Charity Tax : How a UK Charity May Avoid the Perils of UBIT

A key advantage that not for profit organisations operating in the UK have over their US counterparts is their ability to conduct commercial or trading activity through a wholly-owned trading subsidiary without incurring corporation tax on the profits arising. In contrast, under US tax law, an otherwise tax exempt organisation will generally be subject to tax on its income from an unrelated trade or business. Unless the business activity undertaken has a direct cause or relationship to the achievement of the exempt purpose (other than through the production of income), the revenues generated would be taxable as unrelated business income.

The position is quite different in the UK provided the "profit driven" trading activity is conducted via a wholly-owned trading subsidiary of the UK charity. Whilst, ordinarily, any profits generated would be subject to corporation tax, the tax may be mitigated provided the subsidiary makes a gross payment of its profits to the parent charity. From the trading subsidiary's perspective, the donation is treated as a charge against the total profits assessable to corporation tax and is simply deducted from the trading profits generated during the year of the gift.

The basic mechanism for which works in the following way:-

the UK charity establishes and funds a company limited by shares - all the shares are owned by the UK charity; the trading company carries out either primary or non-primary purpose trading activity - since it is not itself a charity, there are no restrictions on its ability to trade as an independent legal entity, its activities should not present a risk to the parent charity's assets; trading subsidiaries may be formed although only one director in place provided that the sole director's is an actual person (it is not permitted to have a company act as a sole director) - the director may be remunerated provided he or she is not also a trustee of the parent charity; whilst the profits of the trading company will be liable to a corporate tax charge, these profits may be donated to the parent charity. This...