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Trading Issues for Trading Companies

on Friday, 26 June 2020.

The impact of coronavirus (COVID-19) has put a tremendous additional work load on schools, particularly their governors and senior leaders. The pace of change has been high and the need for dynamic decision making has never been more important.

But there is one aspect of the independent school structure that should not be overlooked - the solvency or otherwise of any trading subsidiary.

Trading subsidiaries are strictly separate companies with their own board of directors, who will need to consider the position of that company and its financial projections, taking into account their duties as directors of that company. Many boards of directors will have been doing so (likely in consultation with the school) and may have taken advantage of the furlough scheme and the business interruption loan scheme where operations have been affected.

However, the coming months are likely to result in more disruption for school trading subsidiaries as the summer let season approaches, which in most years would be financially lucrative. Directors of the subsidiary must consider its financial position carefully and ensure they are fully up to speed with their contractual commitments, and have adequate financial information in order for them to do so. It would also be right for the school to be kept informed of these matters as (very often) the sole member.

Where the projections for a trading subsidiary do not look favourable, its directors should be mindful of its solvency. There are two key tests for solvency - the income test and the balance sheet test. The majority of school trading subsidiaries will have very few assets and the ability of the subsidiary to pay its debts as they fall due (including to the school itself) will be critical. The directors must ensure they have access to up-to-date and relevant information and keep it under constant review. If there is any question that the subsidiary may face insolvency, the directors should take immediate advice as their duties as directors will change.

Where a subsidiary does face financial issues (whether or not they threaten its solvency) it can be tempting for the school to provide financial support. This is something that should be very carefully considered by the school and its governors should consider the interests of the school (as a charity) alone, and whether it would be a suitable investment for the school to make. Notwithstanding the unprecedented circumstances, providing support should absolutely not be the default position and the Charity Commission is clear that a charity must not subsidise a failing trading subsidiary.

If governors consider that support is appropriate, having taken into account all the circumstances and their investment duties, they must be very careful how the school does so and, where appropriate, ensure that it is structured in the right way (normally by way of a loan or occasionally equity investment) to be compliant for charity law and tax purposes. In most cases it will be appropriate to take advice on these aspects. The likelihood of the school being able to recover its loan or investment will be a critical factor in the governors' decision making.

In making decisions of this type governors must be very careful to ensure that any conflicts of interest (perhaps because they are also a director of the trading subsidiary) are managed and that all decision making is carefully minuted.

Perversely there may also be issues where a trading subsidiary seeks to retain its own profits at the end of the financial year in order to manage its cash flow. Ordinarily the profits would be paid by way of a qualifying donation to the school under the gift aid scheme to limit liability to corporation tax. Corporation tax may become payable if profits are retained and there may also be VAT traps to be aware of in such circumstances.

While we expect the revenue raising abilities of trading subsidiaries to be compromised this year, solvency is only likely to be an issue for very few. Nonetheless we advise directors (and parent schools) to be vigilant.

For further information on these issues please contact Emma-Jane Dalley in our Independent Schools team on 07584 055 017, or complete the form below.

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