Charitable and non-profit making bodies are often under pressure to maximise their income-generating activities through exploiting their assets to the maximum possible extent. Whilst the reason for doing this is entirely understandable, the associated potential tax consequences can be overlooked, which can, in turn, give rise to unexpected tax liabilities. In this article, John Howard, Partner and head of Not-for-Profit at Wilkins Kennedy provides some thoughts on the issues arising.
It is often said that “we are a charity, so we don’t have to pay tax”. Quite simply, this statement is incorrect and corporation tax and VAT can be a considerable burden for some charitable bodies.
Generally, a charitable body can only perform trading activities that further, or are ancillary to, its charitable objects. Typically, a charity’s objects (as set out in the Articles of Association) will dictate what it is entitled to do from a charitable perspective, meaning that it may also have trading activities that have, or are ancillary to, a charitable purpose. The qualifying trading activities are commonly referred to as “primary purpose trading”.
By way of contrast, the exploitation of the charity’s assets may not be eligible charitable trading activities.
Generally, income generated by a charity in terms of its non-charity trading activities will be chargeable to UK corporation tax, although charities are able to undertake a de minimis amount of such trading without becoming liable to corporation tax providing any profits are used in the course or furtherance of the charitable purposes of the organisation. The de minimis threshold is currently £80,000 per annum.
It follows then that, if a charitable body undertakes any activities outside its charitable objects, ie non-charitable trading activities that generate income in excess of £80,000 per annum, it runs the risk of prejudicing its charitable status. To counter this, a charity may consider setting up of a trading company (typically a wholly-owned subsidiary of the charity) through which to channel its non-charity trading activities. Profits generated by the trading company can be gift-aided back to the charity, thereby removing a charge to corporation tax for the trading company.
Indeed, charities that have non-charitable trading income of less than £80,000 per annum may still elect to channel those activities through a trading company in order to ring- fence them from the core charitable activities.
From a VAT perspective, charities will be compulsorily VAT registerable if their trading activities, which may be either qualifying (primary purpose) or non-qualifying from a direct tax perspective, exceed the current VAT registration threshold of £85,000 per annum. For example, if a charity has provides IT consultancy services to a third party, then these services would be subject to VAT if the charity was registered for VAT. If the charity was not VAT registered, the income would contribute to the taxable income in determining whether the charity exceeds the VAT registration threshold. If the IT services were non-charitable non-qualifying activities, the charity would need to consider whether the activities would need to be channelled through a trading company rather than the charity itself.
If the consultancy services were provided out of the trading company and the trading company was VAT registered, then VAT would be due on the services regardless of whether they were qualifying or not. Equally, if the trading company was not VAT registered, the income would be taxable income for the purposes of determining whether the company exceeds the VAT registration threshold.
If a VAT-registered charity finds itself needing to set up and utilise a trading company and the trading company is also necessarily VAT registered, it would be appropriate to consider setting up a VAT group to optimise VAT efficiency.
In summary, the issues that a charity needs to think about in determining whether a trading company should be used are complex. The associated consequences, both in terms of practicality and compliance, should be considered in some detail at the outset. Wilkins Kennedy can provide support in all aspects of the use of trading companies.
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