The use of trading subsidiaries

Many charitable bodies including schools use trading subsidiaries to carry out their non-charitable activities. This is both tax efficient as taxable profits can be reduced through Gift Aid payments and commercially astute as it protects the parent charity from liabilities should anything go wrong. 

Funds generated from the trading operations are often earmarked for specific uses such as bursaries.

However, the pandemic has resulted in many of the activities of trading subsidiaries being shut down/significantly reduced or restructured. Where it hasn’t been possible to cut costs as quickly as a reduction in revenue this can result in the subsidiary having a loss for the year. This creates a few issues that need further consideration to ensure that there are no unforeseen consequences.

1. The good news is that, generally, losses can be carried forward and used against profits in later periods. As always, things aren’t always that straightforward - there are complications that need to be worked through – but broadly a loss now should attract relief at some time in the future. Where this does matter is that losses are offset against the profits prior to considering whether any payment of Gift Aid is required. This means that a charity that has become used to a return of all the profits by way of a cash Gift Aid payment may be surprised that the cash only represents the profit after brought forward losses rather than all the profits of the year. If the cash flow is critical, other ways should be considered to access the cash reserves of the subsidiary – such as repaying amounts loaned to the subsidiary or outstanding on intercompany account.
2. A loss can often be carried back to generate a repayment of tax if any was paid in earlier years. As most trading subsidiaries will have paid no tax because of the Gift Aid payment this will be of no benefit to many businesses.
3. Trading losses are available for carry forward against the profits of the same trade. If, as a result of the pandemic the activities of the subsidiary change then the losses may not be available. Strictly speaking losses can also lapse if a trade ceases and is then revived. The pandemic has meant that many trading activities did cease for a period. One would hope that HMRC will take a pragmatic view if any cessation of trade was short term and involuntary.
4. A Gift Aid payment by the trading subsidiary is treated as a distribution for the purposes of company law. This means that if there are negative reserves as a result of the loss-making year, this may restrict the ability to make a payment of Gift Aid as distributions can only be paid out of realised reserves. Where there are no differences between accounting profits and taxable profits it is unlikely to be a significant problem as the losses offset against the profits in the tax computations will be the same as the amount of profit added to the distributable reserves. If however, there are differences between book and tax it is possible that there may be a taxable profit, while there are no distributable reserves out of which to make a Gift Aid payment. In this case the trading subsidiary may need to make a payment of tax.
5. When the trading subsidiary was created the Trustees of the charity would have needed to consider both why any funds invested in the company were for the benefit of the charity and why the risk taken with the Charities money was sensible given the potential returns available to it. Where a subsidiary is loss making the charity needs to consider how it intends to fund those losses. Supporting a loss-making trading subsidiary is not necessarily an acceptable use of charitable funds. Therefore, if new funds are made available to the trading subsidiary to cover the losses – consideration should be given by the Trustees as to the business case for making that investment. They should document why the expected return is appropriate given the risk to the charitable funds and the actions that can be taken to mitigate that risk in the event of further difficulties and the expected level of return from the investment. While this exercise may have been undertaken when the subsidiary was originally set up, the very different economic environment of today warrants further consideration of the matter.

None of these issues are necessarily show stoppers, but can be the source of potentially unpleasant surprises if not considered on a timely basis.