The problem: charities can be taxed on the wrong kind of trading
Charities get generous tax reliefs, but those reliefs have limits. Income from your charitable purpose is usually tax-free. Income from commercial trading that isn't your charitable purpose — a café open to the public, branded merchandise, corporate sponsorship deals — can be taxable, and doing too much of it inside the charity itself puts your assets and your status at risk.
The standard fix is a trading subsidiary: a separate company, owned by the charity, that does the commercial trading and then hands its profits back up to the charity using Gift Aid so no tax is lost. It sounds fiddly, but the logic is clean. This guide explains when you need one and how the money flows.
Two kinds of trading
The whole thing hinges on a distinction HMRC draws:
- Primary-purpose trading — trading that directly furthers your charitable objects. A charity for the arts selling theatre tickets, or a training charity charging for its courses. This is generally exempt from tax.
- Non-primary-purpose trading — trading done mainly to raise funds, unrelated to your charitable objects. A charity running a public café, selling Christmas cards, or taking commercial sponsorship. This can be taxable, and there are limits on how much you can do inside the charity before it becomes a problem.
There's a small-scale exemption that lets charities do a limited amount of non-primary-purpose trading without a subsidiary, based on turnover and as a proportion of total income (check the current limits). But once your commercial activity gets past that, or you simply want to protect the charity from commercial risk, you set up a trading subsidiary.
What a trading subsidiary actually is
A trading subsidiary is an ordinary company (usually a company limited by shares) that the charity owns. The charity holds the shares; the subsidiary does the commercial trading. Critically, it's a separate legal entity, so:
- Commercial risk sits in the subsidiary, not the charity. If a venture fails, the charity's core assets are ring-fenced.
- The subsidiary can trade freely without the restrictions charity law places on the charity itself.
- The subsidiary pays Corporation Tax on its profits like any company — unless it gives those profits away to its parent charity.
The key move: A trading subsidiary Gift-Aids its taxable profits up to the parent charity. A Gift Aid donation from company to charity is deductible against the company's profits, so the subsidiary's taxable profit drops to nil — and the charity receives the money tax-free. Tax isn't lost, it's neutralised.
How Gift Aid moves the money
Companies can make Gift Aid donations to charities, and those donations reduce the company's taxable profits. So the flow works like this:
- The subsidiary trades commercially and makes a profit — say £40,000.
- Before or shortly after year-end, it donates its taxable profit to the parent charity under Gift Aid.
- That £40,000 donation is deductible, so the subsidiary's taxable profit becomes £0 and it owes no Corporation Tax on it.
- The charity receives £40,000 tax-free to spend on its charitable purpose.
The timing rules matter here — there are deadlines for when the donation must be made relative to the year-end for it to count against the right period. This is exactly the sort of detail worth getting right with an accountant rather than guessing. Get started and we'll set the mechanism up properly.
Worked example
A community charity runs a popular public café to raise funds. The café isn't its charitable purpose (the charity's purpose is youth mentoring), so café profits are non-primary-purpose trading and would be taxable inside the charity. The trustees set up a trading subsidiary to run the café. In its first full year the café makes £25,000 profit. The subsidiary Gift-Aids the full £25,000 up to the charity: the company's taxable profit falls to zero, no Corporation Tax is due, and the charity gets the whole £25,000 to fund mentoring. Had they run the café directly inside the charity and blown past the small-trading exemption, part of that profit could have been taxed and the charity's status exposed.
When it's worth it — and when it isn't
A trading subsidiary is worth the effort when:
- Your non-primary-purpose trading is above the small-scale exemption limits.
- The commercial activity carries real risk you want kept away from charitable assets.
- You're taking on sponsorship, retail, or commercial contracts at scale.
It's probably overkill when your fundraising trading is genuinely small and one-off, where the small-trading exemption may cover you without the extra company. Running a subsidiary means a second set of accounts, a second Corporation Tax return, proper intercompany governance, and Gift Aid paperwork every year. Don't create one for the sake of it.
Governance the regulator expects
The Charity Commission expects the relationship to be at arm's length and properly documented: the charity should charge the subsidiary fairly for any shared staff or premises, trustees mustn't let the subsidiary trade recklessly with charity money, and the arrangement should genuinely benefit the charity. Keep the two sets of books clean and separate. And remember the subsidiary still has its own filing deadlines at Companies House and HMRC.
Not sure which side of the line you're on?
The trickiest part is usually deciding whether your trading is primary-purpose or not, and whether you've crossed the exemption. Tell us what your charity does and how it raises money, and we'll tell you plainly whether you need a subsidiary. If you're still weighing charity vs CIC in the first place, start with does my charity need to register, then get started with us.
