19 February 2020 - Article
Until last year, when a charity made a payment overseas, it had to take such steps as were reasonable to ensure the funds would be applied for purposes that are charitable under the law of England and Wales.
The Finance Act 2010 introduced an element of subjectivity to this requirement such that the steps a charity takes no longer have to be objectively ‘reasonable’, they must be reasonable in the view of HMRC. Some of the uncertainty raised by this new subjective element has been clarified as HMRC has updated the relevant section of Annex II of the Detailed Guidance Notes for charities available here.
Though this guidance comes more than a year after it was promised ‘within weeks’, it is welcome clarification.
Who does this guidance apply to?
This guidance applies to any charity that sends payments outside the United Kingdom, for example, by making a grant to a foreign partner charity to fund a charitable project.
Why is this important?
Charities enjoy a wide exemption from income or corporation tax but must apply their income and gains for charitable purposes only – any ‘non-charitable expenditure’ can lead to a tax charge on income which would otherwise have been exempt from tax. In the context of overseas payments, failing to take steps HMRC consider to be reasonable to ensure that funds sent abroad are properly applied for UK charitable purposes could mean that those funds will be treated as non-charitable expenditure.
It is impossible to know with total certainty what steps HMRC will consider to be reasonable in every case. The revised guidance does not give hard and fast rules to follow but it is clear that if HMRC were to scrutinise an overseas grant, it would have regard to the UK charity’s knowledge of the overseas grantee, its previous relations with the overseas grantee and the past history of the overseas grantee.
In case of challenge, trustees must be able to show HMRC:
- the identity of person to whom the grant was paid;
- the purpose for which the grant was given;
- the assurances given by the recipient that the grant would be properly applied;
- what steps the Trustees took to ensure that payment would in fact be properly applied; and
- what follow-up action was taken by or on behalf of the trustees to confirm that the funds were properly applied.
In other words, charities need to ensure that proper pre-grant due diligence is undertaken, records of the results kept and, in many (if not most) cases, that a written grant agreement is used.
The obligations imposed on overseas grantees should be proportionate to the risks involved and the size of the payment.
What has changed in the guidance?
The guidance now expressly clarifies that payments abroad for goods or services in the ordinary course of the charity’s activities will be outside the scope of ‘charitable expenditure’. This was always the common-sense interpretation, but it is useful clarification.
It is helpful that the revised guidance clearly indicates that payments by a charity to an affiliate or an overseas ‘branch’ or office are subject to the same requirement that reasonable steps be taken. Charities that operate within a network of international affiliates may need to consider whether their existing practices would stand up to HMRC scrutiny in light of the new guidance.
Last year’s extension of UK charitable tax reliefs to eligible foreign entities in the EU, Norway and Iceland has been reflected in the revised guidance, so foreign charities that are eligible for UK tax reliefs will need to consider this guidance when making ‘overseas’ payments. This extension is at present only in force in respect of tax relief under the Gift Aid scheme, but in due course, however, it will be brought into force in respect of all UK charitable tax reliefs, including the income or corporation tax relief, and the accompanying concept of ‘non-charitable expenditure’.
The revised guidance now includes reference to the charity ensuring that any agreements in respect of grants are enforceable. While all well-prepared agreements would aim to be enforceable locally, international enforcement of obligations is complex and often not entirely in the hands of trustees. It is hoped that HMRC will apply this part of the guidance pragmatically.
The guidance sets out four example scenarios. In the first scenario, a pastor from a foreign church visits a UK ‘partner parish’. The UK church decides to donate £500 to help rebuild the foreign church which then sends a thank you note on headed paper and a photo of the rebuilt church. Because in this scenario a relatively small donation is made to a person running an organisation well known to the donor, HMRC considers a light-touch approach reasonable.
Contrast this with example 3a, where a grant of £250,000 is given for an overseas school building project that will take 18 months to complete, and involve the participation of several local contractors. In this scenario HMRC considers reasonable steps might include a detailed project plan, a funding application from the overseas body, records of the evaluation procedure the trustees carried out and a written agreement which linked grant payments to the achievement of specific targets, a series of reviews and ‘clawback’ provisions in case of failure or misuse.
In example 3b, a charity wishes to give £1,000,000 to an overseas body for charitable use at the grantee’s own discretion. In this scenario, HMRC indicate they will consider reasonable either (in brief) a sufficiently detailed and binding assurance from the foreign grantee to ensure UK charitable application, or the charity’s satisfying itself that the foreign body is established and regulated so as to ensure that funds can only be applied for purposes that are charitable under UK rules.
This final alternative option is somewhat surprising and charities should consider carefully before proceeding in reliance on this guidance. The UK does not have a regulatory process akin to the American ‘equivalency determination’, which may be used in some circumstances by US charities in relation to their foreign grantees. It will also be very difficult for a UK charity to establish with certainty that a foreign grantee is structured and regulated in this fashion – legal and regulatory systems differ considerably from place to place, even in jurisdictions that may have historically derived their charity regime from English law.
It is worth remembering that in addition to these tax law requirements, the obligation to take reasonable care is a charity law requirement applying to trustees in any event. Charities that do not take such steps as are considered by HMRC to be reasonable to ensure proper application of their overseas payments risk an otherwise avoidable liability to tax. Trustees allowing such a liability to arise may have committed a breach of trust and so could face a personal liability to make good the charity’s loss.
In addition to having to repay the tax liability the charity suffers, if the funds are actually misapplied as a result of the trustees’ failure to properly monitor the grant, they may also face a separate liability to make good the charity’s loss of the grant itself.
The trustees of any charity established in England and Wales that is considering an overseas payment should also consider the Charity Commission’s publication Charities Working Internationally.