Most charities want to undertake some commercial activities outside their core purpose (non-primary purpose trading) to generate income to fund their charitable work. If this income exceeds the small trading exemption limits, charities will set up a trading subsidiary if they wish to avoid a tax liability.

Charities that have set up a trading subsidiary need to continuously assess the investment, particularly if the subsidiary incurs losses. As most of these subsidiary companies pay taxable profits to their parent charity as a ‘Gift Aid’ donation each year, a period of loss making can very quickly make a charity’s trading subsidiary appear insolvent. This became a hot topic during the COVID-19 pandemic, when many trading subsidiaries suffered financially, for example, if their activities relied on human contact, such as running events and charity shops. This caused cash flow challenges because trading operations often had to be curtailed.

The current economic challenges are negatively impacting the financial resilience of a number of charities and could have the same impact on their trading subsidiaries. This can therefore affect the going concern assessment of these subsidiaries. Where a subsidiary’s financial viability might seem uncertain, the directors of the trading subsidiary company may ask the charity to provide a letter of support, which could also provide a source of evidence to their auditors. This will express a willingness by the charity to give financial support to the company so that it can meet its financial obligations as they fall due. It might, for example, confirm that the parent charity will not require repayment of any balances owed by the trading subsidiary for at least 12 months from the date when the accounts are signed.

A Letter of Support is used to provide assurance about the subsidiary’s ability to continue as a going concern. It can form part of the evidence that is provided to the auditors to contribute to the going concern assessment made by the trading subsidiary company’s directors. There is increased focus by auditors in relation to going concern, following recent revisions to the International Standard on Auditing on going concern – ISA (UK) 570.

Trustees need to consider carefully if a charity is able to issue a letter of support and must follow legal and regulatory requirements to ensure that this is the case. It should not be thought of as a ‘given’. According to the Charity Commission guidance Trustees trading and tax: how charities may lawfully trade (CC35), trustees may be personally liable for losses to the charity arising from their decision to financially prop up a failing trading subsidiary at the charity’s expense.

The parent charity must consider any financial support to its subsidiary company on an arm’s length basis as it would consider other investments.

If the company’s trading is outside the charity’s objects, the charity must not provide guarantees to the trading company as this runs the risk of using charitable funds for non-charitable purposes.

The charity’s trustees should undertake a rigorous evaluation of the likely return on their investment in the trading company, i.e. to ensure that any financial support will protect the charity’s investment and so be acting in the best interests of the charity. They will need to assess the prospects of future returns based on the company’s business or transformation plan and forecasts. If a charity’s trading subsidiary is no longer viable, trustees must ensure they minimise the charity’s losses and should seek independent professional advice. Trustees must not let personal sentiment affect their decision.

The wording that is appropriate in a letter of support provided by a charity will depend on the circumstances of the trading subsidiary. If the auditor has suggested example wording for the letter of support, the trustees need to assess whether it is appropriate for the charity, reviewing it carefully before it is approved by the board of trustees. Retaining appropriate documentation of how the charity’s trustees came to their decision is critical. Charities should consider taking independent professional advice to ensure that they are doing the right thing. This can be a difficult balancing act!

Having a letter of support from the parent charity does not preclude the directors of the trading subsidiary from preparing a going concern assessment.

ICAEW’s Audit and Assurance Faculty’s guidance for auditors explains that letters of support cannot be considered sufficient audit evidence in isolation. Auditors will need to consider the appropriateness of the going concern basis; and conclude, on the basis of the audit evidence, whether a material uncertainty exists in respect of events or conditions that may cast significant doubt on the company’s ability to continue as a going concern. This includes the business rationale for continued support, particularly if the entity is loss making, including what that support is predicated on (e.g., business or transformation plan, forecasts).