Many business owners start to think about giving back to the wider world and their thoughts come to establishing a Social Enterprise or Charity.
Lets look at some of the definitions, structures, advantages and pitfalls.
Social Enterprise – a business with a low profit or not for profit ethos that wants to plough some or all of its profits back into community work. It may be constituted as an ordinary company, a Community Interest Company (CIC), or could be a sole trader/partnership structure. By themselves these businesses do not confer any tax advantage or special treatment. There is no legal definition of “Social Enterprise” – any business can describe itself as such.
Charity – an entity which meets a test of charitable purpose, and either raises funds or provides services for the community. Features:
- Registered with the Charity Commission. To do so it must (a) have a set purpose/aim and (b) that aim/purpose must align with Charitable Purpose.
- Could be constituted as a Charitable Trust or a Guarantee Company. If a Guarantee company, the directors are normally trustees for charitable purposes.
- Tax exemption from fund-raising for charitable purposes and for trading which is part of the main purpose of the charity – see further below on Charities and Trading
- Trustees / directors are normally not paid and cannot benefit from the Charity. Its a moot point as to whether a a yoga teacher who is a trustee/director could be paid for a class on a subcontract basis – its possible, but can run into difficulties around trustee/director benefit especially if its regular/substantial.
- Can receive donations by Gift Aid, which allows the charity to reclaim the Basic Rate Income Tax the donor has paid (eg if an individual gives £80 and signs a gift aid form, charity claims £20 from HMRC).
- Mandatory 80% discount on business rates if occupying commercial property.
- Specified Charitable Purpose includes:
Prevention/relief of poverty
Advancement of education
Advancement of religion
Advancement of health or saving lives
Advancement of arts/culture/heritage/science
Advancement of environmental protection / improvement
Advancement of amateur sport
Advancement of animal welfare
See the full list in Charity Commission Guidance
- Directors who can be paid.
- Shareholders who can receive a dividend subject to dividend cap (unless a Guarantee company – see below).
- Asset lock restricts the transfer of assets to members.
- Cannot be a registered charity.
- No special tax breaks. Any trading profits are subject to Corporation Tax and the post tax surplus available for dividend to shareholders subject to cap or for fulfilment of community aims and ethos, eg providing community services or making grants. The normal tax code for Corporation Tax, VAT and PAYE applies in full.
Company Limited by Guarantee – this was the time honoured way of running a not for profit. A guarantee company has directors but no shareholders – in place of shareholders are guarantors who agree to contribute a token sum, usually £1, if the company fails. There may only be a handful of guarantors, perhaps half a dozen. Features:
- Directors but no shareholders – Directors can be paid unless registered as a charity.
- Can optionally register as a CIC or Charity, but not both.
- No special tax breaks (unless registered as a charity). Any trading profits are subject to Corporation Tax, and the post tax surplus is available for the fulfilment of community aims and ethos, eg providing community services or making grants. The normal tax code for Corporation Tax, VAT and PAYE applies in full.
- As no shareholders, no dividends, and in the event of liquidation any surplus goes to a similar organisation.
Charities and Trading
As alluded to above, Charities are taxed on trading profits unless the trading profits are part of the Charity’s purpose. Eg:
A charity is set up to provide meals and essentials for refugees. It does this by running a restaurant for the public and using profits from that to buy items for for refugees.
Providing relief to refugees is the charity’s purpose. However providing catering to the public is not a charitable purpose, it is trading to generate funds for the charity.
Therefore the profits from the restaurant will be a taxable trade.
The normal way around this is for the charity to own a trading company which runs the restaurant, and then donates its profits to the charity – this is tax efficient and results in no Corporation Tax being paid, but has a high administrative overhead requiring two entities, two sets of accounts, etc.
Take another example:
A charity is set up to help refugees train as chefs and waiting staff so that they have a sustainable income.
As part of the charity’s work the students work in a training restaurant alongside a mentor. The public pay to eat in this restaurant.
As the trading stems from the charity’s prime purpose, the profits are not taxable.
As can be seen in these contrasting examples, getting this right isn’t always easy and, of course, there can be VAT considerations as well. The structure needs to be thought through, and whilst a trading subsidiary is the time honoured way of getting around charitable trading issues, it does increase administration burdens considerably.
A social enterprise, including a CIC, doesn’t have the same problems only because all its profits are taxed anyway!
Making this work in practice
So, whats the best way to make some of this work in practice if you are thinking of some type of community project?
Well, first off do you need any formal structure? If its just you, and maybe a few others, doing some community activities low key, there may well be no need for any special structures – the activities won’t generate much/any income or profit, and can be run informally or as an adjunct to an existing business. Theres nothing to stop you advertising that your business is run on Social Entity principles, as these aren’t defined anywhere – any business can be socially aware.
If you are:
- receiving grants or donations from the public
- working under contract for a grant making body
then you may need to think about formalising things.
A charity gives you the benefit of gift aid and some tax exemptions, but doesn’t allow for the trustees/directors to be paid. This creates a dichotomy if you are setting up something which you want to be part of, but want income from by way of a living wage / subcontract payment.
A CIC gives more commercial freedoms but less in the way of tax benefit.
In both cases there are significant administrative hurdles in both registering and running the entities, eg formation/ registration costs, annual accounts, compliance.
In many cases it pays to keep things informal until there is enough momentum to justify costs of a formal structure. Often people rush into setting the structure up, and then find operationally things don’t work out, and there has been a lot of wasted time and cost.
Whitefield can advise on all the above aspects, and help formulate a business plan.