As more not-for-profit organisations review their structures, we are increasingly seeing arrangements where an incorporated society or charitable trust owns a company.
One question that often arises is whether a not-for-profit company can transfer surplus funds to its shareholder.
Many people assume the answer must be "no", but the position is often more nuanced.
The key issue is not whether funds can move between entities, but whether the transfer is legally permitted and consistent with the organisation's not-for-profit purposes.
Why the confusion?
Many people equate "not-for-profit" with "no money can ever be distributed", but that is not what not-for-profit status means.
A not-for-profit organisation exists to advance its purposes rather than provide private financial gain to members, owners, shareholders, trustees, directors, or committee members.
The focus is therefore on the purpose and effect of a payment, rather than simply whether money is changing hands.
For example:
In principle, that arrangement may be entirely appropriate.
The important question is whether the funds continue to be applied towards the organisation's purposes and do not result in inappropriate private benefit.
Start with the governing documents
The first step is always to review the company's constitution.
Some constitutions contain strict restrictions on distributions to shareholders. Others permit distributions to a shareholder in limited circumstances, particularly where the shareholder is itself a not-for-profit organisation. The constitution will often be the key document in determining what is and is not permitted.
If the company is also a registered charity, its governing document is likely to contain additional restrictions designed to ensure that assets continue to be applied for charitable purposes.
A company’s constitution is not the only consideration. Directors must also ensure that any applicable requirements under the Companies Act 1993 are satisfied, including any relevant solvency requirements.
Does it matter that the shareholder is also not-for-profit?
Yes.
Where a company's sole shareholder is itself a genuine not-for-profit organisation, a transfer of funds is very different from a distribution to private investors seeking a financial return.
If surplus funds move from one not-for-profit entity to another and continue to be used to advance the wider mission of the group, concerns about inappropriate private benefit are often significantly reduced.
However, boards and governing groups should avoid assuming that every transfer will automatically be permissible. The governing documents and surrounding circumstances still matter.
Additional considerations for registered charities
Extra care is required where either the company or its shareholder is a registered charity.
In those circumstances, decision-makers must ensure that funds continue to be applied for charitable purposes and do not enable private benefit. The fact that money is moving within a broader group structure does not remove those obligations.
Documented decision-making: questions for boards and governing groups
A well-documented decision-making process is often just as important as the decision itself. Before approving any transfer of funds, boards should ask:
Does the constitution permit the proposed transfer?
Are there any restrictions on distributions?
Will the funds continue to be applied towards the organisation’s purposes?
Is there any risk that the arrangement could be viewed as providing inappropriate private benefit or private financial gain?
Are there any charity law, tax, or regulatory implications?
Have we adequately documented our reasoning?
It is also important to note that the tax consequences of a transfer can vary depending on the structure and should be considered separately with appropriate advice.
Understanding the key principle
Whether a not-for-profit company can transfer funds to its shareholder depends on the specific circumstances. The answer will usually depend on the governing documents, the nature of the shareholder, and how the funds will ultimately be applied.
In many cases, a transfer of funds between not-for-profit entities may be entirely appropriate. What matters is that the funds continue to be used to advance the organisation's purposes and do not result in inappropriate private benefit.
Understanding the purpose of the payment is often more important than the fact that money is moving between entities.
If your organisation operates through a group structure involving societies, trusts, or companies, it is worth obtaining advice before making decisions about payments, distributions, or transfers of surplus funds.
The team at MoranLaw regularly advises charities, incorporated societies, charitable trusts, and not-for-profit companies on governance structures, constitutions, and the appropriate use of organisational funds. If you would like assistance assessing your organisation's position, please get in touch.