A guide to third sector trading - WCVA

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It’s an idea, but is it business? A guide to third sector trading 1: Getting started 2: First steps 3: Business planning 4: Legal and governance 5: Funding and resourcing 6: Financial controls 7: Managing growth 8: Management and governance 9: Social enterprise 10: Sources of support • take appropriate advice on the investment, and the financial viability of the trading subsidiary − ‘appropriate’ will depend on the circumstances − the cost of taking advice should be in proportion to the size of the proposed investment. • pay attention to the length of time that funds could be tied up in the investment – in case they are needed earlier for some other purpose • consider, and take suitable advice on, the possibility of obtaining independent funding as an alternative to funding by the charity • take account of the fact that there could be adverse tax implications if the loans to or equity investments in trading subsidiaries are inappropriate. Loan repayments and inadvertent insolvency: There is a risk that a charity could accidently make its trading subsidiary insolvent if the trading company pays all its profits to the charity to eliminate its corporation tax liability. This could leave the subsidiary without the resources to continue making loan repayments. Then, without assets to cover its liabilities, it would be subject to the potentially serious restrictions of insolvency legislation. Sharing the risk with outside investors: • Charities are free to look for outside investors to help fund their subsidiaries, either with loans or shares. • Shareholdings are likely to be less attractive than loans for investors whose aim is to profit from the investment, but shares can be a good way to develop local involvement with projects. • Joint venture loan funding can significantly reduce the benefits of the subsidiary to the charity if the interest rates are high. • Trustees should be careful to establish a clear understanding with their partners on the objectives of the investment to avoid irreconcilable differences later which could seriously damage the relationship, and they should plan for an ‘exit strategy’ in case the relationship breaks down. • Joint ventures and gift aid: The treatment of Gift Aid by HM Revenue and Customs changes significantly if charities undertake joint ventures, and trustees should be aware of the implications before they carry out this type of investment. Further information: More information about trustees’ investment duties is available on the ‘Guidance for trustees’ section of the Charity Commission web site. 128
It’s an idea, but is it business? A guide to third sector trading 1: Getting started 2: First steps 3: Business planning 4: Legal and governance 5: Funding and resourcing 6: Financial controls 7: Managing growth 8: Management and governance 9: Social enterprise 10: Sources of support How does this help the charity? What about the charity? In the real world of third sector trading many entrepreneurs will, and should be, motivated by the promise of developing businesses which are owned by socially responsible organisations. They will be driven by enthusiasm to create perceived benefits which may not in themselves achieve the charitable objects of the organisations which set them up – new jobs, management of resources and services by the clients and beneficiaries and so on. Unfortunately, this is not, in legal terms, the purpose of the trading subsidiary. So are the trustees and subsidiaries out of order? Returning funds to the charity: A central job of the subsidiary is to help fund the charity. But this is not difficult to demonstrate in a reasonable well-planned social enterprise. The funding might take the form of a direct return on the investment or other indirect advantages: • the loan repayments and the interest payable on them • Gift Aid (see section 7.6) which is technically a return on the charity’s shareholding in the trading organisation (the benefits of Gift Aid in this context entirely outweigh any reason to pay share dividends) • rent payments for accommodation which the charity would not otherwise be able to let • the shared use of (through user charges) of equipment needed by both the charity and its subsidiary (there could be technical tax implications for this as earned income for the charity, but it is very likely to qualify as small scale trading). Clarifying the charity’s objects: One interesting repercussion of planning to launch trading activities is that trustees may come to see the possibility of changing their charitable objects. • The area of benefit: The most obvious example is to extend the geographical area of benefit so that the charity can generate income from selling its services in other towns or counties without this being regarded as a fundraising activity. This does not usually prove difficult to achieve. • Changes of purpose: More problematic is changing a charity’s purposes. For instance, a charity which was set up to provide recreational facilities for children up to the age of 11 may see commercial opportunities for providing training for disadvantaged teenagers and young adults. But it would need to change its charitable objects if this activity is to be seen as ‘primary purpose trading’ rather than fundraising. 129
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A guide to third sector trading - WCVA

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