Community run commercial ventures are becoming increasingly common as existing village amenities such as shops and pubs close and residents decide to take matters into their own hands.
Community shops, pubs and post offices are a good way of sustaining a vibrant village that would otherwise lose its focal point, and forum for social interaction. They are also a lifeline for residents who are unable to travel far.
However, with all the social advantages of maintaining a vital community spirit, one should not ignore the potential tax issues. This is easily done, as the perception amongst those who may lead these ventures is that as they are intended to be run on a not-for-profit basis, there will be no tax to pay.
This may be the case, but community run businesses need to consider their structure to ensure they do not inadvertently fall foul of HMRC. One such case that was reported in the press in 2012 was that of a community shop in the village of Almondsbury, South Gloucestershire, staffed entirely by unpaid volunteers. Its profits were split between various community groups and local causes, and the managers were shocked to discover the shop was liable to corporation tax.
There are other examples of such ventures where no tax has to be paid. The distinction all depends on the structure chosen at the outset.
Choosing a structure
A shop run through a corporate entity that is trading will be subject to corporation tax on first principles. It may also be subject to VAT where turnover exceeds the registration threshold. Other special rules may also apply.
There are a variety of alternatives that could be used as a suitable vehicle for running a community shop, including:
1. A registered society under the Co-operative and Community Benefit Societies Act 2014 (what used to be called an Industrial and Provident Society);
2. A company limited by guarantee (CLG);
3. A Charitable Incorporated Organisation (CIO);
4. A Community Interest Company (CIC).
The first three would all potentially allow for registration with HMRC as a charity, which would provide tax exemption where profits are applied for charitable purposes. This would include profits from trading within its primary purpose, and income from investments such as bank interest, or letting a flat above a shop.
Although there is often confusion over this, a CIC can never be a charity, so will always be subject to tax. CIC’s have some attraction where the body wishes to pay its key individuals (charity trustees cannot be paid), but this will have a corporation tax downside.
If the entity used is a CLG, the Charity Commission may not accept it has charitable status. Whatever vehicle is chosen, the objects of the company will need to be prudently considered, and legal advice relating to the relevant charity law should always be sought.
Any entity not benefitting from charitable status with HMRC will be subject to tax.
A community run venture brings in the question of mutual trading, i.e. trading with its own members. The most common example of this would be a local sports club. Where the legal entity has a membership structure, then surpluses arising in non-charitable entities may also not be subject to tax. Again, it is important to get the legal structure right at the start if this is what is intended.
The following requirements must be met in order to qualify as a mutual:
HMRC’s Business Income Manual at paragraph 24000 onwards provides the department’s view of how these conditions can be met, and should be reviewed in detail to ensure that the governing documents for an entity intended to be mutual are drafted correctly
Mutuality means surpluses from trading with members are not liable to tax, but, equally, losses are not tax deductible. Other profits arising from trading with third parties (non-members) will always be taxable, as will bank interest and chargeable gains.
Other profits arising, such as from letting surplus accommodation will also be subject to tax under this structure.
Where mutual trading exists, there will be a need to carefully consider the allocation of costs between the mutual and the non-mutual trading elements to arrive at a tax adjusted profit on any non-mutual (taxable) trade.
Another common issue for new community ventures can be the funding of improvements to community buildings. This may be in the form of loans or share capital investment.
Social investment tax relief (SITR) is an attractive vehicle for social investment. Individuals who make a qualifying investment can deduct 30% of the cost of their investment against their income tax liability, either for the tax year in which the investment is made or the previous tax year. The investment must be held for a minimum of 3 years for the relief to be retained.
Where an individual has chargeable gains, the CGT liability can be deferred if the gain is invested in a qualifying social investment. Tax will instead be payable when the social investment is sold or redeemed. The individual also pays no CGT on any gain on the investment itself, but income tax will be payable on any dividends or interest on the investment.
SITR is not an automatic relief, however, and the company will be required to submit a compliance statement to HMRC in order to confirm that it meets the requirements for SITR to apply. This is a similar process to that for other tax reliefs such as Enterprise Investment Scheme (EIS). As with EIS there is also a valuable advance assurance procedure which allows companies to check whether their plans comply prior to individuals committing their investment.
Where the community entity is looking to improve or renovate a building to use as a community shop, minimising costs on the refurbishment is likely to be a key discussion point. The recovery of VAT on improvements to community buildings is another complicated area on which specialist advice should be sought. Community groups should not assume that they will be able to fully recover VAT or benefit from reduced rates of VAT on construction work simply because they are not for profit.
Overall, the intentions for keeping a thriving local community going through the provision of a local shop or similar are most laudable. But even the most benevolent and community-spirited of residents should be wary of diving into such a voluntarily-run activity without first checking that they are not getting into hot water with the tax office.
The original of this blog first appeared in Taxation magazine in April 2017.