May 2010

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Contents

01 Are there too many charities in the UK?

03 Mergers and Collaborative working seminar

07 Why should your charity remain independent? – a challenge

08 Getting the route map right

10 Looking over the Precipice

13 What you always wanted to know (but were afraid to ask) about tax and mergers

15 VAT cost-sharing exemption should benefit the charity and not-for-profit sector

17 HR and pensions issues in charity mergers

19 In the Spotlight: Age UK Creating a stronger charity in harsh times

Introduction In April, I chaired a PwC seminar on Mergers and Collaborations with guest speakers from Age UK, Arts Council England, Princess Royal Trust for Carers and RNIB. Our own Ian Oakley-Smith opened the debate with a challenge: Why would any charity NOT want to merge or collaborate? If beneficiaries are to receive the best service, then working together as service deliverers must make sense.

This edition of Charity News tackles the subject head on. We consider various aspects of working together; from the tax and VAT implications of secondments or a shared service centre, through a consideration of some of the people issues on merger, to the Final Precipice: what to do if you’ve left it too late and are looking over the edge at potential insolvency.

As we wait to see the outcome of the general election, perhaps the party leaders could benefit from reading some of our articles – collaboration and working together effectively will, I hope, be a priority for them all as they work out how to steer the country out of the current financial doldrums.

One thing is for sure, there will be continued pressure on charities to work more efficiently and effectively as costs are likely to increase and funding (especially from government) is increasingly under downwards pressure. It is an interesting time for our sector, and the landscape is likely to change as we all look for opportunities to work together. I believe that whatever the outcome, we are likely to emerge a stronger and more robust sector of the economy, for the sake of all current and future beneficiaries.

Liz Hazell National Charities Group Leader

Are there too many charities in the UK?

According to latest Charity Commission statistics, there are more than 190,000 registered charities in England & Wales. That is more than one charity for every 320 people. There are more than 700 charities which purport to serve blind people and greater than 1000 charities with the ‘cancer’ in their title. The vast majority of charities clearly are important to society, ever more so in a resource constrained environment, but do we really need so many?

With so many charities, the question arises as to whether there is too much duplication and competition for funds. Does this result in unnecessarily aggressive marketing and fundraising?

Lesley-Anne Alexander, Chief Executive of RNIB, the largest sight loss charity in the UK, openly acknowledges that “if there are fewer sight related charities, we would spend less on fundraising and administrative costs, and more on innovation and services to improve the lives of our beneficiaries”. She recognises that too many charities operating in the same field tend to compete for funding or have differing views, which often confuses funders, policy makers and beneficiaries.

Lesley-Anne helped bring together a fragmented policy, and created a single strategy for blind people, allowing the charity to be strategic in its service delivery and opened the scope for more significant collaborations and mergers in the sector.

At a time like this, when demand for many aspects of charity is likely to be higher than normal, and income streams are likely to continue to fall into 2011 and beyond, can charities make better use of the monies raised?

Many charities are too small to benefit from a critical mass which would allow them to function effectively and efficiently, and to leverage the lobbying and buying power that size could afford them. Whilst we recognise that many small charities achieve their objectives, they are usually heavily dependant upon skilled volunteer resource.

This is not to say a shotgun marriage is necessarily the best solution or that merger will always provide significant benefits. There may be very valid reasons for a charity to remain small and independent. “The needs of the locality, and the investment by a community may outweigh economic benefit of a merger”, says Francis Runacres, Director of Investments at Arts Council England.

Conclusion

It is likely that market forces, increased public scrutiny of fundraising and governance costs, and a resource constrained environment will drive many trustees to question why it continues to be appropriate for them to remain as a stand alone entity over the next few years. To support trustees as they explore some of these challenges further our following articles explore some of the above themes in more detail. This is an important topic and one that will be increasingly on agendas of all charities.

For more information contact: Ian Oakley-Smith 020 7212 6023 ian.oakley-smith@uk.pwc.com

01

Mergers and Collaborative working seminar

Ian Oakley-Smith Director, PwC Business Recovery Services

“The challenge to trustees is not ‘what are the compelling reasons for merger or collaboration?’ but rather ‘what are the compelling reasons for us to remain independent?’ There may be justifiable reasons for remaining independent, but the question needs careful consideration to protect the interbeneficiaries.

“ ests of the

PwC hosted a seminar on mergers and collaborations in April, inviting speakers from across the sector.

The speakers challenged charities to consider mergers and collaborative working, whilst highlighting the potential practical considerations.

In this article we discuss the benefits of and obstacles to mergers and collaboration and include a helpful checklist for trustees and senior management to challenge themselves on this topic.

Consideration of mergers and collaborative working

What is the issue?

In the present economic climate, many charities will be considering how they can adapt to a reduction in available income. By common consent, the recession will continue to impact many charities well into 2011 and possibly for some time after that. Most charities rely to some extent upon statutory sources of income and as a consequence are anxious as to the impact of future public spending cuts.

For some charities, reduced income will lead to a reduction in services; for others, it may threaten their very existence, either because they cannot afford even a basic level of administration, or because trustees consider that they have become so inefficient that they are no longer comfortable that funds are being appropriately spent.

Some charities are already looking at what can be done to make more of the money they have available. Once they have exhausted the possibility for internal efficiency savings, they may look at other like-minded charities, many of whom will be in a similar position, in order to think about how their collective position can be enhanced by working together more closely or by merging.

Consideration of collaboration or merger as a possible solution

The extent to which a charity will choose to merge or look to ways of collaborating with others will, of course, depend upon many factors. Indeed, it may be that charities may look towards collaboration as a possible “pilot” for a full merger later down the line.

There are a variety of ways in which charities could collaborate. At one end of the spectrum, a larger charity might provide, say, finance, HR or other services to a smaller one for a share of an existing cost, or charities may agree to “share” various overheads in order to maximise efficiency and create critical mass.

At the other end of the spectrum, certain services may be merged, for example a trading activity might be combined in some sort of joint venture or the delivery of similar services might be combined.

Other interesting areas that might be considered could be fundraising, where similar charities are competing for a similar available pot of funds, and communications, where shared investments in communication might provide an overall increased benefit, without necessarily diluting the message of any one charity.

03

Francis Runacres Investment Director, Arts Council England Services

“There may be funding available to help arts organisations consider collaboration or merger where there is a clear business case for doing so. The arts sector geography and localism play an important role and often serve to reduce the potential benefits of a merger.

“

Who might consider working together in this way?

In theory, any group of charities could potentially share “back office” services, for example finance and HR. However, the most likely candidates are those charities with something in common. This might simply be a question of geographical proximity: charities all operating within the same postcode might find that they have enough in common in terms of access to local funders/donors, access to local radio stations or other media. They might also have local trustees who might be sympathetic to local causes.

However, it is most likely that successful collaborators will also have a common operating model and/or share a common vision or purpose.

It may be that having a shared funder, be it a local authority, a trust/foundation or other common funders, might be a key component as charities may be able to approach that funder and work with it to mutual benefit, particularly if there will be pressures on that funder to find additional efficiencies in grant giving.

The main characteristic of appropriate candidates for collaboration or merger will be an open mind. There will either need to be a recognition of the fact that there might be real benefits to be had which will make the exercise worthwhile or a recognition that the charity’s very survival might depend upon being proactive and investigating the possibilities before it is too late.

How could charities benefit from collaborative working or merger?

In essence, the benefits can be summarised as follows:

• Reduced costs arising from increased purchasing power and efficiencies;

• Improved quality of resource arising from a greater critical mass, for example collaborating charities might be able to afford to employ higher qualified individuals (finance, fundraising, communications etc) than individual charities;

• Reduced risks arising from sharing investments in new services, contracting with third parties etc;

• A reduced need to hold reserves as a result of shared risk-taking;

• Greater access to professional advice (legal, property, accounting etc);

• A more coordinated approach to dealing with beneficiaries, contracting parties etc, leading to better delivery and cost savings; and

• More effective management of the charities’ affairs arising from the need to ensure that each individual charity’s interests is properly protected. Keith Lawson

Senior Manager, PwC Indirect Tax Team

“

“VAT is something which charities need to consider when looking at the potential cost savings from mergers and/or collaborative working.

04

Tom Wright Chief Executive of Age UK

“It was plain to us that what’s needed is a stronger organisation that can raise its game to face up to the immense challenges and opportunities of an ageing society. Age UK was created from a genuine merger of Help the Aged and Age Concern England. We established a new Board of Trustees and appointed a new Chairman and Chief Executive. Establishing Age UK as a new organisation was critical to bring us together with a shared sense of ambition and values.

“

What are the obstacles which might prevent success?

The most frequent issue which prevents collaboration or merger being considered is a perceived loss of independence in decision making or dilution of a brand. This, coupled with a lack of trust of the other organisations or a lack of faith in their competence, often dissuades charities from talking openly about how they might work together.

There are also very real issues around access to funders, with charities being concerned that they will get more “bites of the cherry” as individual organisations as opposed to a group which funders see as one organisation.

The process of establishing what benefits are worth making changes to achieve can itself be time-consuming and at times difficult. This, too, can prove terminal to the success of the process.

Finally, if the result of collaborating or merging includes restructuring of personnel, some charities will find this difficult to implement and knowledge that this might be the case can itself prevent senior management engaging in the process, particularly if their roles may be called into question.

Lesley-Anne Alexander Chief Executive of RNIB

Carole Cochrane Chief Executive, Princess Royal Trust for Carers

“ I am passionate about “Timing has to be right, for a delivering services to the merger to work. Merging is not beneficiaries. Whilst there an easy option as it involves a should not be one “monolithic” great deal of time and energy charity, there should without even with the support of question be fewer charities beneficiaries and funders. than there are presently in the We have set ourselves a timeline sight loss sector to allow us of twelve months to bring about to deliver significant benefits any potential merger. I have felt to blind people. Charities elated, frustrated and worried should be encouraged to join along this journey, whilst still a new “group” structure, whilst maintaining and enjoying my retaining a degree of autonomy.

“

life outside her job.

“

05

Why should your charity remain independent? – a challenge Why might your charity remain independent?

Will you really maximise fundraising opportunities by remaining stand alone?

Points to consider:

• Have you talked to your funders on this topic? They may surprise you.

• Do you compete with other charities in the same sector for the same £? Do you think this may confuse your funders into inaction?

• What evidence do you have that you will lose funders if you merge?

Do you want to maintain a lasting legacy and will you lose this?

Points to consider:

• Do you have to do this alone? There may be another charity which can help you to achieve this legacy over a wider reach or in a shorter timescale.

• Have you ensured that this legacy is focused on the beneficiaries rather than a personal desire to do good?

Are you more responsive to the needs of the local community as an independent charity?

Points to consider:

• Why do you think this is? Can a local branch of a larger charity offer this, together with additional benefits?

• The scope of collaborative working is wider and localised charities with similar aims still have opportunities for closer working. A local partner could provide a much needed injection of energy and challenge to the status quo.

• Have you asked your local community what they would like?

Are you able to best serve your beneficiaries as an independent charity?

Points to consider:

• Are you able to provide the full support to beneficiaries that they require? Do your beneficiaries have a clear understanding of when you support them and what other organisations they should go to? Is it easy for your beneficiaries to get the charitable support they require, or are you one of a number of charities they need to approach? Do you really work efficiently with partner charities to your beneficiaries advantage or could you do this better? Would people unconnected to your charity easily be able to locate and therefore benefit from your services?

Are you the only charity who does what you do?

Points to consider:

• Is this really true? Have you done your homework? In order to answer this question faithfully a great deal of research needs to be undertaken. You also may need to think outside the box to the needs and wants of your beneficiaries, your locality and also to your trustees networks.

• Why do you need to do what you do alone? Could you help your beneficiaries more if you were able to offer them additional support in certain areas?

Are you worried about losing or not recruiting suitable staff as part of a larger charity?

Points to consider:

• Do your staff know your strategy? You need to engage your staff at every step of the process which may involve external help.

• Where does your staff’s loyalty lie? Is it with the trustees, the charity, the beneficiaries or the sector?

Would your charity best serve its beneficiaries and provide its funders best return on their donations by remaining independent?

Points to consider:

• Does your charity spend to high a proportion of its time and funding dealing with accounting and compliance matters? Of every pound donated, how much do you really spend on your beneficiaries?

• What good reasons are there not to combine your back office functions with other organisations to reduce costs?

Can PwC help you?

PwC is committed to the charity and not for profit sector and has a broad range and depth of experience across the sector. PwC has assisted clients in the private and public sector and has experience of pre and post merger scenarios. We have also undertaken financial modelling and options appraisals to look at the benefits of mergers and can act as a critical friend for your trustees and management throughout the process. We can also advise on the VAT implications of mergers which can often be far reaching.

For more information contact: Liz Hazell – Head of PwC Charities Group on 020 7804 1235 or Ian Oakley-Smith – Business Recovery Services and Advisory on 020 721 26023

Getting the route map right

OK, you’ve agreed in principle that merger or collaborative working is a good idea and you’re in talks with your opposite number at another organisation. This is all well and good but do you know how you’re going to get to your destination and what do you want it to look like when you get there?

Mergers and joint working often require major organisational change, and the challenge of moving from ‘talking’ to ‘doing’ is often underestimated. Planning is key, and this involves developing a joint vision and a workable route map to achieve that vision.

From our experience these are just some of the factors you will need to consider in building a route map and strategic vision for joint working:

1. Charitable objectives. Individual charity identity is very important and this is often tied tightly into charit able objectives.The challenge here is to define a set of charitable objectives for the new organisation that remain faithful to the spirit of the legacy charities and which are acceptedby all involved.

2. Stakeholders. One of the biggest barriers to joint working and mergers can often be self-interest and suspicion of motives, but the buy-in of all key stakeholders is going to be key to the success of the new enterprise. Challenge yourself: can you get this buy-in without a third party ‘honest broker’? We have found that our facilitation of meetings and workshops can often make an enormous difference to developing a way forward.

3. Structures. It is important to define some guiding principles on the structural objectives. For example, do you want your new structure to be capable of absorbing further charities? How important are separate management and governance arrangements? There are many options, all of which will have different accounting, tax and legal implications as well as operational implications.

4. Achieving economies. For many charities the incentive for coming together will be driven by financial considerations and it is therefore paramount that any new entity should be capable of delivering savings and therefore directing a greater proportion of funding towards your charitable activities. Careful consideration needs to be given to how this is achieved. Which staff are needed and which may be better deployed elsewhere? What are the cost implications of making staff redundant? Have you considered how this is communicated and how to keep staff turnover from becoming a problem?

5. Project management and delivery. Of course, the best route maps will have limited value if they cannot be delivered. A robust project management structure needs to be put in place, including accountability arrangements and a project manager. Your staff will have the day job to do, and it’s therefore important that your project manager has sufficient time to be able to do that role properly.

It’s a cliché, but ‘fail to plan, and you plan to fail’ is very pertinent to charities going through this kind of significant organisational change. As with all journeys it’s always good to set off with a map.

For more information contact: Matthew Hodge 0113 289 4226 matthew.z.hodge@uk.pwc.com

08

Looking over the Precipice

What if there is no solution and the charity needs to be wound up?

We have discussed at length the issues facing charities who might look to merger or collaborate with others in order to increase their long term viability. In this section, we consider some of the issues facing those charities who reluctantly decide that such an option is not open to them and have to consider seriously whether their activities should be wound up.

While a charity’s objects may not be commercial, faced with this scenario, most trustees are still bound by corporate and insolvency laws and need to be aware of their duties in the context of possible insolvency, and the steps that they should take to avoid exposure to potential risks of personal liability. This article considers the types of issue that are likely to arise, as well as the end game: what to do with the legal entity, once the process is complete.

Considerations for charities

Employees and pensions

Undoubtedly this is the most sensitive area. A charity’s people are its most important asset and uncertainty will inevitably result in anxiety. As well as the need to comply with complex employment issues, particularly relating to consultation and any redundancy process, trustees will want to retain a core team to deal with wind down issues, as it is generally more cost effective for these to be dealt with ‘in house’ than by temporary staff or external consultants. If relations between employees and the management team are strong it will be easier to retain and motivate the people that are needed.

Linked to employment issues is the perennial question of pensions (a topic discussed in much detail in the March edition of Charity News). If the charity operated a pension scheme, either as principal or a participating employer, it will be necessary to assess the obligations to the scheme and settle these. If the scheme is a final salary scheme – often referred to as ‘Defined Benefit’ – then the charity may be liable for some or all of any shortfall of assets – this shortfall may well be significantly higher than many trustees would expect. Assessing any such shortfall can be a time consuming and expensive process, involving the engagement of actuaries and extensive consultation with the trustees of the scheme. Conversely, if the scheme is a Money Purchase/ Defined Contribution scheme the liability of the charity as a participating employer is likely to be limited to the employers’ contributions due up to the date of termination of employment.

Donors

After employees, this is often the second most sensitive area, especially if the donors have a strong emotional bond to the charity and its objects. From a financial perspective it will be necessary to consider whether any of the funds held are repayable on a cessation of charitable activity – this may well be the case if the funds were ‘restricted’ in nature, such that they could only be used for a specified purpose which is incapable of being achieved. In some cases it may be possible to approach the donors and agree some variation to the terms on which previous donations had been made.

Land and Buildings

Where the charity has clear title to its assets – for example, freehold land and building – it should be a question of engaging agents to market the premises and sell them for the best possible price. Often, however, there may be claims against freehold land and buildings arising from grant clawback or some other “trust” based claim. Trustees will need to be confident that the property is able to be sold free of any claims and legal advice may needed.

The situation will be different when these assets are subject to a lease. In these instances the landlord may have a claim against the charity in relation to future rent payable to the end of the lease, subject to mitigation by the rent that the landlord would obtain on reletting to a new tenant. This is a complex area and advice will need to be taken; sometimes it will be possible to negotiate a settlement such that the amount paid is considerably less than the gross value of future rent instalments. Whatever the outcome in the current economic climate, it is likely that the landlord will have a claim against the charity and such a claim is unlikely to have been recognised in the audited accounts.

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Taxation

You may wonder why I have raised this point, as generally speaking charities do not pay corporation tax on their profits. However, there are many other taxes that need to be considered, not least PAYE and National Insurance on payments to staff, including termination payments such as redundancy, pay in lieu of notice and bonuses. Careful thought may be required in relation to the timing and description of these payments, in order to maximise the net amount received by the individuals concerned. At the same time tax planning may be required in relation to other taxes – for example, stamp duty land tax payable by a purchaser of a property or VAT on the sale of chattel assets such as machinery, equipment and office furniture.

Need for a Project Plan

It can be seen from the preceding paragraphs that many complex issues may arise on the wind down of a charity, in particular where employees are involved and substantial, non cash assets are held. It is likely that the trustee body does not possess all of the skills required to manage a project of this nature; although they may be well placed to handle individual aspects themselves, once external advice has been taken. At the same time the trustees will be mindful of their responsibilities to demonstrate that they have acted in the charity’s interests at all time, failing which they may be liable to a breach of trust claim. In these circumstances it is good practice to put together some form of project plan, clearly identifying the tasks to be undertaken, their duration, who they have been allocated to and finally, but perhaps most importantly, dependencies (such as which tasks must be completed before others may begin). It may be sensible to engage a project manager to control this process, who can then report periodically to the board of trustees.

Treatment of Surplus funds

The wind down will be complete once all material assets have been realised, liabilities settled, employees dismissed (having received the entitlements due to them) and the premises vacated. If the wind down has gone to plan – or even better – then surplus funds will be held which will need a home. At this point it is worth mentioning the Cy Pres principle – in essence, surplus funds held by a UK registered charity should be paid to a similar entity with similar objects. Identifying suitable charities for this purpose may require extensive consultation with the trustees, charity lawyers and the Charity Commission.

Solvency – or otherwise?

It may be that prior to the wind down the financial position of the charity appeared to be healthy, as disclosed in the latest audited accounts which showed positive net assets. Frequently this will need to be reassessed, as a result of assets being realised for less than their carrying values and additional liabilities arising on a cessation of trade, such as redundancy, payments to landlords, legal advice and consultancy fees. This ‘double whammy’ can, in extreme circumstances, turn a solvent entity into an insolvent one, so it is important that the trustees monitor the financial position on a monthly basis and take advice from an insolvency practitioner if they have any concerns.

Elimination of the entity

Having determined how surplus funds should be dealt with the trustees can consider the next step, which is the formal elimination of the charity. Many charities are limited companies and thus registered at Companies House as well as with the Charity Commission, so this stage of the process will involve engaging with both bodies as well as the completion of statutory documents.

In most cases the choice will be between a members’ voluntary liquidation – “mvl” – if solvent, creditors’ voluntary or compulsory liquidation if it is not, or a striking off. Deciding between these will depend on a host of factors, including the value of any assets that remain. A striking off is generally more suitable where the gross value of assets is low, as there is a risk that any remaining assets will be claimed by the Treasury Solicitor under the Bona Vacantia rules, and where the likelihood of creditor claims arising is considered to be remote. Conversely, where material assets remain, or there is a perceived risk of creditors coming to light, mvl will be preferred. In cases where a liquidator is to be appointed it may be helpful for the trustees to recommend, in a board minute, the potential beneficiaries of any surplus funds remaining on conclusion of the liquidation.

Conclusion

This article has focused on some of the key areas for charities facing the situation where their activities are no longer viable, no merger or collaboration partner is available and their Trustees are having to consider a managed winding down of their affairs.

What is clear is that there are many complex areas to consider in this route as with any other, but seeking advice during the process can be critical to achieving the right outcome.

As a last thought, trustees who can show that they took every reasonable step to minimise the potential loss to creditors are protected from the risk of personal liability. In general, this often includes promptly seeking advice from an insolvency practitioner and acting on that advice.

For more information contact: Ian Oakley-Smith 020 7212 6023 ian.oakley-smith@uk.pwc.com 11

12

What you always wanted to know (but were afraid to ask) about tax and mergers

Shared Service Centres

We are increasingly seeing collaboration by charities setting up shared service centres to reduce overhead and procurement costs. Typically, this could be IT support or accounts back-office functions. One format would be creation of an “umbrella” organisation of charities partnering to run services used by all. An alternative structure would be individual charities running and contracting out a specific service to peers, whilst perhaps buying in a different service from another charity.

The VAT implications of cost-sharing exemptions are a hot topic in the not-for-profit sector and are discussed in depth on page 15]. Corporate tax issues are similar for this type of collaboration to a trading collaboration.

There is an increasing tendency for used to a simpler life. However drawing organisations to work together and on our experience of transactions in share knowledge, people, resources the commercial world we have set out and facilities. Whether driven by some of the points to look out for and cost-saving, increasing their impact some of the well tested solutions. The or other factors, the models for such key message we would like to leave collaborations range from short-term you with is that it pays to review your secondments to full mergers. position thoroughly at an early stage –

you don’t want to get to contract and These types of transactions can have announcement stage without having quite complex tax implications which understood whether there are tax can come as a surprise to charities disadvantages or risks.

Secondments

A simple and cost-effective way to share knowledge and experience between organisations is the secondment of staff between charities. This can be a neat solution to fill short-term staffing needs whilst other organisations are shouldering a cost of excess capacity.

It is common practice for the main employer to continue to bear the salary payroll costs and associated taxes and charge an agreed fee to the recipient of the seconded employee. However, caution is required as if the secondee is provided with expenses or benefits (particularly those that are private rather than business in nature) by the recipient charity, this may give rise to unanticipated PAYE/NIC liabilities for the recipient.

To mitigate this, a charity may wish to agree that all such items are provided by the main employer (and then possibly recharged) rather than directly by the recipient.

From a VAT viewpoint this is usually a supply of services and therefore VATable – which may be a downside for the recipient charity if it cannot fully recover its input VAT.

Mergers

Mergers, as discussed in other articles in this magazine, can offer significant cost reductions as well as advancementof charitable aims. A merger is a significant event in a charity’s life -cycle and a range of structuring options would usually be examined – each with their own tax consequences. It is important, for both or all parties, to examine and understand the tax history and profile of each other to avoid unexpected implications upon merger. It is also a timely opportunity to consider reorganising the structure of subsidiaries and partners lower down the group. On occasions charities choose to merge with commercial organisations and particular care shouldbe paid to making the mechanics of thetransaction tax-efficient.

Detailed rules set out employee rights and benefits upon transfer to a new organisation. Where employees leave the charity or commercial organisation as a result of the merger, it will be important to ensure that PAYE/NIC is correctly accounted for on any termination payments made. This can be a complex area with a number of issues to consider and so it may well beappropriate to obtain HMRC clearance on the treatment of the payments.

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Thinking of collaborating? Have you thought about...

• Where should trading profits sit?

• Are you making gains?

• Will a joint venture vehicle be able to Gift Aid?

• What are the implications of a shared service centre for CT, VAT and payroll taxes?

• Are assets being transferred stampable?

• Would you still qualify for business rates relief?

• Are you happy with any tax risks you may be taking on?

Case study

A Local Authority wished to enter into a joint venture with a commercial partner to provide socially beneficial facilities. Use of a trade company was ruled out as the joint venture would have been taxable. Use of a limited liability partnership would lead to the council’s share of profits being taxable in the parent itself and thus qualifying for the local authority exemption from tax.

An enhanced model was proposed in which the Local Authority established a charity, to which it transferred the social obligations that the joint venture had been proposed to fulfil. The charity would then set up a trading company subsidiary which would be the partner in the LLP. The LLP’s taxable profits are deemed to arise in the trading company which can make a gift aid distribution to the parent charity to eliminate corporation tax.

The additional value in this model is that the charity benefitted from an 80% reduction in business rates. The Local Authority was then in a position to waive the remaining 20% to eliminate all business rates. A significant cost saving for the group as a whole charity exemption from capital gains tax.

Charity-to-charity

Two or more charities may collaborate to run a joint trading enterprise and share the profits. The joint venture company can be limited by shares or by guarantee and is likely to be jointly owned by the parent charities. Prima facie, the profits of the trading subsidiary would be taxable.

However, the company is charity owned and can therefore make gift aid distributions to the parent charities of its taxable profits. This eliminates the tax charge in the trading company whilst remitting the funds back to the charities. Timing of the gift needs to be monitored in this case – Gift Aid must be paid within 9 months of the end of the year to be deductible.

Charity-to-private sector

The government, through its Office of the Third Sector, have been keen to encourage collaboration between business and the third sector. A variety of innovative partnerships are establishing, at grass-root level, through to national organisations.

However, it could be a costly mistake to replicate the above model when collaborating with a private company-the profits of the company would again, prima facie, be taxable. The private-sector partner, as a commercial enterprise, may well be expecting to pay tax on its share of the joint venture’s profits. However, any distribution by the subsidiary will not be eligible for gift aid because it is not wholly owned by charities. The charity may therefore find itself suffering an unwelcome corporation tax leakage on the profits.

A more efficient structure in this situation would be the use of a limited liability partnership. Typically, a trading company subsidiary of the charity would enter into a limited liability partnership with the private sector company or its special purpose vehicle. For legal purposes, LLPs are a body corporate with limited liability protection and governance.

Partnerships are transparent for tax purposes so the relevant share of the LLP’s profits would be treated as arising in the partner companies themselves. In other words, the LLP’s profits would be treated as taxable in the charity’s trading company. The trading company can then distribute its taxable profits up to its parent charity as gift aid to eliminate the tax charge.

For more information contact:

Amanda Berridge Mark Birtles Shuli Levy 020 7213 2994 0117 923 4132 020 7212 4635

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VAT cost-sharing exemption should benefit the charity and not-for-profit sector HMRC recently announced in the Budget that it will work with the charity and not-forprofit sector to consider the implementation of a VAT cost-sharing exemption.

This is a welcome announcement that will potentially help charities to reduce the VAT incurred on shared costs such as staff and administration expenses and should help ease the impact of the withdrawal last year of the staff hire concession.

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For more information contact: Keith Lawson 020 7804 9064 keith.lawson@uk.pwc.com

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Whilst the announcement from HMRC is good news, there is a great deal of work to be done to establish how article 132(1)(f) will be implemented in the UK.

Issues such as transfer pricing adjustments and the mark-up on charges made under cost sharing arrangements will need to be considered.

Equally, when article 132(1)(f) is finally implemented in the UK, will it have retrospective application for those charities that operate a cost-sharing model that is similar to the new UK VAT Legislation?

PwC has extensive practical experience on how article 132(1)(f) is applied in other EU Member States and the approaches that could be implemented into UK VAT Legislation. We are working closely with the Charity Tax Group in constructing practical examples as to how article 132(1)(f) would apply in the UK which will be discussed with HM Treasury/ HM Revenue & Customs.

Background

The cost-sharing exemption is provided in EU law under article 132(1)(f) of the Principal VAT Directive 2006/112 but the UK has until now always chosen not to implement it.

Based on article 132(1)(f) of the VAT Directive “Member states shall exempt … the supply of services by independent groups of persons, who are carrying on an activity which is exempt from VAT or in relation to which they are not taxable persons, for the purpose of rendering their members the services directly necessary for the exercise of that activity, where those groups merely claim from their members exact reimbursement of their share of the joint expenses, provided that such exemption is not likely to cause distortion of competition”.

Though the application varies across the EU and some Member States (which currently includes the UK) have not implemented it at all, the cost-sharing exemption is mandatory under EU law. Several conditions must be met to apply the cost-sharing exemption:

• Nature of the services rendered: in principle the exemption applies to services only and these services must be “directly necessary for the exercise of the members activities”.

• Capacity of members: in particular, the members are required to perform similar activities or to belong to the same financial, economic, professional or social group and can be natural or legal persons performing activities that are outside the scope of VAT or VAT exempt.

• Remuneration: the consideration charged to each member must represent the reimbursement of that member’s exact share of the joint expenses (potentially leading to full taxation if a mark-up or transfer pricing element has to be taken into account).

Considerations

In the context of creating efficiencies some charities may want to focus on their core activities and in doing so outsource part of their front – or back – office functions.

Currently, by doing so, this could create a non-deductible VAT cost if the service provider has to charge VAT. Even if outsourcing gives rise to economies of scope (or scale) – resulting in a lower base cost – the additional VAT cost associated with outsourcing could frustrate and constrain charities in their outsourcing ambitions particularly in relation to the range of services outsourced.

Ensuring that the input VAT cost does not increase and/or increasing the level of VAT deduction are two strategies that may limit any irrecoverable VAT which would otherwise represent a cost that would need to be passed on (directly or indirectly) to the receiving charities.

Before taking the decision to outsource front - or back - office services, charities might want to consider whether outsourcing is advisable from an operational point of view. To a significant extent the operational perspective will be determined by cost (is it cheaper?) and quality.

In order to ensure that VAT does not potentially inhibit their outsourcing plans, HMRC’s announcement that it will implement the cost-sharing VAT exemption in some form of guise is very welcome.

Apart from the difficulties in meeting the conditions outlined above, VAT incurred on costs by the cost-sharing group (whether or not an independent entity) will not be recoverable and this irrecoverable VAT will need to be taken into account to determine if a cost-sharing arrangement is cost effective.

Consequently, setting up a cost-sharing arrangement might only be worthwhile provided staff is centralised in the cost-sharing entity thus reducing any of its own irrecoverable VAT.

Potential Approach

It is our understanding that, where VAT grouping requires financial, economic and organisational links (typically common ownership) between the members, members of a cost-sharing arrangement could also include unrelated third parties.

An alternative might however be to set up a “consortium” or ‘umbrella organisation’ for the purpose of procuring and/or undertaking those supplies to be enjoyed by the members on a purely cost-sharing basis exempt from VAT. There is also precedent for VAT exemption in other European countries and in case law of the European Court of Justice (Taksatorringen).

Equally, it would seem that article 132(1) (f) could apply in a situation where one charity acts as the service provider and provides a range of back -office services other charities. Provided all conditions are met, such services would be exempt from VAT thus the receiving charity would not incur an irrecoverable VAT cost.

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HR and pensions issues in charity mergers

There are often compelling reasons for organisations to merge, but sometimes the attractiveness of the potential benefits causes important factors to be overlooked. Several surveys in the private sector have highlighted people issues as key “overlooked” factors behind mergers failing to live up to expectations.

Charities are no exception to this. Indeed, the challenges may be even greater, as many employees may be working “for love not money”, so organisational change – or the way an organisation goes about that change – can easily make them “fall out of love” and leave, or become less motivated and less effective.

Understanding the operating style and culture within the merging organisations, and managing the communication with key stakeholders, is key to success. This article will look at this cultural challenge, consider some other common HR issues on mergers and acquisitions such as reward and people costs, and take a look at the additional complexities that arise if defined benefit pension plans are involved.

The cultural challenge

Culture starts with the values of an organisation, in particular its leaders. Values are likely to be important for most employees of charities, and it can be a challenge to integrate two strong and distinct sets of beliefs. Two charities might, on the face of it, have similar organisational goals, and look well suited to a merger, but actually have very different styles of achieving those goals, with a very different day-to-day environment for staff.

Before agreeing the deal

For charities, differences in culture could be a deal breaker, so these need to be understood up front. But how much can one find out before signing on the dotted line to merge? There is in fact a surprising amount that can be done, assuming that there is access to key managers in the charity – and even from a web trawl, or recruitment adverts. An increasing number of companies are including culture within HR due diligence work; charities can lead by example through more open discussion than is typical in the corporate world.

Making the most of the situation

Once a merger has been agreed, it is essential to plan for launch. It is likely you will be able to gain access to the other organisation, so employee surveys or focus groups can be used to compare the two cultures, working practices, usual communication methods and expectations of the other charity. These could be used:

• To aid understanding of the other’s perspective and highlight potential conflict areas, so they are negotiated up front;

• As a base to discuss the desired future culture, structure and norms of the organisation and plan how to achieve this;

• To understand and manage the human factor by developing ways to support employees while they go through the change to minimise the negative impact on productivity; and

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• To inform the communication process of the merger – and the best change approach for the organisations (it may be the process, as much as the end result, that causes disengagement).

Charities should also consider their “external culture” or image – how are the funders likely to react to the merger? Internal and external cultures need to be aligned to be credible.

Other aspects

Culture is only part of the story. As with any merger, HR due diligence, Day 1 planning and merger integration will need to cover a wide range of areas.

We focus on just two of these below – People Costs and Pensions – where the financial impact is most immediate, but there are many other important areas that could impact on success, such as Senior Team Alignment, Organisation Design, Workforce Planning, Support Function Integration and Employee Engagement.

Finally, good communication is essential throughout the process, from announcement onwards, to maintain engagement and minimise any morale dip.

People cost

For charities, People Cost is likely to be the main component of cost, and in the short term may be largely fixed in nature. Due diligence should consider:

• The relative levels of pay and benefits, and hence possible “levelling up costs”;

• If pay is very variable, whether the year being used for assessing the merger is a typical one;

• Whether it is appropriate for any special retention payments to be paid related to the merger (perhaps related to additional work performed, or retention of particularly key individuals);

• Front line and back office synergies and the one-off costs, such as any redundancy costs, to achieve this; and

• Whether there any other pay risks or upsides (for example from known future legislation)

For charities, savings in costs can directly result in more money for the cause, so controlling payroll costs – whilst remaining fair to employees – takes on a special significance.

Pensions

The charity sector has an unusually high number of defined benefit (DB) pension schemes, where the pension paid is related to an employee’s salary and length of service. Finance Directors of such charities will be well aware of the potential volatility of cash costs to fund the promises.

The Trustees of a DB pension scheme also need to monitor how the employer is faring and in particular consider any major changes such as a merger. If they believe a merger might damage the charity and hence the chance of any scheme deficit being rectified, they should look for appropriate recompense – perhaps a large one-off contribution to the scheme or security over assets.

It is therefore essential that on a merger or acquisition, the charity proactively considers the pension situation to ensure:

• Any DB pension scheme deficit or promises are properly priced in the deal and

• That they have considered how the pension scheme trustees and the Pensions Regulator might view any change in the covenant provided to the scheme and the mitigation that might need to be put in place.

Typically this process would involve actuarial, legal and employer covenant input from advisers; we have worked in multidisciplinary teams in many such situations on deals.

Conclusion

People issues are key to any merger – but particularly so in the charity sector.

• Employee motivation and retention in the charity sector is often strongly linked to the culture and goals of the charity – how will the merger impact these?

• How compatible are the financial reward and organisational structures? Will the synergies be achievable or will differences cause “levelling up” costs or challenges?

• Have you considered how the Trustees of any defined benefit pension schemes might respond?

Addressing these challenges up front can reap huge rewards; ignore them at your peril.

For more information contact: Sally Dixon 020 7804 3881 sally.dixon @uk.pwc.com

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In the Spotlight: Age UK Creating a stronger charity in harsh times

On 25 February 2009, two leading charities and social enterprises – Age Concern England and Help the Aged – joined forces to create a new £160m organisation, rising to nearly £400m with its local partners. Age UK. The merger was the largest among charities in the UK since Cancer Research Campaign and Imperial Cancer Research merged in 2002 to form Cancer Research UK.

Chief Executive, Tom Wright, explains how the merger has galvanised their shared mission.

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“Demand is bound to grow and it was plain to both charities that we needed a stronger organisation that can raise its game to face these immense challenges. ”

It’s a very complex integration, however. Both heritage organisations share much in their defined missions – each operates financial service companies; both have retail estates to create a combined network of over 500 shops across the country.

But they’re significantly different, too. Help the Aged, for instance, started as an international relief agency and retains a strong global dimension. Age Concern has a mainly domestic focus in its fund-raising and activities. Similarly, Help the Aged has a strong medical research dimension that distinguishes it from Age Concern.

Age Concern, on the other hand, operates through 320 local organisations across Britain, all of them independent charities under the Age Concern banner. That, plus the differences imposed by political devolution in Scotland, Wales and Northern Ireland, has added further complexities.

“In the end, several different charities all effectively had to agree to merge on one date,” Wright recalls, “with 20 trading subsidiaries to integrate as well. But, of course, the differences between the two organisations also imply a strength – we have huge areas in which our operations complement each other.”

Even before the name was officially launched across the country in April, Age UK has notched up one extraordinary accomplishment: surveys show that it’s already firmly established as one of the top five most recognised forces amongst all of Britain ’s major charities.

Age UK is born from what’s said to be the largest and most complex merger in the Not for Profit Sector: it brings together two of the most muscular agencies working for the welfare of the elderly – Help the Aged and Age Concern, each with annual budgets of some £80m and similar staff complements of around 1,000 to 1,500.

So, size and reputation clearly explain a lot of the combined agency ’s effortless public profile.

The year-long transition that’s now effectively under way is expected to produce important early benefits. With its combined £160m turnover, Age UK expects to achieve operational efficiencies “well in excess of £15m a year ”, with the costs of merger itself fully addressed in the first year.

What’s more, clients of both organisations will see rapid advances in the streamlining of their phone advice services. “We currently provide information and advice to over five million people a year,” says Tom Wright. “Our ambition is to further increase this support at a national and local level. ”

But there’s more to it than that, according to Tom. “What we ’re already seeing is the benefit of speaking as one voice on a subject that people now clearly recognise as a major societal challenge – our ageing population.

“The changing demographics carry an unmistakable message: the over 60’s are the fastest-growing part of our society. Along with the environment, I think meeting their needs, and realising the opportunities, will be one of the biggest challenges our society will have to address.

“We have some 80 world-wide partners, a relationship with about 3.5 million people and over one million direct customers who buy insurance or energy from us. It ’s a well -balanced business – revenue comes in more or less equal thirds from financial services, retailing and trading, and fund raising. You can ’t switch all that in a day!”

Wright himself brings an impeccable pedigree to the task. His years on the board of Saga have given him an invaluable insight into “the older market”. And, as Chief Executive of VisitBritain, he was responsible for merging the former English Tourism Council and the British Tourist Authority.

He acknowledges that the creation of Age UK has excited a lot of interest at a time when all charities are under the twin recession-driven pressures of rising demand for their services and flat or falling revenue from investments and public donations. All the same, he doubts if today ’s harsh economics really provides a merger motivation for other agencies.

“Negotiations for our own merger considerably pre -dated this recession and were under way when the economy was strong. So, although there will undoubtedly be synergies, the financial aspects certainly weren ’t the prime motivation. What’s much more important is that our charitable objectives are completely in line.’

pwc.co.uk

Dates for your diary

Coming soon

Social Return on Investment/Sustainability TBC

Accounting, Legal, Tax Technical Update November 2010

Recent seminars

Mergers and Collaborations March 2010

Pensions (joint seminar with CFDG/Pensions Regulator) October 2009

PricewaterhouseCoopers runs an exclusive seminar programme for charities, trustees of charities and non-executive directors. All our contacts who receive Charity News will automatically receive invitations to all our seminars.

All seminars are held at our Embankment Place office (address below), commence at 4pm and are followed by drinks and nibbles. There is no charge for our seminars and CPD hours can be claimed.

PricewaterhouseCoopers LLP, 1 Embankment Place, London, WC2N 6RN

If you do want to enquire about the latest dates for seminars, please contact:

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