It’s profit, but not as you’d know it…

When we hear about bosses’ bonuses and dividends for shareholders, you could be forgiven for thinking that every company prioritises profit and that a business is only considered successful based on its profitability.

Far from it.

In the UK today, there are approaching 200,000 businesses, accounting for around £88billion of income that are formed and run according to a different model.

A booming sector

The Not-for-Profit (NPO) or ‘third’ sector is booming. Only NPOs with a gross annual income of £5,000 or more have to be registered and it is estimated that the number of organisations earning below that figure, that are unregistered, could number another 100,000.

It sounds like an unlikely business model to be financially healthy, yet the sector is far from crude, or surviving on handouts. It includes many household names, including charities, educational establishments, hospitals, advisory bodies and consumer goods producers.

Not-for-profit types, sizes and sectors

NPOs come in many guises and levels of sophistication according to their purpose, aims and ambitions. They can be micro-businesses, with a sole or few employees, right up to huge organisations such as the National Trust, The Big Issue and Divine Chocolate.

‘Not-for-Profit?’

‘Not-for-profit’ is a description of an organisational structure and business model. It is not a legal entity in its own right. Each type of NPO model has different definitions and rules of governance. NPOs, including charities, must register with HMRC.

NPOs can be structured as:

Charities

Businesses with charitable status use donations or grant funding as their primary source of income. Charities can also benefit from Gift Aid, the mechanism where UK tax already paid on donated items, including money, can be claimed from the UK government.

The Charities Commission regulates all UK charities.

Social Enterprises

A social enterprise is a business formed with the sole purpose of benefiting society in a clearly defined way. Social enterprises sell goods and services in the same way as traditional businesses but reinvest a large proportion of their profits into achieving their aims.

Social enterprises can include credit unions, co-operatives, and housing associations. They can be owned and run by paid employees and have ‘members’ who pay fees as an income source.

Community Interest Companies

Community Interest Companies (CICs) have a charitable purpose but are allowed to distribute some profits as dividends. CIC is a common model for enterprises such as community cafes, arts centres or community shops.

Not-for-profit accounting

NPOs cannot earn profits in a traditional sense, but they have to earn enough money to fully fund their operations to fulfil their aims and charters, including all operating costs, any loan repayments and wages. All, or the majority of any surplus, which would ordinarily be profit is reinvested into the business or used for a common purpose.

Incorporation and the Charities Commission

The decision to become incorporated should be considered carefully. Also, whether it’s possible and advisable to register with the Charities Commission, as all registered charities are NPOs, but not all NPOs are charities.

Community Interest Companies are required to register once they reach surplus earnings of £5,000 or more.

Some are incorporated organisations with trustees. This group of people (the Board of Trustees) make key decisions about how the organisation is run in its best interests, which is known as the ‘public benefit requirement’. Trustees do not carry out the day-to-day running of the organisation.

Being incorporated gives the protection of limited liability to trustees, just as directors have in an incorporated limited company structure. Not being incorporated exposes trustees if the organisation enters into commercial contracts.

Public benefit interest

The public benefit requirement relates to the rule that whilst a charity aims to achieve one or more purposes, each must also benefit the general public not just the charity itself. This is a requirement of the Charities Act 2011.

Charities must have a governance document that proves that the organisation’s aims meet the public benefit requirement.

Taxation

NPOs and charities are exempt from corporation tax and many other taxes. However, they do need to prepare and submit similar business accounting returns to all businesses.

Charities and social enterprises need to prepare:
Business accounts (including Gift Aid records as applicable)
Annual return

Trustees’ annual report (describes the aims and work of the organisation and is a key piece of information when applying to funding bodies. This document must prove that the organisation is meeting its aims to satisfy the public benefit requirement.

Tax differences

Charities are subject to different rules regarding VAT and larger NPOs will also be subject to audits.

NPOs do not pay tax on most of their income as long as it is reinvested for charitable purposes, including expenditure on:

Donations
Profits from trading
Rental or investment income (bank interest)
Profits from selling an asset such as property or shares

NPOs pay tax on:

Payroll
Profits from developing land or property
Dividends received from UK companies before 2016
Purchases (subject to special VAT rules for charities)

How Rackham’s can help

This is a huge topic, and it’s important to take professional advice before you consider starting or becoming involved with an NPO, even taking on a trustee role. The correct structure, governance and regulation is crucial to achieving the organisation’s aims and operating within the rules.

Rackham’s Accountants can advise you of all the current facts that apply to your aims and purpose within the sector you’re looking to enter or already operating in.

Perhaps you’re already set up and need advice to help you make an informed decision about whether your current operating model is appropriate or beneficial to your cause.

From here, we can look after the specific accounting matters that apply to your not-for-profit business structure.

When every penny counts towards achieving your organisation’s aims, that can make the difference between success and failure, and it’s not an area to leave to guesswork.

https://www.gov.uk/government/publications/charities-detailed-guidance-notes

https://www.gov.uk/guidance/charity-commission-guidance