UK: Charities: New Beginnings - Summer 2013

FOREWORD

By Adrian Wild

We have entitled this briefing 'new beginnings', in recognition that we have a new system for Gift Aid claims, as well as the long awaited new accounting standard for the UK. (I won't say that this was eagerly awaited – I think that most people consider that this standard is a bit like a trip to the dentist: not something to look forward to but hopefully not as a bad as feared). However, the new Gift Aid system is genuinely helpful to charities; payments are faster and submissions can be made electronically. At last, it seems as though HMRC are moving in the right direction and using the connectivity that the internet offers to help.

We also have a fairly technical article about recognising when a charity is trading. This is an important area as it has implications for both VAT and direct taxes – get it wrong and it could cost you serious money. In the case considered, the charity has – for now – prevailed. However, there are a number of charities which operate in a very similar manner and if HMRC succeed in their appeal, then these charities will need to consider mitigating action.

Finally, now that the school year is over, we offer some food for thought on what makes an independent school financially viable.

I hope you enjoy this issue and also have a good summer.

INTRODUCING 'CHARITIES ONLINE'

By Emma Dersley

Getting online will make tax repayment claims for charities much easier.

HMRC has now made it easier for charities and community amateur sports clubs to make tax repayment claims, by introducing their new online service via the Government Gateway website.

The options

There are now three options available to charities, although option one will be the typical choice for most charities.

Option one: claim online

Using the Government Gateway, charities can sign up for the new online service and submit claims for up to 1,000 Gift Aid donors, and up to 200 items of other income at any one time.

Such claims can be submitted as often as required and can be made by third party agents on behalf of their clients.

Option two: claim through own database

This option is aimed at large charities who regularly need to claim for more than 1,000 donors.

Using their own developed, compatible software, or a third party package, charities will be able to submit claims of up to 500,000 Gift Aid donors per day.

Option three: paper submission

It will still be possible for those without access to the internet to submit paper forms. The old R68 claim form has been replaced with a new version, form ChR1 and is available to order from the HMRC Charities Helpline (0845 302 0203).

The new design of the form should enable HMRC to process claims more quickly than previous paper submissions.

Claiming online

The claims are prepared on screen and specially formatted spreadsheets, detailing the donations, are uploaded during the process.

The information required for each gift is the same standard details required on any Gift Aid declaration including: full name; address (particularly the postcode); date of gift and value. Charities that have their own electronic records will be able to copy information directly into the spreadsheets.

Once uploaded, the information is validated and summarised on screen immediately. Errors or missing data are automatically highlighted and the claim cannot continue until everything is completed.

Claims can be part-prepared and saved for later submission. They will be available to retrieve for 30 days.

Donations can be aggregated up to £1,000, and claims under the Gift Aid Small Donations Scheme can be included. Likewise, any previous over-claimed amounts can be adjusted using the new system.

Benefits

Faster

Under the new system, HMRC aims to process each claim within 15 working days, whether submitted online or on paper. This compares to a timeframe of 30 working days for the old R68 claims.

Stronger

The checks in place during the claim process highlight any omissions or errors and will ensure that submissions are accurate. This should prevent unnecessary delays caused by the return of incomplete forms.

Successful submissions will be acknowledged and a further confirmation will be received when the repayment is sent, allowing charities to keep track of their applications.

Better

HMRC has aimed to make the system easier to understand by simplifying names and descriptions. In depth guidance is provided by HMRC to assist those making claims, including the 'Online Services Demonstrator' which takes you through the process step by step, with illustrated examples.

Using this new system will place greater pressure on charities to ensure that their contact and payment details are kept up to date. Changes are easy to make using the ChV1 'Change of Details' form but charities must allow 30 days before submitting further claims.

It is reasonable to assume that there may be teething problems within the first few months, but otherwise the new service appears straightforward and easy to use. It should also be quicker for charities to make claims and speedier payments will improve charities' cash flows.

FRS102 HAS ARRIVED - WHAT'S YOUR MOVE?

By Fiona Reid

The wait is over – mandatory from 1 January 2015.

The long-awaited new accounting standard for the UK and Ireland was finally published by the Financial Reporting Council in March 2013 and for charities which are within its scope, will be mandatory for accounting periods starting on or after 1 January 2015 (the standard can be used now provided that using it does not cause a conflict with the SORP). FRS 102, 'The Financial Reporting Standard applicable in the UK and Republic of Ireland,' will apply to all companies and public benefit entities other than those which either have to or choose to apply EU-adopted IFRS, those entities which choose to apply the reduced disclosure framework for IFRS preparers under FRS 101 and those which qualify as small and choose to apply the Financial Reporting Standard for Smaller Entities (FRSSE). As we have reported in the newsletter several times over the past couple of years, this new standard is based on IFRS and there are some significant changes between the requirements of FRS 102 and current UK GAAP.

For charities, the full impact of the change is not yet known because the new charities SORP has only just been issued for consultation and we have not had time to fully analyse its impact. The purpose of the SORP is to provide charities with additional guidance on the application of UK GAAP. The new SORP will provide guidance to those charities which choose to apply the FRSSE, and also to those which will apply the new FRS 102.

Income recognition is a particularly complex area for charities and this continues under FRS 102 and the proposed new SORP.

As of now, a charity must analyse its income between:

• income from exchange transactions
• income from non-exchange transactions, ie donations and grants.

Exchange transactions are those transactions where the charity receives income from a purchaser in respect of goods and/or services provided to that purchaser. For charities, this would include, for example, school fees, entrance fees, etc. Income from such transactions is recognised as goods or services being provided.

However, exchange transactions do not cover grants where a service is provided to a third party. For example, local Government grants to charity to fund a meals-on-wheels service is not an exchange transaction as the recipient of the service is not the funder.

It is important that charities clearly understand their contractual arrangements and not just for accounting purposes. Breach of a performance-related contract could result in damages being awarded against a charity; breach of grant conditions would normally just result in a clawback of the grant.

The existing SORP states that donations and grants are recognised when the charity is entitled to the income, when there is sufficient certainty that it will be receivable and when it can be measured. The proposed new SORP maintains this broad outline, but 'certainty' is replaced by 'probability'. However in practice this should make little difference.

For most charities the key issue regarding income is when to recognise income from donations and grants. Existing practice is that income is recognised in full when the three conditions above are met. In assessing entitlement, the existing SORP requires consideration be taken of any conditions which have to be met, before entitlement passes. Generally any conditions which are within the charity's own control are to be disregarded in making this assessment. Here, FRS 102 differs as it simply refers to performance conditions – there is no distinction as to conditions which are within the charity's own control and those which are externally imposed. However, the proposed new SORP requires that performance conditions within the charity's own control should be disregarded when there is evidence that they have been or will be met. Essentially, the SORP is saying that administrative requirements should be disregarded.

Clearly this continues to be a complex area. For those charities receiving grants and donations, the proposed SORP should be reviewed and the requirements matched to each type of income.

Another area of significant difference is employee benefits. FRS 102 requires entities to recognise holiday pay accruals to the extent that employees have rendered services to the charity which increases their entitlement to future paid holiday. This is something that is not specifically required under current UK GAAP and while not difficult to calculate, it is an additional administrative requirement for accounts preparers. Although the inclusion of holiday pay accruals might change the period in which salary cost is recognised it will not change the cost in total, however, the FRS 102 requirements in respect of accounting for interest cost on defined benefit pension schemes will change the profit and loss charge for most entities with defined benefit schemes. FRS 102 does not allow a higher interest rate to be used to calculate the expected return on scheme assets but instead requires that entities use a discount rate equivalent to the return on high quality corporate bonds to calculate interest on the net pension liability. This could result in the cost of activities increasing under FRS 102.

So, what should charity finance staff do now as a result of the issue of FRS 102? Obviously the SORP is going to be an important document for accounting and reporting under FRS 102, but there are some steps that can be taken now.

• Consider whether your charity will apply FRS 102 or the FRSSE.
• If you choose to apply FRS 102, finance staff and probably also the chief executive and trustees should attend training on this new standard. Your charity's accounts will look very different under FRS 102 and it is important that everyone understands the changes.
• Prepare a timeline and understand when your transitional date is. Your transitional date is the first day of the comparative accounting period in the first set of accounts. For example if your first set of accounts under FRS 102 is to 31 December 2015 then the transitional date is 1 January 2014, i.e. not very far away.
• Set up a working party to deal with the transitional arrangements and consider the implications of the change in accounting framework. For example will loan covenants be affected?
• Review the standard and consider the changes that will apply equally to all entities and therefore are unlikely to be covered by the charities SORP. These are the areas that you can start to work on straight away without waiting for the SORP to be issued.
• Keep abreast of developments and best practice. Review the draft SORP when it is issued and use the consultation period if you have a comment to make.

INDEPENDENT SCHOOLS - CHANGE BRINGS OPPORTUNITIES

By Craig Aitchison

Craig Aitchison explores the changes you can make for the better.

The education sector has been, and continues to be, subject to increasing scrutiny, regulation and challenge. Never has the phrase 'there is nothing permanent except change,' been more apt.

Independent schools continue to cope with issues such as:

• uncertainty over what constitutes 'public benefit' as a pre- requisite of maintaining charitable status
• increasing constraints on parents' ability to meet education costs, especially with the introduction of £9,000 per annum university fees
• additional competition, not only from other independent schools and state sixth form colleges, but from the rising number of state academies and free schools (2,724 academies at 1 March 2013, being 48% of state secondary schools and 79 free schools, with more of both in the pipeline. See www.education.gov.uk)
• demographics in local areas reducing the pupil population
• cost inflation, particularly in respect of the key categories of staff, property, utilities and catering
• falling property prices reducing the value of security available to support borrowing.

Looking at the state of the sector, the latest ISC annual Census (taken in January 2013 and based on responses from over 1,200 schools) reported that:

• at the 1,204 schools completing the census in both 2012 and 2013, pupil numbers were down by 0.3% (compared with a 0.1% survey increase in 2012)
• the average overall fee is up by 3.9%, the lowest annual fee rise since 1994
• the value of means-tested bursaries rose by 6.7%, an increase of almost £19m.

It is interesting to note that the percentage of pupils attending independent schools in the UK still appears to remain at approximately 7% of total UK pupils and there is opinion that this will continue. On the other hand, anecdotal evidence suggests that many schools expect fewer pupils. How can this be reconciled?

Recent years have certainly seen increasing school insolvencies and undoubtedly, this trend will continue. However, in my experience, the majority of pupils either continue as pupils in the restructured school (with new owners, often a schools group) or move to alternative independent schools, frequently local rivals. This would tend to suggest that we are seeing sector changes in how independent school services are delivered (and to whom) rather than an overall decline, a scenario reflecting the nature of all business sectors – in which there are both winners and losers. The winners are those who are most able to identify and adapt to change.

Winning strategies in the independent schools sector include:

• a strong board of trustees - including areas of expertise such as finance, law, property, fundraising, education and human resources
• knowing your market and acting accordingly - a continuous process which might lead to rationalisation, growth organically or by merger or acquisition, academy conversion or joining a wider schools group
• understanding changes in pupil numbers - if reducing, ascertain and be realistic about the reasons; if increasing, how best to capitalise on this
• strict financial control - staff scheduling, supplier contracts, purchasing groups with other schools, joining a wider schools group, reliable and timely accounting information and forecasts
• managing the bank relationship:
  • avoid surprises; identify issues early and present the bank with your proposed course of action to address these
  • funding remains available with banks (and certain equity houses) for investment into viable education proposals
• no 'sacred cows' - rigorously question the existing business model as to whether it is still the most relevant and make appropriate changes based upon a realistic and objective SWOT analysis.

In summary, changes in the independent schools sector do bring opportunities to continue to deliver the best outcome for pupils – the overriding objective of all schools.

CASE STUDY - LONGRIDGE v HMRC

By Mike Marsden

Is a charity carrying on a business for VAT purposes?

In the recent case Longridge on The Thames (Longridge) v HMRC [2013] UKFTT 158 (TC) the First-Tier Tribunal was once again asked to consider whether the activities of a charity amounted to the carrying on of a business activity for VAT purposes. Longridge is a charity formed in 2007 to provide boating and other water-based activities and facilities for young people from its premises on the banks of the Thames. Certain courses are also available for adults.

To improve the facilities on offer, Longridge had constructed a two storey building, with the ground floor designed as a toilet and shower block and the upper floor to be used as training and meeting rooms. On the presumption that the building was to be used solely for a relevant charitable purpose, otherwise than in the course or furtherance of a business (items 2, 4 and Note 6 to Group 5, Schedule 8 VAT Act 1994), the building contractor did not charge VAT. As an aside, it transpired Longridge had not issued to the builder the zero-rating certificate as required by Note 12 (b), but HMRC made no issue of that omission in these proceedings.

HMRC claimed that the nature of the activities carried on by Longridge amounted in whole or in part to the carrying on of a business, therefore denying them the entitlement to claim zero-rating relief on the construction. On the facts of the case, Longridge was acting in "a business-like manner". It had a full-time CEO and fundraiser with a business plan; in the previous year operating income had amounted to 80% to 90% of operational expenses; it is active on a considerable scale; it is professionally run, seeking out paying customers beyond its charitable remit to subsidise its activities; and the way it provides its courses is consistent with those of a commercial provider. Income in 2010/11 was £580,000 and it was holding assets in excess of £2m.

The issue to be decided was whether, at the time the relevant construction services were supplied to Longridge, they intended to use the building for a relevant charitable purpose, or in the course or furtherance of a business.

In considering this issue, the tribunal looked to the six indicators of whether an activity amounts to the carrying on of a business as first set out in Customs & Excise Commissioners v Lord Fisher QB [1981] STC 238.

The six indicators were summarised by Lord Slynn in ICAEW v C&E Commissioners HL [1999] STC 398 at p404e as follows:

"...was the activity (a) a serious undertaking earnestly pursued; (b) pursued with reasonable continuity; (c) substantial in amount; (d) conducted regularly on sound and recognised business principles; (e) predominantly concerned with the making of taxable supplies to consumers for a consideration; and (f) such as consisted of taxable supplies of a kind commonly made by those who seek to profit from them."

Applying these indicia to the present case, while it was clear that the activities of the charity were managed in a professional and "business-like" manner, did not tell the whole story. The charges for the course fees were balanced between the need to protect the long-term viability of the charity for future generations and their affordability for the young people Longridge wishes to benefit. The most significant factor was the reliance on unpaid volunteers to carry out the activities. When taken together the factors all pointed to the intrinsic nature of Longridge's activity being in furtherance of its stated charitable objectives. It followed that the charity satisfied the criteria that enabled it to receive zero rated construction services.

The judgement considers the relevant UK and European legislation and cases familiar to the charity sector, including C&E Commissioners v Yarburgh Children's Trust Ch D 2001 [2002] STC 207 and C&E Commissioners v St Paul's Community Project Ltd Ch D 2004 [2005] STC 95, both of which concerned the activities of charities and whether they were by way of business. So in many ways, the Longridge decision is a useful guide for the charity sector when debating the factors to take into account when the thorny question is raised as to what is or isn't a business activity. Unfortunately, we will have to wait and see if this remains the case as we understand HMRC has now appealed this decision to the Upper Tribunal. Watch this space!

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.