In the first of the articles in this series, Victoria Robinson looked at how to set up a charity and the types of charitable structures that are possible in the United Kingdom (UK). In what follows, Partner Rosamond McDowell steps back to look at one of the main drivers for setting up a charity, namely how they are taxed. Absent the tax reliefs and exemptions afforded to charities, philanthropists may prefer to engage in their activities without contending with administrative burden and the applicable regulatory regime and oversight of the Charity Commission, to be considered by James Bacon in the third article in this series.
To put these charitable tax benefits into context, HMRC have announced that tax reliefs for UK charities and their donors for the tax year ending April 2022 came to £5.4 billion. In addition to this, Gift Aid paid directly to charities at the basic rate of income tax totalled £1.3 billion. The availability of the reliefs is not automatic and charities must apply to HMRC to be recognised as such for UK tax purposes by showing that they meet the relevant criteria.
Tax on gifts to charity
There are various different ways that individuals can give to charity, such that both the individual donor and the recipient charity receive tax advantages:
- Payroll deduction scheme
Employees are able to direct that a part of their salary or pension is paid directly to a charity. Relief is given at their marginal rate of income tax, because the deduction is made before deducting tax under the PAYE scheme.
- Gift aid – income tax
Persons donating money to a charity will qualify for Gift Aid, which gives relief from higher and additional rates of income tax. The donation to the charity is treated as being made net of income tax at the basic rate, which the charity can recover from HMRC, provided the donor’s tax bill covers the tax reclaimed.
Gift aided donations made between the end of the tax year and the date the tax return is submitted can be back-dated for tax purposes, to be treated as paid in the year covered by the tax return. This can be a useful way of reducing the tax liability of donors whose income hovers just into a higher tax bracket.
- Capital gains tax
Gifts of assets to a charity (though not sales at market value) are exempt from capital gains tax. This exemption is extended to certain bodies that are not charitable, but have a public benefit. Similarly to gifts between spouses, the transfer of the asset is treated as being made at ‘no gain-no loss’. The charity is treated as receiving the asset at the base cost for capital gains tax of the donor.
- Inheritance tax – exemption
Transfers of value, which would otherwise be chargeable to inheritance tax at 20% (for lifetime transfers) or 40% (for transfers on death) are exempt if passing to a charity.
Ordinarily, there is no benefit to the donor from the IHT exemption. However, in 2012 new rules were introduced under which a gift to a charity on death can, in certain circumstances, reduce the rate of tax payable on the remainder of the estate not passing to the charity. Provided the charity receives at least 10% of the estate, after deducting all other reliefs and exemptions, and the nil rate band, the rate of tax on the balance of the estate will be 36% instead of 40%.
- Deeds of variation
It is possible for a person inheriting all or part of an estate of a deceased person to vary their entitlement by deed so as to direct all or part of their inheritance to a charity. If done within two years of the death, this re-direction will secure the inheritance tax exemption noted above.
It is possible for the donor to direct a charitable donation under Gift Aid, which makes the gift doubly efficient, saving both income tax and inheritance tax. However, the Gift Aid rules prohibiting a donor from taking a benefit are strict, so it is important that the donor does not benefit from the inheritance tax saving in those circumstances.
Tax reliefs available to charities
Once funds are held by a charity, for use for charitable purposes, various exemptions apply to taxes, which would otherwise be payable:
- Exemption from income tax and corporation tax
Trustees are liable to pay income tax, and companies to pay corporation tax, on all their income. Charitable trusts and companies have long been exempt from these taxes, although since 2010 there have been additional requirements to be met, including a condition that the administrators of the charity pass HMRC’s discretionary ‘fit and proper’ test, which was introduced to prevent abuse of the charitable tax exemptions.
- Exemption from capital gains tax
As with income tax, charities are exempt from capital gains tax on the sale of assets that would otherwise be within the scope of the charge, provided the gains are applied for charitable purposes. Care must be taken, however, not to create a ‘deemed gain’ by a transfer of an asset to a beneficiary, or an offshore charity, or on assets held indirectly through an offshore company, which would not be covered by the exemption.
- Property taxes
Charities are eligible for a mandatory 80% reduction in business rates on premises used for charitable purposes, with a further reduction of up to 20% available at the discretion of the relevant local authority. In addition to this, charities may also be exempt from Stamp Duty Land Tax on the purchase of land or property.
- VAT
A detailed analysis of the Value Added Tax (VAT) rules is beyond the scope of this note. For present purposes, however, it is notable that there is no blanket exemption from VAT afforded to charities, although donations and some charges made by a charity are outside the scope of VAT, and they may pay VAT at a reduced or even zero rate on some goods and services. An important question turns on whether the charity is carrying on a business, to determine whether a charity can recover input VAT, or whether the charity is liable to charging VAT. It is quite common for charities to have subsidiary trading companies to avoid the problems associated with partial exemption. Particular problems often arise for charities in relation to land and buildings, where VAT costs can be punitive.
Charities and the offshore element
Charitable tax exemptions are largely territorial to the UK, but in certain respects, cross-border matters may need to be considered.
- Deemed gains
As noted above, although capital gains made by a UK charity are largely exempt from tax, it is possible for a charity to be caught by anti-avoidance rules that seek to charge UK residents to gains made by offshore companies in which they are interested, and do this by ‘deeming’ the gains to accrue to the ultimate owner. Such deemed gains are not exempted, as they do not fulfil the requirement of being applied for charitable purposes.
- Non-UK charities
Since 2009, UK tax reliefs and exemptions have extended to charities in the European Union (EU) and the European Economic Area (EEA), following a European Court of Judgment case, and equivalent relief was afforded by other Member States on gifts to UK charities. Following the UK’s exit from the EU, the latter were withdrawn immediately. With effect from 15 March 2023, the UK reliefs and exemptions have also now been withdrawn, with a transition period until April 2024 for EU/EEA charities that had already ‘asserted their status’ as a charity with HMRC.
How can we help?
If you are interested in finding out more about the tax benefits available to both charities and their founders in addition to any donors, please do not hesitate to contact the author, Rosamond McDowell, or any other member of the Payne Hicks Beach Private Client Team, who offer a full range of legal services in the charity sector and would be delighted to assist you with navigating the charity tax issues referred to above.
