02 April 2020 - Article
The Chancellor in his Budget speech last week announced a number of changes affecting the taxation of charities and their donors.
1. Anti-avoidance provisions
HMRC’s Press Release BN28 is titled ‘Charities: Anti-avoidance provisions’, and signals the intent of HMRC to clamp down on perceived abuses by donors or charities themselves of the various tax reliefs available relating to charities and charitable giving.
The notes identify three specific areas which the new measures will target.
1.1 Transactions with substantial donors
The first main line of attack focuses on the extent of certain transactions which a charity may carry out with a ‘substantial donor’, by removing tax relief on any payments by the charity in connection with these transactions, subject to some exceptions.
(a) The definition of ‘substantial donor’ is broad, including any individual or company which has given
(1) £25,000 to a single charity in any 12 month period, or
(2) £100,000 to a single charity over any 6 year period.
Any donor satisfying these limits will be treated as a ‘substantial donor’ of the charity for the relevant accounting period and the following five periods.
(b) The new rules will potentially affect a range of transactions involving a charity and any of its substantial donors including the sale or letting of property; the provision of services or financial assistance (such as a loan, guarantee or indemnity); the payment by a charity of remuneration to a substantial donor apart from a payment for services as a trustee approved by the Charity Commission; and investment by a charity in the business of a substantial donor if this is not listed on a recognised stock exchange.
© Where the new rules apply, tax relief will be denied by treating any payments made by the charity in connection with the transaction as non-qualifying expenditure in the hands of the charity, so that the normal tax reliefs will not be available on these sums. Similarly, if there is a difference between the actual price paid for the transaction and the market price and this favours the substantial donor, then this amount will also be treated as non-qualifying expenditure in the hands of the charity.
(d) Thankfully, some of these transactions will be exempt provided HMRC is satisfied that the arrangement is for genuine commercial reasons, on arm’s length terms and not for the avoidance of tax. These include the sale or letting of property, or provision of services where this is part of the business of the donor, or transactions in furtherance of the charity’s objects which are no more beneficial to the donor than on arm’s length terms.
It is unclear as to whether there has been evidence of significant abuse of the charitable tax reliefs available to donors and charities, and to this extent the measures seem somewhat heavy-handed. However, provided the exemptions are applied sensibly by HMRC and the Charity Commission, the new rules should not unduly restrict most donors from activities they would reasonably wish to undertake. Nevertheless, given the relatively low limits specified to qualify as a substantial donor, all charities, but particularly those established or associated with specific donors or families, must be aware of the new rules and consider carefully the nature and extent of any relevant transactions between the donor and the charity.
Particular care may need to be taken by charities in the context of transactions with their own trading subsidiaries, which could easily be deemed to be ‘substantial donors’ under the new rules.
1.2 Non-qualifying expenditure
The second main anti-avoidance provision aims to tighten the rules on non-qualifying expenditure by charities (broadly speaking, expenditure which cannot be justified as being in furtherance of the charity’s objects, normal administrative costs or approved investments).
(a) Until the Budget, these rules did not apply to charities whose relevant income and gains were less than £10,000 per year. This limit has now been removed, bringing smaller charities directly within the ambit of the restrictions.
(b) In addition, the way in which non-charitable expenditure is penalised has been changed. The new rules make a direct link between non-charitable expenditure incurred by a charity and loss of tax relief, by restricting the income and gains eligible for tax relief by £1 for every £1 of non-charitable expenditure.
The new rules will mean that smaller charities will need to take much greater care over their expenditure and all charities will need to review their accounting of expenditure to ensure the approach used previously does not bring an unexpected tax bill.
1.3 Corporate Gift Aid
(a) At present, donations made by individuals or close companies (ie those controlled by five or fewer participators) do not qualify for Gift Aid relief if the donor receives a benefit in excess of the prescribed limits as a result of making the gift.
(b) The new rules propose to extend these restrictions to apply to donations from non-close companies.
Charities in receipt of substantial corporate donations will need to be careful to ensure that reciprocal sponsorship or other beneficial arrangements with their corporate donors will not fall foul of the new rules.
2. Trading Activities Undertaken by a Charity
A more welcome measure is contained in HMRC’s Budget Note 29, which regularises an anomaly in the tax legislation relating to charities whose trading activities only partly relate to primary purpose trade or a trade carried on mainly by the beneficiaries of the charity. Both of these forms of trade should be completely exempt from tax, even when carried out directly by the charity (and not through a trading subsidiary company).
Under the previous rules, if a charity carried out a trade which partly satisfied one of the above exemptions, but in part did not, (for example if only some of the items traded could be said to relate to the primary purposes of the charity), the legislation technically treated the trade as being ‘tainted’, with the result that the profits of the whole trade could in theory be taxable in the hands of the charity. In practice, HMRC did not usually seek to enforce this, and were prepared to treat the different elements as two separate trades, so that the tax relief on the exempt trade could still be preserved.
However, there was no technical legal basis for this approach, and the new rules will ensure that this approach has a sound statutory footing, so that charities can be sure that the exempt elements of their trades do qualify for tax relief.
For non-exempt trading activities, the position remains that charities must either rely on the de minimis limits (that it constitutes less than 10% of the turnover of the trade or if smaller a turnover of less than £50,000 per year), or run the trade through a separate trading subsidiary company.
All of the above rules will take effect from 22 March 2006, though the treatment of non-close companies provision will apply from 1 April 2006. In addition, the rules on substantial donors will not apply where the transaction takes place after 22 March 2006, but as a result of a contract entered into before 22 March.
A consultation has been announced on the partial exemption system for VAT, which applies to many charities which make both exempt and taxable supplies. The consultation will include consideration of combined methods relating to the recovery of VAT on overseas supplies. Any changes resulting are proposed to be introduced in April 2007.
5. Corporation Tax
It is worth noting that the corporation tax starting rate of 0% on profits under £10,000 has been abolished, so that companies in this category will now be subject to the small companies’ rate of 19%. This is likely to have an impact on the administration of many charities’ subsidiary trading companies, which previously relied on the £10,000 limit to avoid additional compliance.