Charities and Loss Making Subsidiaries
In a bid to diversify income and generate much needed unrestricted reserves, an increasing number of organisations are forming trading subsidiaries to operate alongside their charity and allow them more freedom in the activities they pursue.
When successful, profits generated by the subsidiary can be passed to the charity which allows the charity to increase their support to its beneficiaries and further fulfil their charitable objectives.
Regrettably it tends to be the unsuccessful attempts at diversification that appear in the headlines.
The common pitfalls seen in the sector are:
- The charity has no knowledge or expertise of the sector they are diversifying into.
- The charity does not have adequate resource to operate the subsidiary.
- Subsidiary is set up with improper planning, cash flow projections, budgets and lack of business case.
- VAT implications regarding transactions between the charity and subsidiary are not taken in to account.
- Management charges are not accounted for or there is no clear rationale on the calculation, this can lead to the accounts not reporting an accurate picture.
- Costs incurred by the charity on behalf of the subsidiary are not recharged.
- The charity operates an inter company account within the accounting system to allow for movement of funds back and forth, this can often result in unknowingly providing significant bash loans to the trading subsidiary.
- There is no separate reporting or management accounts produced which detail the performance of the subsidiary, this can lead to loss making subsidiaries being undetected.
- Action to minimise any future losses are not implemented quick enough.
- The charity continues to cash flow the subsidiary even when there is no prospect of repayment.
- Decision to close and cease the operations of the subsidiary is not made until it is too late.
There are some critical factors to note:
- If you make investments and loans to prop up a failing trading company, this might not meet your investment duties. It can also result in tax liabilities. In certain circumstances HMRC can decide that the funding was not given for the benefit of the charity and is therefore non-charitable expenditure.
- Charity trustees must be clear that if they use the charity’s assets to support a failing trading subsidiary then they are putting those assets at risk and potentially failing in their duties.
- Charity trustees must minimise any losses to the charity, regardless of any sense of moral obligation they may feel towards the trading subsidiary, its directors and employees.
The documents below provide informative guidance on what you need to think about when operating a trading subsidiary –
If you would like to discuss any of the issues raised, please get in touch today and speak to one of our charity experts.