Annex 1
TRADING
Charities vary enormously and raise income in
many different ways. Some of this income is general donations
but much of it is derived from carrying out activities which fall
within the definition of a trade in Section 832 of the Taxes Act
1988 (ICTA '88) which states that a trade includes, "every
trade, manufacture, adventure or concern in the nature of trade".
This wide definition means that where charities
charge fees for services they are often trading. For example,
a residential care charity contracting with a local authority
or an arts organisation charging a fee for admission to an exhibition
are both trading. Section 505 ICTA '88 gives exemption for trading
profits which are used solely for charitable purposes providing:
— the trade is exercised in the course
of the actual carrying out of a primary purpose of the charity;
or
— the work in connection with the trade
is mainly carried out by the beneficiaries of the charity.
There are also de minimus exemptions that exempt
from tax small trades and an extra statutory concession for special
events, raffles, jumble sales etc. Many charities are confused
as to whether an activity is a trade (an area that has been the
subject of many court judgements) and whether it falls within
the exemptions noted above (for example if the Royal Society for
Protection of Birds sells bird boxes is this a primary purpose
trade). As a consequence charities often use non charitable trading
subsidiaries and profits made by these subsidiaries are paid to
the charity so usually there is no liability to corporation tax.
Trading subsidiaries are usually used for two
main types of trade:
(1) Merchandising and retail operations, this
includes mail order catalogues, sale of bought in goods etc.
(2) Other fundraising activities such as sponsorships,
special events etc.
We have considered both these areas in this
submission. The majority of respondents to a CFDG members' survey
supported the Cabinet Office recommendations "to amend charity
law to allow charities to undertake all trading within the charity,
without the need for a trading company. The power to undertake
trade would be subject to a specific statutory duty of care."
The thinking was that, whilst there were technical
arguments to support the status quo it made little sense in practice
and created an administrative burden that did nothing to help
a charity further its objectives. For example, there is a need
for the charity and its subsidiary to operate at arms' length
and this means that a charity has to make charges to the subsidiary
for use of shared premises, staff and other services. This exercise
is very circuitous as it simply reduced the profit that the trading
company pays back to the charity.
In its response the government turned down the
proposal and cited a number of reasons. We have listed them below
and added our response.
(a) There could be increased risks to charity
assets. Charities' assets would be available to creditors to meet
trading liabilities. In extreme cases this could force charities
to reduce their services to users and beneficiaries, since assets
used in the course of charitable work might have to be diverted
into paying off the debts of failed trading ventures.
Having due regard to the specific duty of care
charities would channel any speculative or risky forms of trading
through a trading company. There is much evidence to show that
whilst there are some failed trading companies most are quite
successful.
(b) The boards of many charities presently
lack trustees with the commercial experience and acumen to establish
and conduct trading operations.
Usually there is much commonality between the
directors of the trading company, the charity trustees and senior
staff. If the expertise does not exist within this group then
we fail to see how having the trade in a separate company helps.
(c) Trustees of unincorporated charities
might be more exposed to personal liability, since their liability
would also extend to trading debts.
See response to (a) above. In general we believe
that where there is a risk of personal liability for debts of
the charity then charities should incorporate. (The new CIO proposals
will assist this).
(d) Some charities might develop trading
to such an extent that they became to all intents and purposes
trading operations with a charitable sideline. This would not
only bring their charitable status into question but, if widespread,
it could erode in the public eye the present clear distinction
between charities and commercial organisations. This could damage
public confidence in charities.
Many charities already derive much and in some
cases all their income from primary purpose trades. For example,
a charitable residential care charity may, prima facie,
be hard to distinguish from a commercial organisation providing
residential care. In addition, most members of the public make
little distinction between a charity and its trading company.
For example, a charity mail order catalogue or Christmas card
sales are usually channelled through the trading company but the
public see it as an income generation activity of the charity.
We find it hard to see how a change that allows a charity to carry
this out without using a trading company can damage public confidence.
There was also concern that small businesses
would see this as unfair competition and we appreciate the argument
but the reality is that charities that want to trade already do
so through a trading company and avoid paying tax by transferring
profits to the charity. It is unlikely that the competition to
small businesses would increase if charities were allowed to trade
through the charity.
The other area that creates the seemingly unnecessary
use of a trading company is the issue of sponsorships. Many charities
are offering corporate donors some recognition for their donation.
What starts as a means of corporate fundraising can have fairly
disastrous tax implications if the arrangements are not properly
structured and planned.
When looking at a transaction of this sort the
Inland Revenue will examine the substance of the transaction and
may conclude that the charity may be providing "advertising
services". The Inland Revenue looks carefully at this and
have stated that, references to a sponsor which amount to advertisements
will cause the payments to be treated as trading income. The Inland
Revenue will regard a reference to a sponsor as an advertisement
if it incorporates any of the following:
— large and prominent displays of the
sponsor's logo;
— large and prominent displays the
sponsor's corporate colours; or
— a description of the sponsor's products
or services.
Similarly, if a charity provides the sponsor
with goods or services in exchange for the payment it may be deemed
to be trading with attendant tax consequences. Some of the examples
provided by the Inland Revenue may seem to be fairly innocuous
they include the use of the charity's mailing lists, logo, exclusive
right to sell goods and services on a charity's premises.
We do not believe that this area of "trading"
impacts on any competition issues nor does it face any of the
risk issues discussed above. Therefore, if there is no change
on the government's position regarding the need to use trading
companies we request that serious consideration is given to allowing
donations which are presently treated as taxable sponsorship to
go through the charity without having to set up a trading company
to receive what is in substance a donation. The requirement to
channel such fundraising through a trading company to avoid a
tax liability from falling on the charity seems unnecessary.
THRESHOLDS AND
GROUP ACCOUNTS
Financial Reporting Standards (FRS2), the Charities
SORP, the Companies Act and other best practice pronouncements
require group accounts to be prepared where there is a parent
subsidiary relationship. Consolidated or group accounts attempt
to present a picture of the charity and its subsidiary undertakings
as an economic unit enabling users of accounts to appreciate the
wider aspects of a charity's work and assets it deploys indirectly
through a group structure. However, the 1993 Charities Act is
based on the premise that charities produce entity or individual
accounts. Such accounts reflect the transactions undertaken directly
by the charity and not the group that is controlled by the charity.
The presentation of entity accounts (a statement
of accounts) may therefore only reflect part of the wider activities
that a charity controls, and the resources it deploys. Activities
and assets indirectly controlled through subsidiary undertakings
are omitted and simply disclosed as investments in the charity's
balance sheet.
The preparation of group accounts is now generally
accepted sector practice and the Commission accepts the filing
of group accounts on a non-statutory basis. The Charities Act
1993 is therefore out of line with UK GAAP, recommendations made
in the Charities SORP, sector accounting practice, and development
of group structures within the sector. A Charities Bill for the
21st Century would be flawed if it failed to address these issues.
There is also the issue of public confidence
and monitoring. Under the existing legislation it would be possible
for a charity to hive down significant income generating activities
into a non charitable subsidiary. For example a subsidiary may
have income of £10 million and costs of £9 million passing
only £1 million to the charity. This charity can file charity
only accounts with the Charity Commission thus failing to bring
other income that may be raised in the name of the charity within
the Commission's scrutiny, monitoring or audit thresholds.
We therefore believe that the requirement should
be to prepare and file group accounts and all thresholds should
be defined at the group level.
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