UK: Charity Tax Law

Last Updated: 5 April 2011
Article by Amanda Solomon

Budget 2011 and other recent developments

Introduction

Giving to charity was an important strand in George Osborne's Budget on 23 March 2011 and the measures he announced have been largely positively received by charities. The changes broadly fall into two categories. First there are changes to the Gift Aid scheme for individuals and the equivalent relief for corporate giving to make them easier to administer and, in some cases, to enable charities to reap additional tax benefits. Second there is a proposed new relief from inheritance tax ("IHT") for individuals leaving legacies to charities in their wills.

In addition to the Budget announcements other recent developments in charity tax law deserve mention. From 1 April 2011 the unpopular so-called "substantial donor to charity rules", designed to prevent abuse in relation to charitable funds, are to be replaced with the "tainted charity donation" rules which, while still complex, should be easier to operate. Second, a new definition of charity for tax purposes was introduced in 2010 extending the tax definition to charities established in the EU and incorporating an express requirement that the charity managers be "fit and proper persons to be managers of the body or trust" in question. So far Treasury orders have made this new definition expressly applicable only for the purpose of Gift Aid and the Budget appears to contain no reference to its further extension in the immediate future.

We await publication of the Finance Bill expected on 31 March where we might find further detail in relation to some of the developments mentioned in this note.

Budget 2011

New inheritance tax relief announced for charitable gifts on death

If an individual gives to charity at least 10% of his/her estate, he/she will pay a reduced rate of IHT on death. (The 10% of the estate is calculated after deducting IHT exemptions such as the spouse exemption, reliefs such as business property relief and the nil rate band.) The reduced rate of IHT is 36% (compared to the normal rate of 40%). The reduced rate will apply in respect of deaths after 5 April 2012. If an individual with a taxable estate of £100,000 (having used his/her nil rate band during his/her lifetime) on death gives £10,000 to charity and £90,000 to his/her children, the IHT on the estate will be £90,000 x 36% i.e. £32,400. Thus £10,000 will go to charity and the children will receive £57,600. But if the charitable gift had not been made the children would have received £60,000 and the Exchequer would have received £40,000. In other words the gift to charity of £10,000 in effect "costs" the children only £2,400. The Government will be consulting on the detail of this measure over the summer.

Gifts by individuals and companies to charities: benefits limit increase

The long standing Gift Aid scheme encourages individuals, sole traders and partnerships to make money donations to charity. Under the scheme the donee charity reclaims tax at the basic rate from HM Revenue & Customs ("HMRC"). The individual donor, if a higher rate taxpayer, may reclaim higher rate relief on the donation.

The corresponding relief for corporate donors to charity works by treating the money donation as exempt from tax in the hands of the charity provided it is used for charitable purposes. The donor company can set the amount of the gift against its total profits to the extent that they are reduced to nil.

In respect of both Gift Aid for individuals and tax relief on gifts by companies a number of conditions must be satisfied including that the donor must not receive significant benefits from the charity. There are two tests of what is a significant benefit. The first test is applied separately to each donation. For donations of £0-£100 the value of benefits must not exceed 25% of the value of the donation. For donations of £101-£1,000 the value of benefits must not exceed £25 and for donations of over £1,000 the value of benefits to the donor must not exceed 5% of the value of the donation. If these limits are exceeded the tax relief is forgone. Note that for this purpose special rules apply to value the benefits in some situations.

The second test of whether there is a significant benefit back to the donor looks at the aggregate value of benefits associated with the donation in question and with any other donations made by the donor to the same charity in the same tax year. Currently, under this second test the donor may not receive more than £500 of benefit associated with the gift in question or the aggregate of all gifts made by him/her to the same charity in the same tax year. Under this second test, in relation to gifts made on or after 6 April 2011 (1 April for companies) this limit will change so that the donor may receive up to £2,500 of benefit in the tax year.

Since the first test described above will remain unchanged, the effect of increasing the limit under the second test will only make a difference in respect of gifts of over £10,000. For example, prior to 6 April 2011 a single donation of £12,000 can attract benefits to the donor of up to £500 in view of the limit imposed by the second test. On and after 6 April 2011, a donation of £12,000 may attract benefits of up to £600. This is because although the upper limit of benefit that may pass back to the donor under the second test increases from £500 to £600 the limit under the first test remains, so restricting benefits to the donor to 5% of the gift ie on a donation of £12,000 the upper limit of benefit receivable by the donor increases to £600.

Note that different sets of rules apply for certain non-money gifts to charity which are not mentioned in the Budget.

Records for small donations to be simplified

From April 2013 charities receiving small donations of £10 or less (but capped at a total of £5,000 per charity per year) will be able to claim a Gift Aid style repayment but without the need to obtain Gift Aid declarations from donors. To qualify for this the charities will have to have been recognised by HMRC for Gift Aid purposes for at least three years, have been operating Gift Aid successfully during that time and have a good compliance record. The Government is to consult with charity representatives on the details of the new scheme during summer 2011.

Gift Aid : online filing for charities

HMRC will introduce a new online system for charities to register their details for Gift Aid and to make Gift Aid claims. To begin with HMRC will publish four new "intelligent" forms for charities to use. These contain automatic checks to improve the accuracy of information and reduce administration. HMRC will also be working with charities to develop a supporting electronic Gift Aid database for gift aid declarations. The new system is expected to be introduced in 2012/2013.

SA Donate to be withdrawn

Under SA Donate self assessment taxpayers due to receive a repayment of tax from HMRC could direct that the repayment should be made instead to a charity of the taxpayer's choice. Taxpayers could also apply Gift Aid to the donation provided they had paid enough tax to cover the charity's repayment claim. HMRC would then pay the basic rate of tax due in respect of the donation to the charity. SA Donate was introduced in 2005 but has been underused, and is regarded as not cost effective and vulnerable to fraud unless it is substantially upgraded. It is therefore to be withdrawn for repayments of tax relating to tax returns for the tax year 2011/12 onwards and tax returns up to and including 2010/11 where the repayment is made on or after 6 April 2012. The resources saved from withdrawal of SA Donate will be redirected to support the introduction of the online claim system for Gift Aid. Legislation will be introduced in the Finance Bill 2012 to give effect to this.

Gifts of art

The Government is considering introducing a tax reduction for taxpayers who give a work of art or historical object of national importance to the State. A consultation on the proposal will take place over the summer of 2011.

There is already a long-standing "acceptance in lieu" scheme whereby "pre-eminent" items may be offered for public ownership in lieu of IHT on death. As part of this arrangement a percentage of the tax is remitted back to the estate. The new proposal would presumably relate to income tax but we must await publication of the consultation for clarification.

VAT cost-sharing exemption

Consultation is ongoing on the options for implementing the VAT cost-sharing exemption into UK legislation. This would be relevant for organisations such as charities, universities and housing associations wanting to make efficiency savings by working together. Under UK legislation as it stands, this can give rise to a VAT cost which gets in the way of such sharing. The purpose of an exemption, if implemented in the UK, would be to remove this VAT cost in certain circumstances. Consultation on this is to continue.

Other recent developments

New provisions on "tainted" charity donations

Anti-avoidance legislation was introduced in the Finance Act 2006 to restrict a charity's tax exemption where a substantial donor enters into certain transactions with the charity, for example letting property to it or renting property from it, as the result of which the value passes back to the donor. This anti-avoidance code is known as the "substantial donor to charity" rules.

A substantial donor is one who has made donations to a charity of at least £25,000 in any 12 month period or at least £150,000 (increased from £100,000 in April 2009) in any six year period. A person is a substantial donor for every tax year (if an individual) or accounting period (if a company) falling within the 12 month or six year period in which the substantial donation or donations falls and for the following five tax years or accounting periods.

These rules have been regarded as problematical. Since the penalty is in effect borne by the charity the onus is on the charity to police the rules. Because a donor (of £150,000 or more in any six year period) could fall within the definition of "substantial donor" for up to 18 years, there is an onerous compliance obligation on the charity to maintain records of "substantial" donations and of any "transactions" which could potentially trigger the rules. The records required cover not only substantial donors but also connected persons. Although modifications were made in 2009 to try to ameliorate these obligations, in principle, the problems remain. Reform is therefore welcome.

The proposed replacement for the substantial donor rules are called the "tainted charity donations" rules. The relevant legislation was included in the Finance Bill 2011 published at the end of 2010 and is intended to take effect from 1 April 2011.

The new rules in effect look at the purpose of any arrangements entered into between the donor and the donee charity and the extent to which an advantage is obtained by the donor or connected person from such arrangements. There is no de minimis test so the new rules could apply to any donation no matter how small (or large).

For a donation to be tainted three conditions need to be satisfied. First, the donor (or a connected person) enters into arrangements which it is reasonable to assume would not have been entered into independently of the donation to charity. Second, the main purpose (or one of the main purposes) of the arrangement must be that the donor or a connected party receives an advantage directly or indirectly from the charity. Third, the donor must not be a "qualifying charity owned company" in other words, the new rules do not apply to charitable trading subsidiaries.

The donor is treated as obtaining an advantage from the charity if the arrangements he/she enters into include transactions under which the terms are more favourable to the donor, or less favourable to the other party, than they would have been in absence of the arrangements. The kinds of transactions potentially falling within the new rules are similar to those under the substantial donor rules, for example, selling or letting property.

In determining whether there is a tainted donation any benefits which are within the limits permitted under the Gift Aid rules (as to which see above) may be ignored.

The effect of the tainted donation rules applying are that (a) no tax relief is due to the donor and (b) where Gift Aid is withdrawn as a consequence of a tainted donation, the donor is liable to income tax on the repayment of tax due to the charity. The charity itself is not liable to income tax unless it is a party to, and "aware" of, the arrangements. There are also special provisions on liability where income of a trust is paid to a charity under a tainted donation. Finally there are special rules to deal with the transition between the substantial donor rules and the tainted donation rules.

Examples of how the tainted donation rules will apply are given in the explanatory notes with the draft legislation. For example, if a donor makes a Gift Aid donation of £100,000 (which under the Gift Aid scheme would gross up to £125,000) to a hospital on the understanding that he would receive treatment worth £125,000, the donation would be tainted. On the other hand if donors of £5,000 or more to a conservation charity are automatically provided with a "package" allowing them to attend a conference, and to receive a monthly newsletter and a calendar this is unlikely to be tainted on the basis that the donation would probably have been made in any event and furthermore the benefits received are probably within the Gift Aid limits and so are permitted.

An important change from the substantial donor rules is that it is the donor who is liable for any tax arising from the arrangements rather than the charity. Although the rules are complex, once practitioners, charities and donors have become familiar with how they work, they should represent an improvement on the previous rules.

Definition of charity for tax legislation

The Finance Act 2010 introduced a new definition of charity for the purposes of tax legislation. This was following a formal request by the EC Commission to the UK to end its discrimination against non-UK EU charities on the ground that, before the change in definition, only charities established in the UK benefitted from the UK charitable tax reliefs. Thus the new definition extends the meaning of charity to include equivalent organisations in the EU and the European Economic Area. At the same time other important changes were made to the tax definition of charity including the much commented upon express requirement that the managers be "fit and proper" persons to be managers of the charity.

The new definition came into force on 6 April 2010 specifically in relation to Gift Aid. HMRC have taken the view that the new definition applies only in the context of charities claiming repayments of tax under Gift Aid. An alternative interpretation is that the new definition applies wherever tax legislation does not provide a definition, for example in the Value Added Taxes Act 1994. In any event HM Treasury is given authority to make orders to replace other definitions of charity appearing in the tax legislation. There have so far been no such orders and there is no indication in the Budget that any are forthcoming in the immediate future. We are preparing a separate note on the practical implications for charities of this new definition, which will be published on our website shortly.

Conclusion

Charity trustees, managers and advisers will no doubt welcome the prominence given to charities in George Osborne's Budget on 23 March. It is clear that charities play a significant role in Government thinking (not least in the light of David Cameron's Big Society initiative). For the small print on some of these changes we will need to await the outcome of consultation due to take place over the summer. We will be following these with interest and will be reporting on future developments.

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.

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