Trading places

  • 4th April 2024

With growing economic pressures on parents paying school fees, schools need to maximise their income. John Foskett advises on setting up a trading subsidiary


You may be considering implementing a trading subsidiary, or possibly already have one set up at your school, but are unsure why it’s there. A trading subsidiary can be set up for several reasons including protecting your school’s assets from commercial risks or to shelter profits from non-charitable trading.

A trading subsidiary that was set up to minimise Corporation Tax could inadvertently lead to costly implications across other taxes, as well as opening up risks to maintaining strong governance.

What does the school pay tax on?

Due to their charitable status, the majority of independent schools have exemption from Corporation Tax on any income arising from undertaking their ‘primary purpose’ activities. These will be those activities set out in the charity’s objects. The charitable objects of the school may not have been reviewed for a number of years and could be restrictive in what is permitted, for example, being limited to a particular geography or class of beneficiary, so it’s important to check what falls within them before commencing a new venture.

Likewise, Corporation Tax is not due on income from activities that are ancillary to the primary purpose, such as student accommodation, books, uniforms etc. In addition, income arising from property held by the school, such as rental property, will not be subject to Corporation Tax where the profits are reinvested back into the school’s primary purpose and while additional services (for example, the provision of staff) are not provided to the tenant.

Non-primary purpose trading turnover of up to £80,000 per annum can remain within the school without adverse tax implications, although there may still be risk management or governance reasons why the charity would want these activities to be ring-fenced into a separate company.

What happens if you need, or want, a subsidiary?

An alternative way of trading would be to put in place a trading subsidiary that could carry out the non-primary purpose activities. The profit that the subsidiary realises from these can then be paid up to the school under charitable donation provisions. The trading subsidiary does not pay Corporation Tax on any profits donated to the school, and no Corporation Tax will be due from the charity on the donations that it receives.

What about other taxes?

Although a trading subsidiary may result in Corporation Tax savings, the trading subsidiary will not benefit from all of the same charitable exemptions that the school currently does, such as in relation to VAT.

A charity is usually an eligible body for the provision of education and provision of sport for VAT purposes, therefore it can treat such supplies as exempt and no VAT needs to be charged on the income under the current rules. It is likely that schools will be required to account for VAT on fee income if the Labour Party forms a government and this may be legislated for by removing independent schools from the definition of an ‘eligible body’.

An off-the-shelf trading subsidiary is not generally an eligible body for the provision of sport or provision of education in the same way, meaning VAT normally needs to be charged by the trading subsidiary. Given that a usual example of trading in a subsidiary is the provision of sports facilities to third parties, which will likely be supplied to organisations and individuals that cannot recover VAT, there will be a commercial implication to moving these sorts of activities out of the school.

However, with proper planning it is possible to extend the VAT exemption to many of the income streams generated by a trading subsidiary. This typically requires a careful review of the subsidiary’s Memorandum and Articles of Association as well as how it is to operate in practice. Regular reviewing of what’s happening ‘on the ground’ is key here to ensure that the original carefully implemented planning has not been eroded with the passage of time and this often forms a central part of any HMRC compliance checks.

How will the school and company interact?

In order to protect the charitable assets, the trustees will need to be confident that there is a robust rationale for allowing the subsidiary to use the charity’s premises, staff, resources etc. This will mean that consideration needs to be given to the school allocating and recharging relevant direct and indirect costs to the subsidiary, for example by entering into formal lease agreements for the use of property.

Charges to the trading subsidiary from the school for use of its facilities, staff and other assets are, by default, subject to VAT unless specific planning arrangements (such as dual contracts of employment) are put in place. This applies regardless of whether any profit is realised or intended. However, if a profit is realised, under the Corporation Tax rules this is likely to be taxed as non-primary purpose trading profit in the hands of the school.

A potential solution to the additional VAT costs is to set up a VAT group registration that includes both the school and the trading subsidiary. This would allow charges between the entities to be disregarded for VAT purposes. This needs proper consideration before implementing to ensure no unintended consequences arise, for example reducing the right of the trading subsidiary to recover VAT that it incurs.

While VAT has been a significant factor when considering whether to incorporate a trading subsidiary in the past, if VAT becomes due on school fees this will reduce its importance in this area as schools are likely to have a right to recover the VAT incurred on charges from the trading subsidiary. Although it is usually the Corporation Tax or risk issues that drive the use of a trading subsidiary, there may be particular instances where there are VAT benefits to using a trading subsidiary. Specialist advice should always be taken before implementing these types of arrangements.

Are there any non-tax issues?

There are a number of governance issues that must be considered before setting up a trading subsidiary and a few are noted below, although this is not by any means an exhaustive list.

The charitable donation payments from the trading subsidiary must be actually paid over to the school. Therefore, it is important that the school and trading subsidiary have separate bank accounts so that the transaction can be seen to have taken place.

Under the Companies Act, it is unlawful to make distributions in excess of distributable reserves, therefore needing to ensure that the trading subsidiary has sufficient distributable reserves at the time the charitable donation payments are made. This has proved challenging during the lockdown period when subsidiaries have not been able to generate income and is an issue that can be difficult to resolve simply.

The Charities Act reiterates that the trading subsidiary must be financially viable in its own right: the school cannot support the trading subsidiary through donations, gifts or services in kind or by settlement of debts. Particularly during the initial set-up, how the subsidiary will fund its cash flow requirements will need attention to ensure compliance with charity law and to ensure you do not fall foul of unexpected tax consequences.

Not every school will need a subsidiary company but where you determine that you do, a holistic approach to its operation needs to be taken to ensure that charity law, tax and governance issues are proactively addressed.


John Foskett is a partner at business advisor RSM.

John Foskett

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