In our first blog post of the year, Annie has identified and will be debunking some of the common “myths”, misunderstandings and misconceptions that surround common legal structures in the third sector.
“Charities cannot carry out trading activities”
Many people have got the impression that charities cannot trade. This is untrue and charities are able to use a social enterprise way of working are able to carry out trading activity if it’s within charity and tax laws. Charity law sets out what kind of trading activities charities are able to do and to what level they can trade, and some types of trading are subject to tax. Trading is often part of charitable activities to raise funds for a charity, but these must be applied toward their charitable purposes. This is known as primary purpose trading. Charity law allows non-primary purpose trading up to certain specified limits and if there is little risk to the charity. OSCR (the Scottish Charity Regulator) have a helpful Charities and Trading Guide, which discusses the different types of charity trading, the use of a trading subsidiary and the duties of charity trustees in relation to trading.
“Charities cannot pay board members”
Whilst it is more difficult to pay board members as a charity, it is possible if you are complying with the conditions set out in Scottish charity law. If you intend to pay board members, you should first consider whether this will be payments or reimbursing expenses, as trustees are entitled to be reimbursed any out of pocket expenses incurred in carrying out their duties. With regard to payments, charities are already legally able to pay trustees if they are permitted to do by their constitution, subject to the overriding requirement that paying them is considered by the board to be in the best interests of the charity. The Trustee Investment (Scotland) Act 2005 sets out certain conditions that require to be met to allow the remuneration of charity trustees. These include setting out the maximum amount of the remuneration in a written agreement, ensuring it is reasonable in the circumstances and that less than half of the total number of charity trustees are being directly or indirectly remunerated.
“If I become a CIC or a charity, I will be guaranteed funding”
Many people think that by becoming a CIC or a charity that they will definitely be able to secure funding from grant funders. While these are structures that are more attractive to funders than others, funding opportunities are competitive and not guaranteed. The crux of being a social enterprise is that you trade to achieve your social aims. This means selling goods, services and products. Many social enterprises do access grants to help with start-up or with certain projects. A social enterprise should aim to use a grant as an investment with a view to developing an income generating idea once the grant runs out so that the organisation is able to remain sustainable.
“All social enterprises can be charities”
The Social Enterprise in Scotland Census 2019 found that 72% of social enterprises in Scotland are registered charities. This does not, however, mean that all social enterprises can be charities, as to do so you must be able to pass the charity test. All social enterprises have a social mission which is a primary objective to achieve social and/or environmental benefit, and aim to create an impact socially. This does not guarantee that this social mission will consist of exclusively charitable purposes. OSCR will look at aspects of your organisation such as your trading activity and any private benefit to proposed trustees and others. So while tax and rates advantages enjoyed by charities may be attractive, it is important to consider whether your social enterprise would actually be able to obtain charitable status and if this structure this would fit in with your activities.
“As a non-charitable social enterprise, I cannot accept donations”
Social enterprises can accept donations. The way these are dealt with depends on which legal structure the organisation is set up as, what form the donation is made in and whether the donations are coming from individuals or businesses. For monetary donations, if you are set up as a charity, you will be able to claim gift aid on the donation. For other legal structures, the donations will be treated as potentially taxable. Some organisations apply to HMRC to be recognised as being not for profit. This can result in HMRC treating some forms of income as non- taxable.
“If I am a social enterprise, I am not allowed to make a profit”
Most social enterprises are ‘for profit’, but these profits are dedicated to achieving a good cause. Many social enterprises can also pay dividends from profits to investors and shareholders, although this is usually restricted so that a majority of profit is dedicated to social causes. There are also some organisations who operate as for–profit businesses for example B corps who commit to create a material positive impact on society and the environment through their operations and co-operatives who generate an income for the community members that are shareholders.
“A company limited by guarantee comes with an asset lock”
A company limited by guarantee can be set up as a private company and does not come with a statutory asset lock unlike with a CIC or a charity. Instead it is something that is drafted into your articles of association to clearly show that you are a social enterprise and you will be re-investing the profits back into the business for future development or into the beneficiary community and the profits will not be distributed to owners/members/investors. Drafting the asset lock into your articles is a fundamental to being a social enterprise, especially if you intend to pursue grant funding.
“By becoming a charity automatically makes me exempt from tax”
It is a common misconception that charities don’t pay tax of any kind. While charitable status can bring with it tax exemptions and reliefs in certain circumstances, it does not does not automatically mean you are completely exempt from paying tax. As a charity, you may qualify for a number of tax exemptions and reliefs and to claim these you must apply to HMRC for recognition as a charity for tax purposes. As with all organisations, as a charity you must register for VAT if you fall within the appropriate criteria.
Advice and Assistance
There are several myths surrounding legal structures in the third sector which can result in organisations potentially selecting the wrong legal structure based on incorrect information. It is therefore essential that you take advice and receive accurate information to allow you make an informed decision. We offer a free initial consultation during which we can provide tailored advice for your organisation on the legal structures available and which might fit in best with your activities.