The curious world of a charity being at ‘arm’s length’ to its own subsidiary company
The idea behind a subsidiary company is to unlock the enterprising side of the charity, within the confines of separate limited liability structure.
Unfortunately, it is not as simple as it first appears and there are a number of principles and rules that must be adhered to, particularly with regards to support for the subsidiary from the charity.
There is a requirement in law and practice that the subsidiary operate at ‘arm’s length’ to the charity.
There are several reasons for this 'arm's length' principle:
- The need for a charity to be able to justify that any investment in the subsidiary is objectively: a commercially sound transaction; an appropriate programme-related investment or a suitable ‘mixed motive investment’;
- HMRC requirements that any loan to the subsidiary be on commercial terms;
- The need for third parties to effectively differentiate between the subsidiary and the charity.
The subsidiary needs, therefore, to stand on its own two feet as an operation, and have sufficient integrity of its own to justify investment in it. That said, it is owned by the charity and its purpose is to raise funds for it or deliver specific operations.
- There needs to be clear lines between the two entities - such as the subsidiary paying market rates for any management and premises provided, etc.;
- There may be overlap at board level, but there should be at least a director of the subsidiary who is not connected to the charity;
- There are opportunities to gain tax advantages by the use of a trading subsidiary e.g. in relation to VAT;
- There are special accounting rules to be followed;
- There are risks to charity trustees in supporting a loss-making subsidiary, particularly if an investment is not also programme-related;
- There will need to be an agreement regulating the relationship between the charity and subsidiary;
- Tax advice (particularly in the instant circumstances) should be obtained;
- Most important of all, however, is for the subsidiary to bring benefit (financial or operational) to the charity.
In the end, the real challenge is to ensure that, unlike many start-ups in the commercial sector, the subsidiary lives long and prospers.
For more information please contact our Charities team.