The new 'fit and proper person' test has introduced a raft of uncertainty into the taxation of charities and charitable giving. HMRC revised its guidance on Friday 9 July 2010 on the test but issues remain to be considered. We provide answers to the key practical questions charities and their donors are asking about the changes.
What exactly has happened?
Back in March at the time of the initial 2010 Budget (see Extension of Tax Reliefs to certain European charities) we reported that the extension of charitable tax reliefs to certain eligible European charities had been announced, but that the detail had yet to be released. Since then, the Finance Act 2010 (the "Act") has been brought partially into force, including the introduction of a new definition of 'charity' for tax purposes. HM Revenue and Customs (HMRC) has also issued guidance intended to indicate how it will be interpreting the new legislation and exercising its statutory discretion.
The definition contained in the legislation is very widely cast
and contains in particular a new test that the charity's
'managers' must be 'fit and proper persons'. In
principle, this management test should be very straightforward.
However, HMRC guidance indicates their application of a very wide
definition of 'manager' and gives very little guidance on
what 'fit and proper' means.
At present, the revised definition has been brought into force only
in respect of Gift Aid. However, in due course the new definition
will also apply to other income tax, capital gains tax, corporation
tax, VAT reliefs and exemptions, inheritance tax and the various
stamp taxes.
Why is this test being introduced?
The extension of charitable tax reliefs to eligible European bodies has been on the horizon for several years after a series of European Court of Justice decisions determined that a European Union Member State may not discriminate against another Member State's entities when providing charitable tax reliefs. (see Hein Persche v Finanzamt Lüdenscheid and Tax deductibility of gifts to non-UK, EC member state charities for more details.
We are told that the change to the definition of what constitutes a 'charity' has been introduced in order to address the problems of tax fraud and 'sham charities', thought to be likely to increase following the extension of UK reliefs to European organisations.
FOR CHARITIES
Who Is A 'Manager' Of A Charity?
The term 'managers' is defined in the Finance Act 2010 as 'the persons having the general control and management of the administration' of the charity. Though this wording is identical to the definition of 'charity trustees' in the Charities Act 1993, it is clear from its guidance that HMRC intends to apply the term 'manager' to a wider class than simply the charity's trustees, including for example, employees who are 'able to determine how a significant proportion of the charity's funds are spent'. Members of the senior management team or 'executive board' of larger charities are expressly referred to as within the definition of 'manager' in the HMRC guidance.
Sector groups including the Charity Tax Group and the Charity Law Association have raised with HMRC the difficulties that such a wide definition of 'managers' will raise for charities, particularly those with large and complex operations. Some progress has been made on this point in that in response to heavy criticism, HMRC has accepted that its initial guidance was inappropriate and has reissued revised guidance which has removed a statement that all cheque signatories would be 'managers'.
However, it seems unlikely at this stage that any future revised guidance will limit the scope of the new test to charity trustees alone since the fraud risk HMRC has identified extends also to persons with control of charitable assets. If the guidance continues to refer to 'managers' being all those with control over charitable assets, it will be difficult for charities to decide with certainty how far this control test goes and whether those who determine charity budgets (or who manage petty cash) will be caught.
HMRC's wide interpretation may be open to legal challenge and this, combined with pressure from sector groups, may in time lead HMRC to amend its guidance further.
What Does 'Fit And Proper' Mean?
Another difficulty with the legislation and the HMRC guidance is a lack of clarity about the criteria for meeting the 'fit and proper person' test. The term 'fit and proper person' is not defined in the legislation and the HMRC guidance provides a non-exhaustive list of 'factors that may lead HMRC [to decide] that a manager is not a fit and proper person'. This short list will be difficult for charities to apply in practice and includes a person:
- With a history of tax fraud
- With a history of other fraudulent behaviour including misrepresentation and/or identity theft
- About whom HMRC has knowledge of involvement in attacks against or abuse of tax repayment schemes
- Who is barred from acting as a charity trustee or company director by a regulator or court
It is also unclear what level of proof will be required and it seems possible at this stage that a person could be deemed to be unfit even if HMRC lacked sufficient proof of fraud to lead to a conviction in court. This is another area of uncertainty for charities which has been repeatedly raised with HMRC by the Charity Tax Group and other sector working groups.
Does The Charity Commission Not Already Require Charity Trustees To Be Fit And Proper?
No, the Charity Commission does not apply a 'fit and proper person' test. Instead, charity law requires that charity trustees must not be disqualified from acting as such, for example, by having a conviction for an offence relating to dishonesty which is not 'spent'. The charity law requirements are narrower in scope and are more certain and it has been argued that these ought to be sufficient for the purposes of satisfying a proper management condition.
However, it is clear that HMRC considers it appropriate for it to carry out additional fraud-focussed checks that charity regulators, whether in the UK or in Europe, do not undertake.
This means that trustees will not be able to rely on the fact that a proposed manager is not disqualified from acting under charity law. Instead, they will have to take reasonable and prudent steps to determine that any person being appointed as a manager is fit and proper on the basis of HMRC's criteria. Good record-keeping will be important in case of challenge, so charities will want to keep an audit trail of decision-making in relation to each appointment.
What Happens If A Charity Fails The Test?
On the face of it, a charity which does not satisfy the management condition is not eligible for tax reliefs including (once the Act is entirely in force) not only Gift Aid but also relief from income tax, capital gains tax, corporation tax, the benefit of VAT reliefs and exemptions, and relief from inheritance tax and the various stamp taxes. This is because it is technically not a 'charity' for tax purposes if it does not satisfy the management condition.
The linking of charitable tax reliefs to the status of individual trustees and employees is clearly a significant development in the law and regulation of charities. There have been calls to amend the Act to remove this linkage, but at present there is no indication that this is planned by the new Coalition Government.
How Will We Know If We Fail The Test?
HMRC will first raise its concerns with the manager in question and give him or her the chance to challenge HMRC's view. The charity will only later be involved in this discussion, after HMRC has notified the manager in writing that he or she is not fit and proper.
Is There Anything That Can Be Done If A Charity Fails The Test?
Yes. The legislation contains a discretionary power for HMRC to 'deem' that the management condition has been satisfied despite HMRC determining that a manager is unfit.
HMRC may allow tax reliefs throughout the entire period such a manager was in office if it is just and reasonable to do so or if the manager is not able to 'influence the charitable purposes of the charity or the application of its funds'. Further, HMRC has a wide discretion to work with charities to 'remedy' the situation and may require the charity to dismiss the individual in question as a condition for continued relief.
In its revised guidance, HMRC has sought to give comfort to charities about how it will exercise this discretionary power, including by indicating that it does not intended to withdraw tax reliefs during a period of enquiry as to fitness. However, HMRC may withhold repayments of tax depending on the circumstances.
HMRC has also indicated that it may require a charity to make organisational changes, including introducing supervision to unfit managers or moving them to other roles, as a condition to maintenance of tax reliefs. Although the legislation does not refer to a charity's knowledge of fitness, HMRC has indicated that it will 'work with' a charity that 'innocently' appoints an unfit manager who in fact misapplies funds, and that it will not necessarily deny the charity tax reliefs. Finally, HMRC has indicated that it will take a 'risk-based' approach to its role which may ease the burden on domestic registered charities with 'low-risk' managers.
Ultimately however, if HMRC does not exercise its discretion to permit continued tax reliefs, there is no statutory appeal process (either by a manager or by a charity), only the usual means of challenging HMRC, namely appeal to the internal adjudicator or judicial review.
We Are In The Process Of Setting Up A New Charity - What Does This Mean For Us?
Entities not yet in possession of an HMRC charity reference number will be required to file a new HMRC form, ChA1, which is currently being revised by HMRC.
This must be submitted to HMRC with a copy of the charity's governing document, any registration documents issued by the appropriate charities regulator, any available accounts, bank account statements and evidence of the charity's public benefit activities. The information requested includes the funding history of the charity, the manner in which it proposes to raise new funds, the charity's area of operation, and a description of the public benefit the charity provides and the identities of certain individuals, including:
The Authorised Official - the person inside the charity authorised to deal with HMRC in relation to the charity's tax affairs;
- Nominee - the person outside the charity (if any) who has been authorised to submit Gift Aid or other repayment claims; and
- Responsible Persons - Between 2 and 4 persons nominated by the charity to be 'Responsible Persons', able to notify HMRC of changes to the charity's details and changes to The Authorised Official and the Nominee.
Even though only some managers are to be included on this form, it is important to remember that all managers have to be 'fit and proper persons'.
An application cannot be made until the charity is registered with any domestic regulator (such as the Charity Commission or OSCR) with which it is legally required to be registered. This extra step will lengthen the overall inception and registration process and it is not immediately clear how HMRC will treat donations made between the date of inception and the date HMRC finally recognises charitable status.
Though some comfort for domestic charities can be found in the fact that the additional information required is largely the same as that required for registration with the domestic regulators, there will be a duplication of effort as a result of the addition of another, separate application process. This increased administrative burden is another issue that sector bodies have raised with HMRC in consultation.
We Are An Existing UK Charity - What Do We Have To Do?
The positive news for existing UK charities already registered with HMRC for tax is purposes, is that no HMRC Charity Application form needs to be completed. Instead, existing charities only have to provide additional information when they next seek to change the person nominated to deal with HMRC on behalf of the charity.
However, the fit and proper person test applies equally to existing domestic charities, so the board will need to satisfy itself that all 'managers' are 'fit and proper persons'. Exactly how this should be accomplished is left up to charities.
HMRC suggests that charities may wish to use of some kind of manager declaration form to show HMRC that they have taken steps to ensure its managers are fit. Such a form is really just a self-certification of fitness, however, and a person 'with a history of tax fraud' will not necessarily admit this to a charity. HMRC suggests that charities need to decide for themselves what to do if a manager refuses to sign such a declaration form.
From a practical perspective, all charity boards should ensure that they have read the revised HMRC guidance (particularly the section entitled 'suggested procedure for charities when they appoint new managers) and considered who might be 'managers' at their charity. When this group has been identified, it would be sensible to ensure that the managers are briefed on the new requirement and that it is emphasised that the charity's tax status may be at risk if they have any tax-related skeletons in the closet.
From a charity law perspective, the trustees will have to apply a procedure that is reasonably and prudently in the interests of the charity. Trustees who appoint unfit managers recklessly could in theory find themselves personally liable to the charity for the loss the charity suffers by losing its tax reliefs.
Is There Anything Else We Should Know?
The Act also includes a change to the legislation relating to payment of funds overseas. You might recall that when a charity transferred funds to a non-UK body, it had to take 'such steps as are reasonable' to ensure the funds would be applied for purposes recognised as charitable under English law. Now, the Act has inserted the words: 'the Commissioners of Her Majesty's Revenue and Customs consider' between 'as' and 'are'. The consequence of this is that the steps no longer have to be simply 'reasonable', they have to be reasonable in HMRC's view. There may well be pressure for this amendment to be reversed, but it is unlikely that anything will change in the near future.
Charities grant-making internationally will need to take a fresh look at their practices for assessing grant applicants and monitoring grants and ensure that the board is comfortable that these would stand up to scrutiny. An audit trail of board decision-making has always been important in relation to overseas funding but is particularly so now that HMRC's subjective view has been added in to the legislation.
FOR DONORS
Does This Mean I Can Obtain A Tax Break For Donating To Foreign Charities?
Possibly. Higher and additional rate tax payers giving to eligible organisations based in any of the EU Member States or in Norway or Iceland may be able to reclaim in relation to donations made since 27 January 2009. Such foreign organisations must be:
- Established for purposes that would be charitable in the UK;
- If required by law, registered with the local charities regulator;
- Managed by 'fit and proper persons'.
The process for establishing eligibility for UK tax reliefs is similar for that described above for new charities. The foreign charity will have to submit an HMRC Charity Application and supporting documents, and if successful, will be listed on the HMRC website. It is difficult to say how onerous or drawn-out this process will be in practice, but it is good news for donors who wish to support European charities.
This Change Won't Impact On My Domestic Charitable Giving Will It?
The uncertainty described above for charities will have an impact on donors as well. If a charity is determined by HMRC to have an 'unfit' manager, and if HMRC does not exercise its discretion to overlook this, then a donation to that charity is not in principle eligible for the Gift Aid scheme. Basic rate tax-payers will have the disappointment of learning that the charity will not be eligible for the tax rebate and higher and additional rate tax-payers will miss out on reclaiming their additional tax relief.
For this reason higher and additional rate tax-payers may consider it sensible to carry out additional due diligence on the donee charity before making any large donation that must be made tax efficiently, possibly asking for assurances that the charity has itself taken appropriate steps to evaluate the fitness of managers. Where tax efficiency is crucial to a donor's tax position, he or she may wish to deal further with this issue in the donation documentation or grant agreement.
What About Corporate Donations?
Corporate donors are often overlooked. Gift Aid allows a corporation tax deduction for qualifying donations to charity. Like higher-rate taxpayers, corporate donors will want to take care with donations to avoid donating out of pre-tax profits without the benefit of a corporation tax deduction.
Where Do We Go For Guidance?
Charities, trustees and both corporate and individual donors should consider HMRC's revised guidance and, if necessary, take professional advice as to the impact of these changes on their circumstances.
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.
