Financing the trading company

Contents

62. Tax. Charities investing in their trading companies

Charities which own companies set up to carry on non-exempt trading activities will usually need to consider investing funds in the company when the company is set up. The company may also need injections of money to fund expansion or development of its business after it has been established.

There are special rules in the Taxes Acts that apply to investment of a charity's funds in a trading company. If these rules are not followed the charity will risk losing some or all of its tax exemptions. To qualify for relief an investment must be made:

  • for charitable purposes only
  • for the benefit of the charity, and
  • not for the avoidance of tax

Investments will be regarded as made for charitable purposes and for the benefit of the charity if they are commercially sound. Usually, charities should ensure that investments are secure, carry a fair rate of return (actually paid) and, in the case of loans, provide for recovery of the amount invested in due course.

When deciding whether to make an investment, charities should bear in mind the requirements of charity law relating to:

  • objectivity in the selection of investments
  • the need to avoid undue risk or speculation; and
  • the need for a proper spread of investments.

Charities should also bear in mind the scope of the requirements of the Trustee Act 2000, Charities and Trustee Investment (Scotland) Act 2005 and the Trustee Investment Act 1961 as applied to Northern Ireland by the Trustee (Amendment) Act (Northern Ireland) 1962 and the Trustee Act (Northern Ireland) 2001 as well as their own investment powers as set out in the charity's governing document. For tax purposes, Sch 20 ICTA 88 may also require account to be taken of the Trustee Investment Act 1961. All investment decisions should be properly minuted, including the factors on which the decisions were based. Depending on the size of a proposed investment, the decision may be based on the following:

  • business plans
  • cashflow forecasts
  • projections of future profits.

Investments should be reviewed regularly.

63. Tax. Investing in a company which sheds its profits to the charity

Most commercial companies keep part of their profits to provide them with funds for day-to-day expenses, working capital and normal development of their business. However, companies which intend to donate all of their profits to charity every year may not be able to retain the funds they need to carry on in business. Charities may therefore want to ensure when a company is set up that it is provided with enough capital to enable it to shed its profits every year and stay in business.

Although the 9-month rule paragraph 58 should assist with cash flow, the passing of profits up to the parent charity may result in a serious drain on the company's cash. If so, care should be taken to avoid a pattern of frequent injections of funds by the charity in order to keep the company in business. Such a practice might put at risk both the charity's tax exemptions and the company's deductions for its Gift Aid payments. In some cases where there is a serious cash drain in the company, it will be necessary for the company to change its practice so that it keeps part of its profits. In these circumstances some tax will become payable by the company.

Charities should note that the substantial donor rules apply to transactions with companies unless they are wholly owned subsidiaries.

64. VAT. Financial services

Certain financial services are exempt from VAT. Many services which are associated with finance are not covered by the exemption. This is a particularly complex area where the VAT liability can depend on how a particular supply of finance or financial services is actually being made. Charities are therefore advised to contact the HMRC Charities Helpline, 08453 02 02 03, to discuss the VAT implications of any supplies of finance or financial services they intend making or receiving.

65. Tax and VAT. Getting professional advice

Where a charity is considering making an investment in a trading company it should consider seeking professional accountancy and legal advice.