New Guidance from the Charity Commission
The Charity Commission has published new practical guidance (CC35) on when and how charities may engage in trading. What constitutes trading in a charity is not straightforward, however a key feature of trading is the sale of goods or services.
The identification of trading activities is important as trading profits may be taxable and subject to corporation tax. Trading which furthers the objectives of the charity, or where the trading profits are to be used for the furtherance of those objects, does not prevent an activity from being regarded as ‘trading’.
Factors to consider when identifying trading include the number and frequency of transactions, the nature of the goods, the intention of the charity in acquiring the items to be sold, the nature of the sale and the presence or absence of a profit motive. Charity law allows charities to trade provided that the trading falls into one of the following categories listed below:
- ‘Primary purpose trading’ - trading which contributes directly to the objectives of the charity as included in its governing document.
- ‘Ancillary trading’ - it contributes indirectly to the successful furtherance of the purposes of the charity.
- ‘Non-primary purpose trading’ - it does not involve significant risk to the resources of the charity and is simply carried out to raise extra funds.
The following activities are not considered as trading and any profit derived is not regarded as trading profits:
- The sale or letting of goods donated to a charity for the purpose of sale or letting
- The sale of investments
- The sale of assets which the charity uses, or has used, for its charitable purposes
- The letting of land and buildings where no services are provided to the user
Charity trading profits are exempt from corporation tax (or income tax in the case of charitable trusts) where the trading is:
- ‘Primary purpose trading’
- ‘Ancillary trading’
- Within the terms of the ‘small scale exemption’ - profits from small-scale non-primary purpose trading are exempt if the profit is applied for the charity’s purposes
- A lottery - the profits from such lotteries are exempt from tax connected with certain fundraising events.
Further details can be found in the Charity Commission’s guidance Charities and fundraising (CC20). Alternatively, trading can be undertaken in a subsidiary trading company. This is a company owned and controlled by the charity in order to generate income for its parent charity.
Where there is risk arising from non-primary purpose trading, a subsidiary company must be used. The main benefit is to protect the parent charity and its assets from the risks involved in trading; however there are disadvantages including the additional costs associated with establishing and operating a trading subsidiary. Other issues can include managing any conflicts of interest between the charity and the subsidiary, and funding the capital requirements of the subsidiary. Additionally, any profits in the subsidiary that are not gifted to the charity will be subject to corporation tax.
Other new Charity Commission Guidance:
There have been two recent Charity Commission updates:
1. Charity Commission guidance no. 12 on “Managing a charity’s finances; planning, managing difficulties and insolvency”
The guidance has been updated to emphasise that trustees are ultimately responsible for their charity’s finances. Trustees should comply with their duties to manage and safeguard their charity’s assets.
The overall responsibility for effective governance and the implementation of proper financial management rests with the trustees; however it is probable that the financial aspects of a charity are delegated to staff members. Ultimately, trustees need to ensure they are fully aware of the financial health of their charity. It is also important for planning and mitigating purposes that the trustees are aware of the ways in which their charity’s assets and resources can be used should the charity face financial difficulties and/or potential insolvency. There are two separate tests trustees must consider for insolvency and failure as either might be an indication of insolvency; 1) the charity cannot pay its debts as they fall due for payment; or 2) the value of its liabilities exceeds the value of its assets.
There are various questions and considerations for trustees in this situation. These are detailed in the guidance published on the Charity Commission website.
2. Charity Commission guidance 19 on Charity reserves and Charity governance, finance and resilience.
The guidance emphasises the need for trustees to decide, publish, implement and monitor their charity’s reserves policy so that they can comply with their legal duties. Such a policy is important as
it explains to readers of the accounts why a charity is holding a particular amount of reserves.
A reserve policy should be developed to:
- Fully justify and clearly explain the level of reserves
- Identify and plan for future identified costs that reflect the risks of unplanned closure associated with the charity’s spending commitments, potential liabilities and financial forecasts
- Help to address the risks of unplanned closure on their beneficiaries (in particular, vulnerable beneficiaries), staff and volunteers.
Charities should publish the reserves policy (even if not required to by law) and ensure
it is tailored to the charity’s circumstances - it should not be just a standard form of wording. It should explain to funders, beneficiaries, the public and the Commission exactly what reserves are kept (or not kept) for, and when they are to be used. Once a reserves policy is set, it should not be regarded as a static policy but instead be regularly monitored and reviewed to ensure it is effective in the light of the changing funding, the financial climate and other risks.