Surely charities don’t need to worry about tax, do they?
Yes they do! The very first thing for charities to understand about tax is that they cannot simply ignore it. By this we mean that charities do not have a blanket exemption from taxes: there are of course generous tax reliefs for charities but the only safe starting point is to recognise that charities are treated for tax purposes in exactly the same way as everyone else unless the precise terms of some specific exemption or relief are satisfied. So, for example, a charity which carries on a trade is subject to tax unless the trade fulfils one of several alternative conditions which we look at in more detail below; a charity carrying on a business or having rental income may be liable to account for VAT on its turnover; and a charity which employs people is going to be subject to the same PAYE obligations as any other employer. A charity which has taxable income is required to notify HMRC and to file a tax return in exactly the same way as any other taxpayer and is liable to the same penalties if it fails to meet its obligations.
Who gets the exemptions?
Only bodies recognised by HMRC as charities qualify. If you are recognised as a charity by the Charities Commission or the Office of the Scottish Charity Regulator (“OSCR”), HMRC will usually accept that you are a charity for tax purposes. Occasionally, because Scottish law differs from UK tax law, things may not be quite so straightforward for a Scottish charity; but this will be rare.
Some charities are not registered with the Charities Commission or with OSCR. This may be because the charity is excepted or exempt from registration or if its income is below the income threshold. Such unregistered charities are still able to access tax reliefs and exemptions but they must establish their charitable credentials with HMRC by submitting details of their governing documentation and charitable objectives and activities.
What exemptions are available?
Provided the income is applied only for charitable purposes, charities are exempt from UK tax on most types of investment income (including income from investments overseas) and on rental income from property. Where tax has been deducted at source from exempt income charities are able to claim repayment of the tax; they are not, however, any longer able to reclaim payment of tax credits in respect of dividends. Charities are also exempt from Capital Gains Tax provided the proceeds of disposal are used for charitable purposes only.
It is in relation to non-investment income (in particular, trading income) that the main complications arise. There is no blanket exemption from tax for such income, though there are no fewer than five separate exemptions which might apply: if none of those is available it may be advisable to consider trading through a subsidiary (non-charitable) trading company.
How do trading reliefs work?
There are five possible exemptions from Income Tax (or Corporation Tax if the charity is a company). In each case there is a common requirement that the profits must be used for charitable purposes only. The exemptions are briefly described below:
“Primary purpose” trading. This is trading which is carried out in the course of carrying out a primary purpose of the charity. Examples might include an independent school or a museum – the trade is carried out not to raise funds for the primary purpose of the charity but is itself the primary purpose. This exemption also extends to trading activity which is not itself part of the charity’s primary purpose but which is ancillary to the “primary purpose” trading. An example would be a museum running a café to cater for visitors to a museum or sale of necessary text books to students of an independent school run by a charity. Something to watch out for here is that trading may be partly ancillary to primary purpose trading and partly not. For example, a shop associated with a museum may sell both goods related to the primary educational purpose of the charity (books about the exhibits, for example) and pure fund-raising items (such as mugs, pens and other souvenirs). Subject to de minimis rules, such mixed trading may lead to the partial loss of exemption.
“Beneficiary” trading. This is trading where the work is mainly carried out by beneficiaries of the charity – for example, a workshop for the disabled selling goods produced in the workshop is likely to qualify; the exemption is still sometimes referred to as the “blind basket weavers” exemption. Another example would be a catering school running a canteen open to the public where the food is prepared and served by students as part of their course.
Minor trading. Where neither of the main exemptions applies in full, profits may be exempt if the gross turnover (NB not the profit from the trade) is less than 25% of the charity’s annual income and is also less than £50,000. However, regardless of the level of the charity’s income, a trade with a turnover of less than £5,000 will always be exempt. This can be combined with the main exemptions: so if for example a trade is largely covered by the “primary purpose” exemption but a small part is not, the non-exempt part may be covered by the minor trading rules.
Fund-raising events. Profits from events which are undertaken by a charity are exempt from Income Tax or Corporation Tax if they meet the definition of “VAT-exempt” events. For more detail of “VAT exempt” events, see below. One rather confusing point to remember is that although the VAT relief can apply to bodies which are not charities, the corresponding direct tax relief is restricted to charities.
Lotteries. If a charity organises a lottery to raise funds, any profits are exempt from tax provided the lottery is promoted and conducted in accordance with the terms of a lottery operating licence.
What about sponsorship income?
The tax treatment of sponsorship income may require careful examination. If the charity gives nothing substantial in return for a donation from a business, the donation will retain its character as a gift, even if a business donor seeks and obtains good PR from the gift and indeed may see it as the main benefit of the gift. However, where the charity provides some goods or services in return for the sponsorship this may be regarded as amounting to a trade, which will not usually fall within any of the tax exemptions; and it can sometimes be difficult to know where the line is drawn. Where an event promoted by a charity is sponsored by a business, the sponsorship will not amount to a receipt of a trade merely because there is a simple acknowledgement of the sponsorship in the programme for the event. But a more fulsome acknowledgement, perhaps including prominent display of the sponsor’s logo or a description of the sponsor’s business may well be regarded as the provision by the charity of advertising services, which would (subject to the exemptions above) be a taxable business. Other services which a charity might provide in return for business sponsorship might include some form of product endorsement or recommendation, or perhaps access to the charity’s mailing list: either of these might well give rise to taxable income. This area is particularly fraught and great care needs to be taken at the margins.
Rather than itself trade, a charity may establish a company in which it owns all the shares as a vehicle through which all trading is conducted, with a view to procuring that the company pays all its profits to the parent charity under Gift Aid. There are two main reasons for this. First, the charity may not wish to expose all its assets to the commercial risks of trading; second, if there are non-charitable activities for which the charity would not be entitled to relief, this does not matter: taxable profits will be “washed out” by the Gift Aid payment. There is a special relaxation of the Gift Aid rules for companies owned by a charity whereby payments made within nine months of the end of the company’s accounting year can be “related back” to the accounting year: this will make it easier to ensure that the full amount of profit for the accounting year is paid up as Gift Aid rather than having to make an educated guess.
Because a charity is at risk of losing some or all of its tax reliefs if it makes any loans or investments which are “non-qualifying”, it is important to ensure that any investments which a charity makes in a trading subsidiary are commercially justifiable: for example any loan should carry a reasonable rate of interest which should actually be paid. Charities will also need to bear in mind the constraints imposed by charity law, which are covered elsewhere in these notes.
How does Gift Aid work?
Both companies and individuals can make payments under the Gift Aid scheme, although the detailed rules differ. From the charity’s perspective the important point is that Gift Aid receipts from individuals (but not companies) are treated as if they had had basic rate tax deducted from them, which tax is repayable to the charity. Thus with basic rate tax at 20% a Gift Aid receipt from an individual of £100 will be treated as a gift of £125 from which tax of £25 has been deducted and will generate a tax repayment of £25 for the charity. Most charities will be familiar with the basic Gift Aid procedures for cash donations and we shall not cover those here. But there are some complexities…
Gifts of money
Gift Aid relief can be claimed only on gifts of money (though there are special rules about gifts of shares, securities and land). This includes cash, cheque, credit / debit card and all other forms of money transfer, and the gift can be in sterling or foreign currency (though to make a Gift Aid payment the payer must be liable to pay UK Income Tax or Capital Gains Tax of at least the amount which is treated as deducted from the payment).
Retail Gift Aid
A particular Gift Aid issue can arise in respect of the sale of donated goods. If a donor gives goods worth say £10 for sale through the charity’s shop the proceeds of sale are of course tax-free and the charity receives £10. If the donor sells the goods himself and donates the cash proceeds to the charity, the donation can be gifted-aided and becomes worth £12.50 to the charity. For this reason various “Retail Gift Aid” schemes have evolved whereby the charity purports to act as undisclosed agent for the donor in selling the goods and in receiving the cash proceeds of sale which are then (as cash gifts) donated to the charity under Gift Aid. These schemes can certainly work, but only if they are meticulously planned and carefully implemented: they are full of pitfalls for the unwary.
Gifts with strings or a quid pro quo
Gifts “with strings” do not count: so Gift Aid would not apply to “gifts” which are in any circumstances repayable; or gifts made on behalf of other people. “Gifts” which are in fact payment for goods or services are not within Gift Aid; but the provision of benefits which are of small value relative to the gift are acceptable. For gifts up to £1,000 the value of the benefit must be less than £25 and less than 25% of the gift; for larger gifts it must be less than £2,500 and less than 5% of the gift. There are, however, special exemptions of which the main one (the so-called “National Trust” exemption) operates to permit Gift Aid in respect of annual subscriptions affording the giver free or reduced-rate admission to view property the preservation of which is within the charity’s charitable purposes.
Buying the benefit
Where a Gift Aid payment would otherwise fall foul of the “benefit” rule, it is possible for the donor to make a separate payment for the benefit (“buying the benefit”) and only to claim Gift Aid on the remainder of the payment. This can be done only where
- the benefit is available to be purchased separately (i.e., is commercially available) and
- the donor is aware of the value of the benefit at the time he makes the payment.
This can be helpful at charity auctions, but only where the item sold is in fact commercially available. The problem with many charity auctions is that the lots offered are unique and are not commercially available; as for example a football shirt signed by a star player or a handbag donated by a celebrity. It is not then possible to identify separate elements of donation and payment for the benefit and Gift Aid cannot apply to any part of the payment – even though the amount of the successful bid will almost always have been inflated by an intention to benefit the charity.
Gift Aid Small Donations Scheme (“GASDS”)
In some circumstances Gift Aid “top-up” payments can be claimed in respect of individual donations of up to £20 even if the donor has made no Gift Aid declaration or if you do not know the identity of the donor. Typically this may apply to street collections or donations made at meetings (such as church services). The maximum which can be claimed under the GASDS for a year is 10 times the amount claimed under the main scheme, and there is an separate £5,000 limit for each “community building” in which collections are made and on donations collected other than in a “community building” such as street collections.
Charities and VAT
Charities are generally subject to the same VAT rules as other businesses: if they make supplies which are in excess of the VAT registration threshold they must register and account for VAT on any supplies made in the course of business. The question what supplies are treated as business supplies and what rate of VAT is chargeable on any particular supply can be complex and we can only give a broad outline here.
Among the more common receipts are:
- Donations and grants – normally outside the scope of VAT: but if a grant is conditional on the charity supplying services (even if to “clients” rather than to the grant-awarding body) VAT may be due
- Advertising – normally VAT is due but there are exceptions
- Fees from “affinity” credit cards – in principle subject to VAT; but depending on the exact arrangement it is often possible to treat some of the fee as a VAT-free donation
- Other sponsorship – if the sponsor receives anything in return for the sponsorship – e.g. display of the sponsor’s logo – this is likely to be treated as a business supply and subject to VAT
- Sales in charity shops – sale of donated goods is usually zero-rated: other sales are taxable at the usual rates.
- Other regular trading (including “primary purpose” and “beneficiary” trading) – this will almost always amount to the carrying on of a business and VAT will be due at the rate which is applicable to the particular supplies in question.
VAT and fundraising events
Where a charity (or a company owned by a charity) runs an event which is organised and promoted as a “fundraising event” the income is exempt from VAT. As a rule of thumb, for the exemption to apply, you are not allowed to hold more than 15 events of the same kind at the same location in any one financial year. A single event can extend over two or more days and still be counted as a single event: but an “event” which involves several successive performances (such as a play) counts as separate events. But fundraising events which gross less than £1,000 a week don’t count towards the total – so, for example, running a charity quiz night every week raising £500 each time would remain exempt.
The exemption applies to funds raised at the event – things like admission charges, sponsorship, brochures and commemorative items sold at the event; but does not apply to income arising subsequent to the event (audio or video recordings, for example).
“Charity challenge” events present their own difficulties and there are a number of ways of dealing with them. The danger is that if a “registration fee” is charged or a minimum level of sponsorship must be raised as a condition of taking part in the event, VAT may be chargeable on these amounts. This is thus an area in which great care must be taken to ensure that there is no needless loss of VAT.
VAT on purchases
Finally, it should be noted that there are many areas in which special reduced or zero rates of VAT apply to goods or services which are bought in by charities. These reliefs sometimes apply only to supplies made to a charity of a specified kind but in some cases also extend to companies owned by charities. The list may include, according to the exact circumstances:
- Aids for the disabled
- Equipment for talking books and newspapers
- Construction work
- Installation of energy-saving materials and equipment
- Fuel and power
- Medical, veterinary, scientific and rescue equipment
- Medicinal products, drugs and chemicals
In summary, the application to charities of VAT is one of the most complex areas of VAT: most charities except the smallest and simplest are likely to find a review of their VAT position worthwhile.