary donations will not be taxable but if there is a requirement to make a minimum donation, that would not be regarded as voluntary and so it would be, in principle, taxable as an entry fee.
2.8 Lotteries (raffles, sweepstakes, tombolas, etc)
The Charity Commission regard the holding of lotteries by charities as permissible non-primary purpose trading within the relevant gambling legislation because it carries negligible risk. The profits from a lottery will be exempt from tax if applied to the charity’s charitable purposes and either the lottery is an exempt lottery or is promoted in accordance with a lottery operating licence under the Gambling Act 2005.
The two types of lottery which are exempt and which are most likely to be of relevance to charities are firstly those within the category called “incidental non-commercial lotteries” and secondly “small society lotteries”.
An incidental non-commercial lottery does not require a licence from the Gaming Commission, nor does it require to be registered with the local authority. In these cases the lottery must be incidental to an event which is not held for private gain and the tickets must be sold on the premises at which the event is held. Furthermore, the total spent on prizes must not be more than £500 (prizes which are donated do not count in this figure) and all tickets must be sold at the location during the event and the result must be made public while the event takes place. Examples of such lotteries would be those held at a school fete or a social event such as a dinner dance.
The small society lottery must be set up for non-commercial purposes and there is a limit of £20,000 on ticket sales. Such lotteries must be registered with the local authority. They must always be run by non-commercial societies which would include charities.
3. Business rate
Charities qualify for relief from business rate in respect of premises occupied by them, where the premises are wholly or mainly used for charitable purposes. The relief is mandatory as to 80% of the business rate and the local authority has power to grant additional discretionary relief up to 20% so that, if a local authority looks with favour upon a charity, it may achieve 100% relief from business rate.
This relief is available for offices occupied by a charity for its administration but also applies where the charity occupies a shop for its primary purpose trading or for the sale of donated goods. However, occupation by a trading subsidiary or where goods are sold by a charity on behalf of supporters, would not be regarded as occupation by the charity for the purposes of the relief.
Where both the charity and a trading subsidiary occupy premises it will be necessary for the charity to show that the premises are mainly occupied by it. This is often taken to mean that the floor space occupied by the charity is more than 50% or the charity’s turnover in primary purpose trading and sales of donated goods (if any) is greater than the turnover in non-primary purpose trading and bought in goods.
4. Value Added Tax
Although charities have a number of general exemptions from tax such as income tax, capital gains tax, inheritance tax and stamp duty land tax, there is no such general relief from VAT for charities. Thus, if a charity makes taxable, i.e. VATable supplies, of more than the VAT threshold (currently £70,000) it must register for VAT purposes. It will then have to charge VAT at 17.5% rising to 20% from 1st January 2011 on services or supplies which are not exempt or zero rated. Additionally, the charity will pay VAT on goods and services which it purchases like everyone else, although it will be able to recover VAT against outputs if any.
4.1 Exempt supplies
If supplies by the charity are exempt, no VAT is chargeable and they do not count towards the VAT threshold.
4.2 Zero rated supplies
A number of zero rated supplies may be especially applicable to charities so that no VAT is chargeable and the charity would be able to recover VAT on relevant inputs. Examples are the supply of books, pamphlets, brochures and leaflets and the sale of donated goods. The sale of donated goods is a very important case of zero rating for VAT purposes because many charities raise funds by the sale of donated second hand goods. The zero rating for the sale of second hand goods also applies where the goods are sold through a trading subsidiary of the charity so long as the trading subsidiary has agreed in writing to transfer to the charity its profits from the supply of the goods or the profits otherwise payable to the charity. A letter of agreement is required.
4.3 Fund raising events
Certain fund raising events are zero rated in the circumstances described at paragraph 2.7 above. Exemption applies to the supply of goods and services provided by a charity in connection with an event that is organised for charitable purposes by a charity where the primary purpose of the event is the raising of money and which is promoted as such. Those attending the event must be made aware of the fund raising purpose.
The exemption will not apply where there are more than fifteen events of the same kind at the same location in any financial year.
The kind of fund raising events which will be treated in this way for VAT is the same as listed in paragraph 2.7 above.
The exemption from VAT will also apply where the supplies are made by a charity’s trading subsidiary which has agreed to transfer all its profits to the charity and it can also apply where the event is organised by more than one charity.
It follows that supplies such as admission charges which would otherwise be chargeable to standard rate VAT will not be so charged if they come within this exemption.
VAT is a complex and very detailed tax and even although a charity may think it can take advantage of an exemption or zero rate or that the supply is outside the scope of VAT, it is always going to be appropriate for the charity to take specialist advice in this complex area.
5. Trading subsidiary
5.1 What can be done if there is no exemption for taxation purposes for the charity’s trading activity?
The same question arises if the charity carries on primary purpose trading or ancillary trading which it regards as putting the assets of the charity at risk.
The common answer to these situations endorsed by the Charity Commission is the formation by the charity of a trading subsidiary company limited by shares and wholly owned by the charity. The intention is that the trading subsidiary company (“TSC”) will make profits which will be donated to the charity by way of gift aid and so tax on those profits will be relieved.
5.2 Investment considerations
However, it is important to remember that the charity’s provision of funds for the running of the TSC must be made on good investment grounds. The Charity Commission have said in guidance:-“The making of investments in companies which are owned wholly or substantially by the charity is within the scope of the general power of investment. But the suitability and diversification considerations apply as much to this form of investment as to any other. So does the duty to take proper advice”.
The trustees of the charity should therefore take the following steps in deciding whether to set up a TSC in which any funds of the charity will be invested:-
5.2.1 satisfy themselves that it is in the charity’s interest to make the investment;
5.2.2 compare returns likely from the investment with returns from other possible forms of investment;
5.2.3 obtain sufficient information and advice to make a reasoned decision. Such information would include market research if it is a new venture, cashflow for the trading activity, a budget for income, expenditure and capital requirements and a business plan;
5.2.4 consider the need to diversify the charity’s investment;
5.2.5 consider realistically how long the investment is for;
5.2.6 consider whether advice is required on the proposed investment;
5.2.7 cause minutes to be prepared recording the reasons for investment decisions.
5.3 Investment by loan or share capital
It is desirable for a TSC to borrow funds from a commercial lender in order to avoid the difficulties inherent in justifying investment by the charity but this is in itself difficult to achieve because of the reluctance of lenders to risk default and the cost of borrowing which would be incurred. It is often the case, therefore, that charities provide funding for a TSC.
The most common method is by way of loan. Any loan should however be at a proper rate of interest, secured and provide for repayment. An interest free loan would not generally be acceptable. The interest rate should be at least equal to the rate available to the charity in the open market and should take account of the risk involved.
With regard to repayment, it has to be remembered that in order to be able to repay the loan, the TSC will have to retain profits which will not therefore be available to be given to the charity under gift aid and so a corporation tax charge will arise. This too is a factor to be weighed by the trustees when making the loan.
With regard to security, this could be provided by a fixed charge on land and buildings or a fixed and floating charge on the undertaking of the TSC. There is still a problem here in that if the charity donates all its profit to the charity, that form of security may be illusory as the TSC will not be able to build up reserves.
The loan route does therefore need careful consideration of the implications before being implemented.
5.3.2 Share capital
The Charity Commission accept that a charity may, subject to the points made at 5.1 invest in a TSC by way of equity shares and may take account of the desire to give confidence to third parties about the security of the TSC and in order to avoid insolvency. However, the investment should nevertheless be appropriate having regard to the factors referred to in paragraph 5.1.
5.4 Tax hurdle
A very important consideration when a charity is contemplating the establishment of a TSC is the need to avoid loss of tax relief when a charity invests in a TSC. It is essential that the charity makes sure that the investment is not treated by HMRC as non-charitable expenditure. If a loan, for example, is regarded by HMRC as non-charitable expenditure, the amount of the loan will be taxable in the hands of the charity. For a loan or an investment in shares to not be regarded as non-charitable expenditure, the charity should make a claim to HMRC in respect of it and must satisfy HMRC that the loan or share investment is made for the benefit of the charity and is not made for the avoidance of tax. The loan or investment should therefore be secure, carry a fair rate of return and, in the case of loans, should involve repayment in due course.
5.5 A subsidiary for primary purpose trading
The guidance contained in paragraphs 5.1 to 5.4 above applies to TSCs set up to carry on activities which are fund raising and are not intended to implement the charitable purposes of the charity. However, if the TSC is set up to carry out the trading aspects of the charity’s own charitable purposes, then the situation is very different. This step would be taken where the charity trustees regard the trading risk for the charity as too great and wish to protect the assets of the charity by placing the risk within the TSC with limited liability. In these circumstances, a loan by the charity to the TSC may be on favourable terms rather than commercial terms and HMRC should more easily be able to regard the loan as for the benefit of the charity and not for the avoidance of tax.
Although trading by charities is permissible with the appropriate authority contained in the charity’s governing document and is often exempt from tax, it can be a complex area with hidden traps. It is generally advisable for charities to take both accountancy and legal advice to make sure that there is no breach of trust, that advantage is taken from available tax exemptions and that risk is minimized.
We are able to offer specialist advice in relation to all areas of charity law including as to
- The formation of subsidiary trading companies
- Advise as to a charity governing document and whether this permits trading – or whether amendment is required