Don’t let trading be too taxing!
Generating revenue is a positive way of future-proofing your finances, but what’s the most tax-efficient legal structure for schools? Chartered Accountant Phil Reynolds explains the pros and cons of setting up a trading arm versus establishing a Community Interest Company
However, if your trading has nothing to do with your primary purpose then you may have to pay tax on the profits from that trade. I say ‘may’ because if your turnover from this trading is below the small trading tax exemption limit, you don’t need to pay tax. The small trading limits are shown below.
|
Charity’s gross annual income |
Maximum permitted small trading turnover |
|
Under £20,000 |
£5,000 |
|
£20,001 to £200,000 |
25% of your charity’s total annual turnover |
|
Over £200,000 |
£50,000 |
Should your breach the above limits, then you will have to decide upon the best option going forward to ensure you have the most tax-efficient legal structure. Your options are:
- Establish a trading company
- Establish a Community Interest Company (CIC)
Before deciding upon the best structure it is recommended that discussions are held with your financial advisors and that you have a clear strategic plan in place which sets out your aims. This, coupled with the pros and cons of each type of entity, will enable you to make the best-informed decision.
Any good strategic plan will evaluate your current standing and what your aims for the future are. From there it will identify the school’s success factors and then develop a strategy for accomplishing each success factor. Some typical examples of aims schools would include pupil number growth, improved student and staff wellbeing and site expansion.
Setting up a trading subsidiary
This option will enable the independent school or academy trust to setup a trading arm so that they can separate income-generating trading activity from their core charitable activities. A trading arm is a self-sufficient limited company operating as wholly owned subsidiary of the school or trust, but being run and financed independently.
As with any new business venture careful consideration will need to be undertaken. Any new business will naturally be a risk. It is essential therefore that the school or trust considers these in full. The trading arm should have a business plan in place from the outset. The school or trust will also need to consider if funding a trading arm is a good use of public money. Any finance it provides the trading arm by way of loans should be secured. A school may wish to do this to ease cashflow whilst the trading arm establishes itself or to help with developing additional resource for the future ie building expansion or taking on additional employees.
Budgets and cashflow forecasts will also be essential before a decision to proceed is made – these should ensure that the trading arm can be self-sufficient. If it is not and finance is provided by the school or trust, then it should be forecasting when repayment of such finance is to be made and monitor this closely as trading commences.
The trading subsidiary’s performance can be monitored to ensure it is self-sufficient. This will enable smarter and quicker decisions regarding the entity’s future as the information will be more reliable. The school or trust should ensure that there is a full recharge of any relevant costs to the trading subsidiary which it incurs on its behalf eg light, heat and rates. This will help to protect against the performance of the trading subsidiary being hidden by the core charitable activities of the school or trust. Essentially the trading entity should not be supported indirectly by the school or trust.
The trading arm does not need to have the same directors as the school or trust. This can be to its benefit as they will be persons empowered to ensure the entity performs well as the Board of Directors at the school or trust can hold these persons to account. By having the same directors this may result in a lack of independence and therefore tough decisions may not be made. The directors of the trading arm can even be paid which may help incentivise them to ensure the entity performs well.
A trading arm can pledge or gift aid its profits back to the school or trust and thus avoid having to pay corporation tax, but the school or trust should not use any of its money or resources to support or manage the company. This will represent the most tax-efficient way of generating money. However, the trading arm should also consider retaining some profit (which will be taxable) for working capital purposes going forward.
Recently, the Financial Reporting Council announced that when gift aid payments are recognised they should be recognised as a distribution within equity, not as an expense recognised in the profit and loss account. Therefore all trading entities need to ensure they have positive reserves before making such a distribution – much like dividends. For example, if the trading arm makes a loss of £100,000 in year one and then a profit of £50,000 in year two, the £50,000 profit cannot be gift aided up as the net position of the entity will be negative reserves of £50,000. An example is provided below.
|
Year |
Profit/(loss) for year |
Profit and loss reserve balance |
Donation available to make |
|
1 |
(£100,000) |
(£100,000) |
£0 |
|
2 |
£50,000 |
(£50,000) |
£0 |
|
3 |
£75,000 |
£25,000 |
£25,000 |
|
4 |
(£10,000) |
(£10,000) |
£0 |
In terms of negatives, there will be more regulation as accounts will need to be delivered to Companies House each year (along with other statutory forms) and a Corporation Tax Return will need to be filed with HMRC whether there is tax to pay or not.
The other issue is that such entities can struggle to receive donations due to not being a registered charity and therefore its ability to raise funds can prove challenging. Ideally these should pass through the School or Trust.
Typical examples where schools or trusts have setup a trading subsidiary are that of a separate nursery being run on commercial terms ie no government funding, also a Sports Centre that is being used for more than just standard lettings eg gym membership.
Community Interest Company (CIC)
This a relatively new type of company created for those wishing to establish a business with a social purpose (a social enterprise) in a legal form. A CIC can adopt a co-operative, not-for-profit or general commercial company model.
When setting up a CIC it is important to remember that the CIC Regulator will need to approve the entity as well as The Registrar of Companies. The current fee for incorporation is £35.
There are a number of obligations that a CIC has to meet and continue to meet in addition to those imposed on an ordinary company. These are:
- To satisfy a community interest test
- To adopt certain statutory clauses in its constitution
- To deliver an annual community interest company report with its accounts
The community interest test looks at the underlying motivation of the company in terms of what it will do, who it will help and how. If it makes a profit what will the company do with it. This information is made available on the public record after incorporation.
The statutory clauses have the following effect:
- To lock in the assets to benefit the community it was set up to serve. This is referred to as the ‘asset lock’.
- To prevent the CIC falling under the control of individuals or organisations who are not members.
The asset lock prevents the CIC from giving away community assets for less than the true market value unless the distribution is to another asset-locked body, such as a CIC or charity or to benefit the community it was set up to serve. The asset lock does not affect the ability of the CIC to use its assets in the normal course of business. For instance, they will be able to use their assets as collateral for finance, and if they do so, the assets will be available to creditors in the event of default. It could be argued that schools have an ‘asset lock’ in place already, as the DfE and local authority do not allow schools to sell buildings or land without prior approval but CIC rules stipulate an ‘asset lock’ must be in place.
CICs can pay a dividend, if agreed by a resolution of its members. But again, the entity needs to ensure it has distributable reserves. Dividends payable to private shareholders (non-asset-locked bodies) will be subject to a dividend cap as well which will seen as a negative for some.
The annual CIC report is another administrative burden for the entity and could be seen as a loss of privacy but can also be a good source of information for anyone considering providing funds to the entity. In addition, there is a £15 filing fee to go alongside this document when filing with your annual accounts.
CICs can be a good vehicle for helping to generate and secure funding. As their purpose is to ensure any money generated is used for community interest, there is likely to be more of an incentive for funders and donors to provide funding to the entity (as opposed to a trading arm) as they will see this as a way of helping boost the local community.
Forming a CIC can also be quite time consuming. Some instances have taken nearly two months for the CIC to be formed and this is before a bank account is established, which many people find a painful process these days. In addition, no real tax incentives apply, a CIC is subject to business rates (charities are not) and corporation tax.
Subsidiary entities
All of the above options can be formed as a subsidiary of the Independent School or Academy Trust. This will help the school or trust maintain control over the performance of the entity as this will be an investment made by the entity.
Having a subsidiary entity will mean that the Independent School or Academy Trust may have to produce consolidated group accounts each year. This will depend upon the reporting requirements and size of the group as medium sized groups have to produce consolidated accounts. This can bring another potential administrative and cost burden though.
The following size requirements currently apply for medium groups:
- Turnover not more than £10.2m (net) or £12.2m (gross)
- Gross assets not more than £5.1m (net) or £6.1m (gross)
- of employees is more than 50
Groups must meet 2 out of the 3 requirements in 2 of the past 3 reporting years.
For many multi-academy trusts of a reasonable size they will breach these limits quite comfortably. However, a controlled subsidiary may be excluded from the consolidation if its inclusion is not material for the purposes of giving a true and fair view in the context of the group. Should the subsidiary be excluded, the results and details of the subsidiary still have to be disclosed in the parent entity’s financial statements.
There is no simple flowchart or checklist that can be provided to enable schools to make the best commercial decision with regards to the vehicle they will to form to generate revenue. Each school’s plans and ideas will be different alongside their cultures and values. Therefore, before making any decision on the vehicle you wish to form to generate revenue for your School or Trust, it is always advisable to seek professional legal and accountancy advice so that you make the most relevant and informed decision to suit your school.
Maintained Schools
Unfortunately, maintained schools have limited options available to them when it comes to trading. They do have the ability to form “school companies” – this can be stand-alone or as part of a collaboration with other schools – under the Education Act 2002 section 11 and the School Companies Regulations 2002. However, consent must be sought from the relevant local authority – which is unlikely to be a “yes” and it can only be used for certain purposes ie providing services/facilities to schools, procure services/facilities for schools from third parties or exercise local authority functions that the local authority may contract out.
However, what many maintained schools do have are Parent Teacher Associations (PTAs). These could be formed as an unincorporated charity. This will give them charitable status and therefore the option to claim Gift Aid on donations ie an extra 25p for every £1 received.