For those involved in academy trust finance or governance, you may have heard the term trading subsidiary. They are becoming more common for various reasons. In this blog we will attempt to answer some of the common questions we are asked about them.
What is a trading subsidiary?
A trading subsidiary is a company. A separate legal entity from, but controlled by, an academy trust. By incorporating a trading subsidiary an academy trust is creating a group of companies. All companies need to comply with the Companies Act 2006.
Do you need one?
All academy trusts have charitable 'objects'. An academy trust can only carry out activities which further its objects, or which are ancillary to furthering those objects. Fundamentally this means teaching children of compulsory school age.
For academy trusts with DfE model objects, they may also carry out trading which has an educational purpose, or is ancillary to an educational purpose. Trading which is not carried out in accordance with the objects is called 'non-primary purpose trading'.
Some academy trusts have an additional object in the Articles of Association which allows for the provision of services to the local community. You can check whether a trust has this object by downloading its Articles of Association from Companies House. The DfE is increasingly reluctant to permit new Trusts to be incorporated with this object.
Trading subsidiaries can be set up for a number of reasons:
Academy trusts can generate small-scale trading income up to a threshold of £80,000 (£50,000 before April 2019). If an academy trust exceeds the threshold, all trading income becomes chargeable to corporation tax. i.e. if the Trust generates £85,000, the full £85,000 is taxable as opposed to just the £5,000 above the threshold. The most common reason for trading subsidiaries being set up is to avoid the breach of this threshold.
Academy trust funds must not be used to purchase alcohol for consumption, except where it is to be used in religious services. Purchasing alcohol for resale to improve the provision of some community services (theatres using school facilities are the most common) will need to go through a trading subsidiary.
With an increasing focus on risk management in academy trusts, a trading subsidiary may help to ensure loss making trading activities are not supplemented with charitable funds.
What if you need a trading subsidiary and you don't set one up?
The most common problem is corporation tax chargeable on all profits from trading income when the total value exceeds £80,000. Assessing which streams of income are taxable and which are not can be a time consuming and subjective exercise.
If an academy purchases alcohol and this is reported to the ESFA, it may find itself subject to an ESFA investigation for a non-compliant use of public funds. This could result in the academy trust receiving a Notice to Improve.
If an academy trust supplements loss making trading activities with public money intended for charitable purposes, the resulting breach of the Charities Act 2011 could cause reputational damage to the Trust and its Trustees.
How do you set a trading subsidiary up?
Anybody can set up a company purchased off the shelf from Companies House. Unfortunately, this will not suffice for an academy trust trading subsidiary. The model Articles of Association will not cover the requisite clauses to protect the Trust and its Trustees from safeguarding assets which are ultimately controlled by the academy trust.
Trading subsidiaries are companies limited by shares (unlike academy trusts, which are limited by guarantee). In most cases the academy trust will be the sole shareholder. Be sure to take legal advice if there is the prospect of another shareholder being brought into the arrangement.
It is more important to consider who will be appointed as directors. This group will make strategic decisions on behalf of the Subsidiary and take on the fiduciary duties of directors under the Companies Act 2006. An academy trust may be appointed as a corporate director, so too may any senior employees of the Trust. It is also common to bring in another stakeholder of the Trust (who isn't a trustee - maybe a local governor) to act as an independent voice on the Subsidiary's Board of directors
How will it fund itself?
Many trading subsidiaries need little financial support in the form of working capital. Most will be using assets already owned by the shareholding academy trust which have spare capacity (buildings, facilities or human resources). As a result, the need for long term funding is limited. If the Trust does need to advance cash to the trading subsidiary, most solicitors will be able to draw up a basic loan agreement as part of an incorporation service package.
Third party loans are seldom required but are permissible if necessary. The important thing to note is that an academy trust must obtain prior approval from the ESFA for any guarantees, letters of comfort or indemnities in accordance with the delegated limits set out in the Academy Trust Handbook.
How will it function?
As most trading subsidiaries will be relying on the use of trust assets to generate profits, a service level agreement (SLA) with the Trust for use of its resources will be required. Most solicitors will be able to draw up a basic SLA as part of an incorporation service package. This will set out the services required by the subsidiary, the expected level of service from the Trust and the level of remuneration the trust will expect to receive for providing those services. If services are human resources, the costs will be easy enough to calculate. If the services are the use of assets, a pricing model should be drawn up. There is no benefit to charging excessively profitable rates as the Trust may become subject to corporation tax charges, not to mention the subsidiary becoming loss making. The important thing is for the Trust to cover its costs with the charges it renders.
In most cases, the subsidiary will use the Trusts existing systems procedures and controls for overseeing any compliance requirements associated with its operations. These will include health and safety, safeguarding and accounting functions. Charges to cover these costs can be worked into the SLA.
The majority of the time, the costs of a trading subsidiary employing its own staff may outweigh the benefits. As a result, the cost of staff employed by the Trust are likely to be recharged to the subsidiary under the SLA. In some cases it may be prudent to protect the Trust by employing staff in the subsidiary, especially if there aren't suitable alternative roles for staff in the Trust if the subsidiary is unable to continue trading for any reason.
Maintaining accounting records is another important consideration. The subsidiary's own accounts are likely to be subject to statutory audit requirements. The financial results will need to be consolidated into the statutory accounts of the Trust. If there is only one subsidiary and it is not material to the financial results of the Trust, it could be excluded on those grounds. This may cause complications in the future if it does become material.
What about tax?
A trading subsidiary helps to make the most efficient use of an academy trust's assets by not allowing trading profits to be subject to Corporation tax. To do this the subsidiary must make a cash payment of its profits to the Trust as a Gift Aid donation within 9 months of the accounting year end. Before making a gift aid payment to the parent charity, the trading subsidiary directors must be satisfied that it has distributable reserves at least equal to the distribution, and that the company will continue to be able to meet its liabilities as they fall due.
It is not uncommon for Gift Aid payments to be made under a deed of covenant. To protect all parties, ensure this deed states the payment will only be made if there are sufficient distributable reserves as it is illegal to exceed these. Ensuring statutory accounts are drawn up and audited in sufficient time for this payment to be made will be key to obtaining the tax relief.
Trading subsidiaries cannot reclaim VAT refunds as an organisation not registered for VAT like an academy trust can. For the trading subsidiary to reclaim VAT it must register for VAT as a standalone entity or join a group registration if the Trust is already VAT registered. Careful consideration about the type of income and expenditure may avoid the need for either but taking advice is recommended on incorporation and if the circumstances of the Trust or the subsidiary change. Under a group VAT registration, one return is generated per submission to HMRC and all Intra-group transactions are excluded.
If the subsidiary employs staff it will need to register as an employer. It can take up to 5 days to get a PAYE reference. Somebody will also need to process the payroll.
With sensible planning and sound advice, a trading subsidiary and group structure can be advantageous for an academy trust in terms of observing good governance, ensuring regularity and separating its commercial income streams from core educational activities.
Originally published 10 August 2021
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.