The tax exemption for profits from mutual trades is not as widely known about as it should be. This is an old concept, deriving from cases concerning co-operative societies and members’ clubs, but equally applicable to trade associations and Local Authority trading companies.
If a mutual trade exists, the business is exempt from tax on those profits. Depending on its activities, this can result in significant tax savings, although it is worth noting that any losses from the mutual trade are not available for offset against other profits. Results from trade with non-mutual trade and other income, such as bank interest receipts, remain chargeable to tax in the normal way.
The basic principle behind the exemption is that a business cannot trade with itself. Provided that there is complete identity between the members of the entity and its customers, it follows that profits (or losses) from any trade between them are exempt from tax.
The case law has established certain key requirements to identify whether there is complete identity between the members and the customers. It is easier for this to be met by a company limited by guarantee, so that is our recommended structure. However, with careful drafting of the Memorandum and Articles it can be possible for a company limited by shares to meet these requirements as well.
In either case, we advise that the possibility of claiming the mutual trading exemption is explored up front so that the most suitable structure can be used. This includes careful drafting of key legal documents to ensure they include the case law principles; standard Companies Act Articles do not meet these requirements so will always need tailoring. If the business has already been established, it may be possible to revise its constitution so that it meets the requirements, but of course there may be commercial barriers to this.
Ensors Corporate Tax experts can work with businesses to establish whether or not the mutual trading exemption applies for them and advise on the actions required to achieve.