DCH 43 Charity Finance Directors' Group
BRIEFING - CHARITIES
BILL ORAL EVIDENCE
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 £1 million and costs of £900,000 passing
only £100,000 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.
15 June 2004
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