Currently there is not a great deal of guidance provided by the Education and Skills Funding Agency (ESFA) in this area – although it may decide to introduce more guidance as such trading subsidiaries become more common in the academies sector.
A trading subsidiary is essentially a company which is a separate legal entity from the Trust, although it is owned and controlled by the Trust.
There are a number of reasons why Trusts may consider establishing a trading subsidiary. This may be to legitimately avoid paying tax on their profits if they have non-ancillary trading income exceeding the £80,000 small trading limit; it may be so they do not need to register the Trust for VAT if they have VAT-able income over the £85,000 VAT threshold; or it may be simply to provide additional protection to the Trust from the risks associated with non primary purpose trading.
Setting up a subsidiary
The model articles provided by the DFE do include a specific power to establish a trading subsidiary, but each individual Trust will first need to check its own articles to ensure that such a move is allowed.
Generally the shares in such a trading company would be owned by the Academy Trust – getting advice from a specialist solicitor and accountant is vital here. To keep things clean, it’s best to transfer letting activities into the subsidiary with effect from 1st September. Don’t forget that a corporation tax return will need to be filed for the trading subsidiary.
The trading company will need its own bank account so that it can pay its profits over to the Trust, within nine months and a day from the year-end (i.e. 1st June).
Those profits will need to be gift-aided to the Trust under the company gift aid scheme, to ensure that no tax is payable. This will require a Deed of Covenant to be in place between the subsidiary and the Trust, creating an obligation for the profits to be distributed so that they can be accounted for in the year they are generated. The Deed of Covenant is a legal document which will again require the input of a solicitor.
Governance
It is best practice for the trading subsidiary to have directors who are independent from the parent charity in order to maintain independence in decision-making and to ensure that both entities can be quorate if there is a conflict of interest.
There is not a specified number for this, but assuming the board of directors will be small, it would be good practice for there to be at least two independent directors. Separate meetings need to be held, agreements for use of property drawn up (see below), and any loans should be at arm’s length.
The subsidiary will become a related party of the Trust and this should be borne in mind in view of any ESFA requirements for reporting on related parties.
It will be necessary to draw up an agreement between the trading subsidiary and the Trust covering the use of the Trust’s facilities at an appropriate rate (this could be a peppercorn rent amount). Paragraph 5.25 of the Academies Trust Handbook refers to a trust needing ESFA approval when granting a leasehold interest, but it’s unlikely to apply in this case as it is limited to a right to access to use facilities – but this is something on which you should seek legal advice.
Other considerations
One important thing to take into account is the employment implications for the staff working in the areas of the proposed subsidiary’s operations. It might be that a recharge would be suitable, however there may be VAT implications here for the Trust.
On the subject of VAT, if all VAT-able activities are transferred to the subsidiary then the subsidiary could register for VAT, with the Trust continuing with its usual VAT claims rather than needing to make full returns. The pros and cons of this will be different for each Trust, so it is important to seek specialist VAT advice to see what set-up will work best for your particular Trust.
The subsidiary company is likely to require an audit, with the inevitable additional ongoing audit costs. In addition, the Trust accounts will gain another level of complexity as they will require the subsidiary company to be consolidated into them, which will also add to audit costs.
Should you go down the trading subsidiary route?
The answer to this question will very much depend on the particular circumstances of each individual Trust, but there are clear advantages to separating trading activity from charitable Trust activity, both in terms of finance and taxation and, just as importantly, governance.
A separate subsidiary keeps trading activity in one place, allowing the Trust to concentrate on delivering educational and charitable activities. Although many such subsidiaries are primarily set up to avoid breaching the small-scale trading income threshold for corporation tax, that separation is an important and often overlooked factor. For example, it can highlight where trading activities are making a loss, which might not be so evident if the activities are accounted for within the Trust.