Charity Tax Update

Overview

Charity matters have been in the news lately as a result of both:

the conclusion of consultations begun under the previous Government: the submission (13 October 2010) to the Economic Secretary to the Treasury of the report from the Gift Aid Forum and her response (dated 3 December 2010) report and response available to view at www.hm-treasury.gov.uk/8519.htm ; the publication (see www.hm-reasury.gov.uk/d/tainted_charity_donations.pdf ) of draft legislation (to be enacted in Finance Act 2011) reforming the much criticised substantial donor rules to: target the legislation such that it only bites where there is a tax avoidance purpose (the current rules being too widely drafted such that innocent transactions can be caught); and adjust the balance such that where the rules are breached the penalty will mostly fall on the donor rather than (as is currently the case) on the charity. David Cameron's emphasis on the Big Society and the role the third sector and the development of a culture of philanthropy will play in this strategy (for a recent speech by the Culture Secretary Jeremy Hunt on boosting philanthropy see www.culture.gov.uk/news/ministers_speeches/7633.aspx ). The Office of Tax Simplification work on tax reliefs which will consider a number of charitable reliefs. It should also be noted that charities are still coming to terms with the legislation passed in Finance Act 2010 which (without prior consultation or proper Parliamentary scrutiny) saw the introduction of a new definition of charity for tax purposes. To be eligible for charity tax reliefs, an entity must:

be established for charitable purposes only; meet the jurisdiction condition - UK and EU charities and any other territory specified in regulations made by the Commissioners for HMRC (we know that it is intended that Iceland and Norway will be specified territories); meet the registration condition; and meet the management condition - the managers are fit and proper persons to be managers of the body or trust, with HMRC given discretion to deem that the condition has been met should it consider that (i) any failure has not been prejudicial to the charitable purposes of the body or trust, or that (ii) it is just and reasonable in all the circumstances for the condition to be treated as having been met throughout the period. The management condition is highly controversial given the discretionary power it gives HMRC, and the fact that the regulation of charities should (for England and Wales) be within the remit of the Charity Commission. HMRC has issued guidance on the 'fit and proper person' test. There is a basic guide for charity managers available at www.hmrc.gov.uk/charities/guidance-notes/chapter2/model-dec-ff-persons.pdf and more detailed guidance available at www.hmrc.gov.uk/charities/guidance-notes/chapter2/fp-persons-test.htm .

Replacement of the anti-avoidance legislation which can apply where there are substantial donations to charities – Finance Bill 2011 draft legislation

Introduction

Generally substantial donations to charities are a good thing and encouraged by the tax system. However, in 2006 the Government was concerned that improper advantage was being taken of the charity tax relief provisions. As such the onerous Substantial Donors Rules were introduced. Applying to transactions occurring on or after 22 March 2006 the rules were supposed to target charities controlled by a donor where:

the charity was used as a personal money box; and the actions of the charity and the donor are in effect the same. The actual legislation enacted, however, is far wider than this and has been described as 'ill thought through' and 'overly complicated' and can catch wholly innocent transactions. Where triggered, the Substantial Donor Rules impact on the tax position of the charity (restricting the usual reliefs from income tax and capital gains tax). Given self-assessment this means that bona fide charities cannot safely ignore the Substantial Donor Rules and the legislation has, therefore, increased the administrative burden on charities. Concern over the rules also has the potential to deter bona fide large donations to charity.

Overview of the Substantial Donor Rules

The Substantial Donor Rules work by classifying certain transactions between a charity and a donor as substantial donor transactions and penalising the charity where there are such transactions. The provisions are complex but, broadly any benefit received by the donor from the transaction will result in a restriction of the charity's income and gains eligible for tax relief by £1 for every £1 of benefit received by the substantial donor where:

there is a relevant transaction (defined on page 3); the benefit deemed to arise to the substantial donor does not fall within the de minimis conditions such that it can be ignored; and HMRC cannot be satisfied that the 'commercial reasons' defence applies (such that the transaction is classified as an exception). For there to be a substantial donor transaction there must be a substantial donor and a relevant transaction. An individual, a trust or a company is a substantial donor in connection with a specific charity if their donations to the charity meet specified conditions or if the donation of anyone connected with them meets either of the specified conditions.

The specified conditions are relievable gifts to a charity of (i) £25,000 or more in any twelve-month period, or (ii) £150,000 (prior to 23 April 2009 the figure was £100,000) or more over a six-year period. The donor will be a substantial donor for the chargeable period in which these limits are exceeded and the following five chargeable periods. Note that in the first year the donor is caught, one has to consider transactions between the donor and the charity at any point in the tax year and not just from the time that the donor came within the substantial donor definition.

There are eight categories of relevant transaction:

The sale or letting of property (not confined to land) by a charity to a substantial donor; The sale or letting of property (not confined to land) to a charity by a substantial donor. The provision of services by a charity to a substantial donor; The provision of services to a charity by a substantial donor (remuneration paid to a substantial donor is treated as non-charitable expenditure unless it is remuneration for services as a trustee which is approved by either the appropriate statutory UK charity regulatory bodies or a court). The exchange of property between a charity and a substantial donor; The provision of financial assistance by a charity to a substantial donor (and for these purposes financial assistance includes the provision of any loan, guarantee or indemnity). The provision of financial assistance to a charity by a substantial donor (and for these purposes financial assistance includes the provision of any loan, guarantee or indemnity). The investment by a charity in the business of a substantial donor (although not if the business is listed on a recognised Stock Exchange). The review

A limited review of these rules was announced in 2008. The majority of responses to the 2008 consultation on these rules were 'critical of the current regime, stating that it is complex, insufficiently targeted, places a significant administrative burden on charities, prevents certain transactions from taking place and does not help foster an environment of giving between charities and their major donors'.

In the light of the highly critical responses received as a result of this consultation exercise it was announced, at Budget 2009, that there would be further informal consultation with charities based around amending the current legislation so as to introduce in Finance Bill 2010 an effective anti-avoidance purpose test. However, although a number of announcements were made at Budget 2010 relating to charity taxation, nothing substantive was said in respect of these changes, the HMRC website stating:

Informal...