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” or “not for profit” – 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 someone who is a trustee/director could offer services 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 (this example comes from our Daughter business, YogaTax):
A charity is set up to provide yoga classes for refugees. It does this by running classes for the public and using profits from that to hire a space to run classes for refugees. Providing classes to refugees is the charity’s purpose. However providing classes to the public is not a charitable purpose, it is trading to generate funds for the charity. Therefore the profits from public classes will be a taxable trade. By contrast if the refugees paid towards their classes this would not be taxable.
The normal way around this is for the charity to own a trading company which carries out trading operations, eg in the above example runs the public classes, and then donates its profits to the charity – this is tax efficient and results in no Corporation Tax being paid, but has a higher administrative overhead requiring two entities, two sets of accounts, etc.
Take another example:
A charity is set up to help refugees train as yoga teachers so that they have a sustainable income. As part of the charity’s work the trainee teachers teach classes alongside a mentor. The public pay to attend these classes. 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 social enterprise / philanthropy?
Well, first off do you need any formal structure? If things are low key there may well be no need for any special structures and trading can be run as an adjunct to an existing business. Theres nothing to stop you advertising that your business is run on Socially Ethic or Social Enterprise 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.
Social enterprises and Charities – a comparison
|Community Interest Company||Company Limited by Guarantee||Charity|
|Legal structure||Limited company with shares||Limited company with guarantors||Normally Company limited by guarantee or a trust. Maybe Charitable Incorporated Organisation|
|Registration obligations||HMRC, Companies House, CIC regulator||HMRC, Companies House (Charity Commission if registering as a charity)||Charity Commission, possibly Companies House|
|Can become a charity?||No||Yes, potentially, but separate registration||n/a|
|Tax Exemptions||None||None unless a charity||Some, on non trading activities. Business rates exemptions|
|VAT exemptions||None||None unless a charity||Some limited exemptions and complex|
|Governance||Board of Directors||Board of Directors (who are also Trustees if a charity)||Board of Trustees|
|Pay Directors / Trustees||Salary under PAYE. (Very limited dividend rights.)||Salary under PAYE||Possible, but only in exceptional circumstances.|