A key advantage that not for profit organisations operating in the UK have over their US counterparts is their ability to conduct commercial or trading activity through a wholly-owned trading subsidiary without incurring corporation tax on the profits arising. In contrast, under US tax law, an otherwise tax exempt organisation will generally be subject to tax on its income from an unrelated trade or business. Unless the business activity undertaken has a direct cause or relationship to the achievement of the exempt purpose (other than through the production of income), the revenues generated would be taxable as unrelated business income.
The position is quite different in the UK provided the "profit driven" trading activity is conducted via a wholly-owned trading subsidiary of the UK charity. Whilst, ordinarily, any profits generated would be subject to corporation tax, the tax may be mitigated provided the subsidiary makes a gross payment of its profits to the parent charity. From the trading subsidiary's perspective, the donation is treated as a charge against the total profits assessable to corporation tax and is simply deducted from the trading profits generated during the year of the gift.
The basic mechanism for which works in the following way:-
- the UK charity establishes and funds a company limited by shares - all the shares are owned by the UK charity;
- the trading company carries out either primary or non-primary purpose trading activity - since it is not itself a charity, there are no restrictions on its ability to trade as an independent legal entity, its activities should not present a risk to the parent charity's assets;
- trading subsidiaries may be formed although only one director in place provided that the sole director's is an actual person (it is not permitted to have a company act as a sole director) - the director may be remunerated provided he or she is not also a trustee of the parent charity;
- whilst the profits of the trading company will be liable to a corporate tax charge, these profits may be donated to the parent charity. This arrangement can be used to reduce the trading company's tax or profits to zero, which means that it has no tax to pay.
Because the trading subsidiary model enables trading activities to be conducted tax efficiently, it provides the charity with the flexibility to hive-down either purely taxable activity (non-primary purpose trading), purely non-taxable activity (primary purpose trading), or a combination of taxable and non-taxable trade.
Repatriation of funds to the US
Where a US charity conducts its commercial activity within the UK to benefit from this structure, it should still be possible for the US charity to derive a direct financial benefit from having done so. Whilst the UK charity should not simply transmit funds to its sister organisation in the US on a default basis, charitable distributions from the UK to the US would be possible provided that they are conducted on an arm's length basis. For example, provided the US charity submitted to the UK charity an appropriate programme related grant request which, having been duly considered by the UK charity board, resulted in the board exercising its independent discretion to make the award, no difficulty should arise. That said, given that the UK Charity Commission is sensitive to the issue of independence and given also that there might potentially be governance issues relating to conflicts of interest between the UK and US charity, an alternative option would be for the UK charity to collaborate with its US counterpart to support joint projects and other types of joint charitable activity; in this way the US charity would be relieved of some of its own funding commitments.