Service level agreements – should I have one?

charities-service-level-agreements

On 29 March 2019 the Charity Commission published new guidance on charities connected with non-charitable organisations. Part of the Commission’s focus is on charities that share and recharge costs with a trading subsidiary.

In many cases the cost allocation or recharge between the two is at best, ill-defined, and at worst, completely artificial. The Charity Commission recommends using written agreements or contracts to protect both parties, but a service level agreement (SLA) between the two entities defining the costs is often absent.

So, the short answer to the question above is yes, you should have an SLA. But first, let’s look at what that means.

What is a service level agreement?

An SLA in this case should ideally be a written agreement between two entities that defines the relationship between them, and also lays out clear policies and guidelines on how costs should be allocated in each entity, and the method by which those costs will be recharged (and when). The agreement should be signed by the parent charity trustees and the subsidiary directors. It should also be reviewed regularly for any change in circumstances.
The methods for calculating and apportioning costs should be reasonably detailed where possible. Arbitrary figures or guesswork is likely to be looked at closely in any HMRC review.

Why might I need one?

What might be the risk if you don’t do this? The problem is a balancing act between two possible issues.
On one hand, if the charity is allocating costs to the trading subsidiary that bear no relation to the trading activities, then HMRC can argue that these costs do not relate to the business and should be disallowed. This could create a larger taxable profit in the subsidiary.

That’s no problem I hear you say, we will just Gift Aid that anyway! The danger is that if your subsidiary doesn’t have sufficient reserves to Gift Aid all the larger amount, it will end up with a tax bill. The subsidiary must not pay over more than it can afford, and a large amount of disallowed costs could easily create a difficult situation.
On the other hand, the charity itself could be carrying costs that relate to its trading activities. This not only masks the performance of the trading activities by creating false profits but also creates the possibility of the HMRC arguing that the charity costs are not being used for a charitable purpose – with a potential tax liability as a result (in the charity itself). Public perception of such items would also be very poor.

An SLA acts to clarify the position, and safeguard against possible enquiries in the future. It also forces trustees and management to think clearly about cost allocation while drawing up the agreement. In many cases you may be surprised at how the current process works, or whether it fairly reflects costs allocations between the two entities.

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Other services that are shared

It’s not just recharged costs that are affected by the relationship, there are other important considerations such as data sharing and GDPR, the use of brands and logos, and the use or access to premises and fixed assets.

The relationships can be complex and any SLA should try to consider all potential shared factors to ensure that in future, any potential disputes or confusion over ownership is minimised.

The use of a SLA is covered in section 6 of the guidance. Furthermore, the new guidance includes an Appendix and a checklist (Checklist 1) which is aimed at all trading subsidiaries of charities. Trustees and management should read and complete this checklist to ensure that they have considered the trading subsidiary operations, risk and independence. Please see: https://www.gov.uk/guidance/guidance-for-charities-with-a-connection-to-a-non-charity

Conclusion

Having an SLA is not a magic bullet, and any costs that appear to be artificially allocated will always draw attention. But it will always be a factor in minimising the risks involved in such relationships, and a useful management tool in understanding both the charity’s activities and also the real costs in its trading subsidiary. It’s always best to be prepared.

We recommend all trustees get acquainted with the guidance from the Charity Commission referred to above, especially section 6 on the use of written agreements.

This article was written by Charity Specialist Michael Cooper-Davis. If you have any questions regarding this article you can contact Michael using the form below.

We always recommend that you seek advice from a suitably qualified adviser before taking any action. The information in this article only serves as a guide and no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or the firm.

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