Top tips for setting up trading subsidiaries

We have highlighted below some key considerations for a charity in deciding whether to set up a trading subsidiary. These points would equally apply if a charity were to undertake a review of whether to continue with an existing trading subsidiary. 

Have a clear plan

Think about why you want to set up a subsidiary in the first place. It may be to allow the charity to undertake more trading activity, and ringfencing the risk for this is in a subsidiary.  Tax considerations can also be relevant.  However, setting up a subsidiary creates an additional administrative burden and additional directors will be required for a separate company board. There may be crossover between the charity’s board and the subsidiary board but the Charity Commission recommends that there is at least one independent on each board.

Decide on an exit strategy

It may seem strange to consider the exit strategy when setting up the subsidiary, however it is worth considering what the charity would do if things didn’t go to plan and the subsidiary is making a loss.  The subsidiary is a separate company and the directors of that company must comply with company and insolvency law.  It is unlawful for the subsidiary to operate at a loss.  The subsidiary may need to access additional funding or be wound up.  If the charity is to loan funds to the subsidiary, then advice should be sought about those arrangements as it must be treated at arm’s length particularly if the subsidiary looks to be in financial difficulties.

Formalise the arrangements between the charity and subsidiary

We have already mentioned loans from the charity to the subsidiary must be on an arm’s length basis and documented as such.  The charity may support the activities of the subsidiary in other ways, usually staff time particularly in relation to back-office functions.  However, the contribution by charity staff must be documented and accounted for usually by way of a recharge to the subsidiary. An intra group services agreement provides a record of such arrangements.

Consider the controls of the charity

For the trading company to be a subsidiary, it will be wholly owned by the charity.  Usually, the subsidiary will be a company limited by shares and the charity will be the sole shareholder (also known as the member).  The articles of association for the subsidiary can include controls for the member to appoint directors of the subsidiary and also reserve certain decisions for the member.  However, care must be taken to ensure that the subsidiary still functions as a separate entity, for example holding (and minuting) separate meetings of the charity and the subsidiary.

Manage conflicts of interest

The charity and the subsidiary must manage any conflicts of interest arising.  The conflicts between the two organisations for usual day to day matters can usually be “blessed” within the governing document.  However, as mentioned above it is advisable to have an independent on each of the boards to assist in managing more complex conflicts of interest. It is important that each board minutes all decision making, and the management of such conflicts based on the knowledge of each board at the time.