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Embarking on a commercial venture

OSCR's latest "OSCR Reporter" update email sets out the top 5 FAQs they get. One of them is a question that we see often in practice - the establishment of a trading company.

In a nutshell here are some high level key issues to consider before a charity embarks on trading:

Why do it?
There are usually three interlinked key reasons for considering the creation of trading subsidiary: 

1. The wish to carry out non-charitable activities (e.g. some forms of social enterprise or an income generation programme to fund charitable activities), which are themselves not charitable for OSCR and/or HMRC purposes
   
   
2. To avoid tax leakage from the charity carrying out trading activities (there is no blanket exemption for charities having to account for tax on trading income, but a trading subsidiary can "gift aid up" profits to the charity to minimise the overall tax loss on commercial projects)
   
   
3. To risk manage and give strategic focus to new ventures

Is this an "investment"? Is it a sound investment?
Depending on how the subsidiary is funded the trustees will need to consider (with appropriate financial advice) whether or not the new venture is a proper investment and use of the charity's resources. Appropriate due diligence must be carried out to formulate and support a decision to embark on a commercial subsidiary.

Parent charity controls
It is important that the charity has appropriate controls over the activities of the trading subsidiary. Poorly drafted Articles of Association for the trading subsidiary that fail to appreciate the dynamic between charity and trading subsidiary as well as parent charity as (sole) shareholder can lead to a number of potential governance, reputational and financial risks.

The charity needs to have effective control mechanisms that it can use to appropriately oversee the commercial activities. While the charity trustees will wish to allow the directors of the commercial company to have sufficient freedom and flexibility to be a commercial success, parent charity controls over certain strategic issues must be built in.

Trading company board composition
The trading company will want to engage the appropriate skills mix to make the commercial venture work. However, in arriving at board composition and reporting structures, the parent charity will wish to carefully consider these issues at the outset to set the tone for how the subsidiary will operate and interact with the charity.

Can a trading subsidiary also be a charity?
Yes. Often this may not be desired, but there is no rule against a charitable trading company. It depends on whether or not the activities carried out by the trading company are charitable (for OSCR and HMRC purposes). While a charitable parent and subsidiary structure may be focussed on risk management and strategic focus, there will still be important tax matters to address.

Charitable trusts and unincorporated associations
Charitable trusts and unincorporated associations must be very careful with commercial ventures - personal liability can be very real!

This is a serious issue for charity trustees of trusts and unincorporated associations to consider. It leads to issues of the preferred legal vehicle for the parent charity as well as the drafting of the trust deed or unincorporated association constitution, if that vehicle is preferred.

Trustees of trusts and office bearers and members of unincorporated associations can easily attract personal liability.

There are unfortunate quirks of trust law which should be considered. For example, unless a trust deed provides otherwise the trustees have obligations to be directly involved in the management of business activities.

The start of a commercial venture can be exciting and daunting. We have thought about these issues on a number of occasions from relatively small projects to ventures running to many ten of millions of pounds and more. We also appreciate the dynamic between the parent and trading entities and the two sets of boards. Those relationships are critical and top quality structuring advice at the start will help avoid disappointment later. MMS is unusual, if not unique, in Scotland to have highly rated charities, corporate, tax and trusts lawyers in the same firm with real experience. We also know the need for quality financial and accountancy and we are experienced at working with other advisers to achieve the right outcome.

Keep up to date with MMS

Lawyers are not cool or fashionable - fact! That is why our very regular tweets on charity law and related issues are not to make us trendy, but to give you the opportunity to hear about developments in charity law and practice speedily and easily.

For example: On Budget Day as part of our live tweeting, we were straight on to the impact on charities of the proposed change to tax relief. OSCR gave some highlights of its Protecting Charitable status in its "OSCR Reporter" update. Our February tweets gave a daily highlight from that report to focus charity trustees on the big issues.

Twitter may not be for everyone, but if you are a citizen of the twittersphere you can "follow us": @MMS_Law

MMS supports the Scottish Youth Parliament Awards 2012

MMS' Alan Eccles was delighted to attend the Scottish Youth Parliament Awards 2012 to present the Achievement of the Year Award. Alan, part of the judging panel for the Awards, was pleased to congratulate and present the award to Caitlin McDowell MSYP from Dumfries and Galloway on the success of her drug education work in her local area.

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Contact us

For further information, please contact:

Alan Eccles
Associate
0141 271 5375
alan.eccles@mms.co.uk

This briefing is written as a general guide only. It is not intended to contain definitive legal advice which should be sought as appropriate in relation to any particular matter.