Charity: Issuing a letter of support

Charities seeking to undertake commercial activities, above the small trading exemption limits, often establish a trading subsidiary. The trading subsidiary will undertake the commercial activity and via a gift aid donation it will distribute its profits back to its parent charity. This situation works very well for profitable trading subsidiaries with little to no tax leakage.

Unfortunately, many trading subsidiaries suffered during Covid with many recording losses and due to their policy of distributing all their profits to their parent charity, these losses create an insolvent balance sheet position. An insolvent balance sheet creates a going concern issue for the trading subsidiary, especially if they are not forecasting and immediate return to profitability.

An insolvent balance sheet and possible ongoing loss-making situation leads to the suggestion, or possibility of the parent charity being requested to issue a letter of support to the auditors of their trading subsidiary, to support its going concern basis.  Whilst this letter in isolation would not be sufficient audit evidence, it would provide support to other evidence the auditor has around going concern.

There are however several key issues to consider before the trustees issue a letter of support in respect of the charity’s trading subsidiary:

• CC35 Charity Commission guidance suggests that trustees may become personally liable for losses to the charity arising from their decisions to continue to support a loss-making trading subsidiary.
• Any ongoing support to the trading subsidiary must be considered on the same arm’s length basis as any other investment by the Charity.
• If the trading subsidiary’s trade is outside of the charity’s object, this causes an issue as the charity should not use charitable funds for non-charitable purposes.

A letter of support suggests a willingness of the charity to financially support the company for at least twelve months from the date the accounts are signed. As such, the trustees will need to have fully considered the level of support and how the trading subsidiary will repay any support provided. This consideration will include carefully reviewing the trading subsidiaries profit projections, cash flow forecasts and plans for the future. If a letter of support is to be issued, the wording of the letter needs to be very carefully considered by the trustees, with this consideration documented in trustee meeting minutes.

Additionally, for a loss-making trading subsidiary, especially one with a history of losses, the trustees will need to consider the level of exposure to the charity. If the trading subsidiary has a history of losses and this is forecast to continue, the trading subsidiary may not be viable, the trustees should in this situation ensure the charity minimises any losses.

Where the trustees are considering, either a letter of support or the future of the training subsidiary, they should take appropriate professional advice and ensure this is advice is documented in the minutes along with any decision taken.

If you have questions or need any advice regarding a letter of support or a trading subsidiary, please get in touch with me or your usual Ensors contact.