Where a charity's income and gains are not applied solely to charitable purposes, its exemption from tax may be restricted.
This restriction of tax relief may apply where:
2.1 Charitable expenditure is that which the charity has incurred for charitable purposes only. It will include such items as charitable grants and expenditure incurred on the administration of the charity. It is important to remember that charitable expenditure does not include investments that the charity has made or loans which are accepted as charitable loans or investments for the purposes of Schedule 20, For detailed guidance about charity loans and investments see Annex III. This is because the making of an investment is not generally regarded as expenditure. However, if the charity makes a non-charitable (non-qualifying) loan or investment this is treated for tax purposes as non-charitable expenditure.
2.2 Non-charitable expenditure can be described as:
2.3 Charities may make trading losses. If the losses arise from primary purpose trading they will be regarded as charitable expenditure. If the losses arise form non-primary purpose trading (or deemed non-primary purpose trading for chargeable periods beginning on or after 22 March 2006) they will be non-charitable expenditure. For detailed guidance about charity trading losses see Annex IV.
'Relievable income and gains' means the amount of income and gains that are eligible for tax relief or exemption. It includes Gift Aid donations; income such as rental income; interest received; profits from a charity's primary purpose trading activity; and capital gains. It doesn't include income which does not qualify for tax exemption, such as the profits of non-charitable (non-primary purpose) trading or amounts taxable under anti-avoidance provisions.
Nor does it include legacies and other donations that are outside the scope of tax altogether, e.g. amounts received from payroll giving, donations made outside the Gift Aid regime, etc.
4.1 For chargeable periods commencing on or after 22 March 2006 all charities that incur (or are treated as incurring) non-charitable expenditure will lose tax exemption on an equivalent amount of their relievable income and gains. Charities can no longer set their charitable expenditure against relievable income and gains before their non-charitable expenditure.
4.2 For chargeable periods commencing before 22 March 2006 the rules were different; for guidance about the situation prior to 22 March 2006 see paragraph 10.
| Income and expenditure | Amounts (£) |
|---|---|
| Relievable income | 31,000 |
| Less: non charitable expenditure | 7,000 |
| Income on which relief is allowed | 24,000 |
Tax relief is disallowed in respect of £7,000 of relievable income.
4.3 Where a charity has the tax exemptions on part of its relievable income and gains restricted it can choose which sources of relievable income and gains the restriction is applied to. The charity must notify HMRC Charities of its preference within 30 days of being notified of the restriction. If the charity does not specify a source then HMRC will do so for the charity.
4.4 If a charity has incurred non-charitable expenditure HMRC Charities will expect it to complete a Self Assessment / Corporation Tax Return for the chargeable period concerned and account for any resulting tax liability. If the return shows the relievable income and gains being allocated against particular sources of income HMRC will accept this as notice being given as in paragraph 3.3.
The chargeable period for a charitable trust is the tax year ending 5 April. For a charity treated as a company for tax purposes, the chargeable period is its accounting period.
6.1 The amount of non-charitable expenditure incurred by a charity in a chargeable period may be greater than the relievable income and gains in that period. Where this is the case the excess non-charitable expenditure is set against the total income and gains of the charity i.e. the sum of the charity's relievable income and gains plus all other sources of income or gains, whether chargeable to tax or not (e.g. non-taxable grants and other gifts and legacies received etc.)
If there is still an excess of non-charitable expenditure that excess is carried back to the previous chargeable period, where it is treated as non-charitable expenditure of that period, and so on until either:
6.2 Where excess non-charitable expenditure is carried back to earlier chargeable periods, an assessment may be made to disallow the appropriate amount of tax relief and adjust the tax liability of that earlier period.
6.3 A restriction created under the new rules, after 22 March 2006, may only be carried back to previous years in which the old rules applied to the extent that a restriction would have also arisen under the old rules.
| Income and expenditure | Amounts (£) |
|---|---|
| relievable income | £30,400 |
| less: non-charitable expenditure | £35,000 |
| Income on which relief allowed | £0 |
| Income and Expenditure | Amounts (£) |
|---|---|
| total income and gains | £32,000 |
| less: non-charitable expenditure | £35,000 |
| Excess non-charitable expenditure | £3,000 |
6.4 The excess non-charitable expenditure of £3,000 is carried back first to the previous chargeable period and the charity exemptions restricted in that period. If there continues to be an amount of unapplied excess the balance is carried back to the period before that, and so on.
7.1 If expenditure is clearly of a charitable nature, but it is not specifically authorised by the terms of the governing document of the charity, it will not necessarily be treated as non-charitable expenditure. HMRC may seek the views of the relevant charity regulator in considering the tax treatment of such expenditure.
7.2 If a charity's governing document specifically prohibits or restricts certain expenditure, it will be treated as non-charitable expenditure.
Where a charity accumulates income, or builds up reserves, we need to decide if this is within the meaning of the phrase "applied to charitable purposes only". HMRC Charities will challenge accumulations of income on the grounds that the income has not been applied to charitable purposes: if income is not invested at all but kept in cash or in a current account; or if it becomes apparent that investment decisions are not made exclusively for the benefit of the charity, e.g. where accumulated income is being invested in a project in which there is a potential conflict between the interest of the charitable trust and the interest of the trustee or provider of the trust funds.
9.1 When a payment is made or is to be made to a body outside the UK, this will only be considered charitable expenditure if
'Applied for charitable purposes' means applied for purposes, which are regarded as charitable within Section 2 of the Charities Act (England and Wales) 2006. The same definition of charitable purpose applies for all charities claiming UK tax reliefs and exemptions, wherever the charity is located, whether in the UK or other member states of the EU, Iceland or Norway.
It is not sufficient for the charity to establish that the overseas entity is a charity under the domestic law of the host country.
The rest of this chapter deals with the situation where the charity makes a payment for which it must take steps to ensure that the payment is applied for charitable purposes.
9.2 The charity trustees must be able to describe the steps they take, explain how those steps ensure charitable application of funds, demonstrate that those steps were reasonable and produce evidence that the steps were, in fact, taken.
9.3 When considering whether the steps taken by the charity were 'reasonable in the circumstances', HMRC will have regard to:
9.4 When reviewing payments made to overseas bodies HMRC will generally ask the charity trustees to provide information about:
The Commissioners for HMRC must be satisfied that the steps taken by the trustees are reasonable in the circumstances. If HMRC Charities is not provided with sufficient evidence of the steps taken it may not be able to accept the expenditure as charitable expenditure. This may give rise to a liability to tax. The steps to be taken will depend upon the nature of the expenditure. The rest of this section explains what sorts of steps would be reasonable depending on the circumstances of both the donating charity and receiving bodies.
9.5 Trustees are expected to make adequate enquiries to find out such information as is reasonably available about the overseas body, and establish what evidence will be provided or made available by that body to show that the payment(s) will or have been applied for charitable purposes. The nature of the steps will depend upon the scale of operations and the size of the sums involved.
9.6 In the case of small one-off payments, an exchange of correspondence between the charity and the overseas body will normally be sufficient. Where possible, the correspondence should be on headed paper and it should:
A situation where a thank you note on headed notepaper will be sufficient evidence
A pastor from a church outside the UK visits a partner parish in the UK. On his return home he discovers that the church building in his home town has burned down. When writing to the UK church to thank them for his visit he mentions this and the UK church decide to donate £500 to help rebuild the church. The overseas church sends a thank you note and a picture of the new building when it is complete.
This is a situation where the local pastor is known to the UK charity, the amount is a small, one-off payment and there are likely to be good connections between the charity and the overseas church. In this case a thank you note on headed paper is sufficient.
The relatively small amount of the donation affects the level of evidence required. In a situation like this HMRC would accept that the trustees' personal knowledge of the pastor and his connection with the overseas church is sufficient evidence.
Where there was no personal connection with the pastor more evidence would be needed, for example press reports confirming that the building had, in fact burnt down, and was, in fact, a church and had been rebuilt.
9.7 More thorough work by the trustees will be required where the sums involved are larger or where a transfer of funds is to form part of an ongoing commitment. This might include independent verification of the overseas body's status and activities along with reporting and verification of the manner of application of resources provided. The steps required can be reviewed in the light of evidence of proper use of funds and resources from earlier involvement with a particular project.
A situation where further evidence of action taken, is required.
A UK charity becomes aware of a small overseas hospital that is struggling to afford drugs to treat a local epidemic. They agree to provide funding for six months supplies at the cost of £10,000 and enter into an arrangement with a pharmaceutical company close to the hospital. The company supplies the necessary drugs and invoices the UK charity.
In this situation the invoices from the drugs company are not sufficient on their own. The trustees must be able to produce sound evidence to show what they did to verify that the hospital warranted funding. This might include evidence of governance arrangements, financial controls and alternative available funding. In addition as things progress the trustees should check that the correct drugs are actually being delivered to the hospital in the amounts invoiced. A letter from the hospital confirming that they have received what the charity purchased would be acceptable evidence.
The larger level of the donation, a lack of detailed knowledge of the recipient charity and the existence of a third party means that more evidence is required than for Example 1 at paragraph 9.6. In a situation like this the evidence to verify the suitability of the expenditure is likely to include:
9.8 The steps taken are to 'ensure' that the payment to the overseas body will be applied for charitable purposes. If the recipient body is not bound by its own domestic law to apply all of its income for charitable purposes, then the trustees of the paying charity should consider seeking a legally binding and enforceable agreement to ensure that their payment will be applied charitably. If the overseas body declines to enter into such an agreement, the trustees of the paying body may have difficulty ensuring that the payment is applied for charitable purposes. If an agreement is entered into the trustees will need to have a means of establishing whether the agreement has been complied with.
9.9 Where a charity makes a series of payments to the same overseas body for the same charitable purpose, it is not necessary for fresh enquiries to be made in respect of each new payment. If the trustees have recently checked the overseas body is applying its charitable funding properly, for example within the last year, and they are satisfied that the overseas body has an ongoing need for funding and is bound to apply payments from the charity for charitable purposes, then it is not unreasonable for the trustees to rely on the results of this review for a payment shortly afterwards.
9.10 However, reliance on the overseas body's integrity may diminish with the passing of time and the trustees should be able to demonstrate that they are making enquiries of a sufficiently searching nature at regular intervals to ensure that the funds are being properly applied for charitable purposes.
A situation where more positive action is needed.
A charity is approached by an overseas body to provide support for a school building project. This is scheduled to take 18 months to complete. The proposed project is evaluated by the trustees who consider this to be within their charitable objects. They agree to provide staged funding totalling £250,000.
In this case the trustees must be able to produce evidence to demonstrate the research carried out in advance of any funds being made available and detailed records of how the grants were actually spent.
In a situation that involves large sums of money and a long term commitment, which could involve several overseas contractors, HMRC would expect to see comprehensive evidence of the trustees' considerations. This might include:
In addition HMRC would expect the funding to be dependent on the overseas body entering into a formal agreement with the charity providing for:
The trustees should also be able to produce evidence of ongoing evaluation as the project advanced including recommendations in relation to further funding.
A charity wishes to endow an overseas body with £1,000,000 to be used for charitable purposes at the body's own discretion. The charity will need to either:
If the charity is seeking binding assurances it will need to:
If the charity is relying on the manner of establishment of the overseas body and local regulation it will need to:
10.1 For accounting periods beginning before 22 March 2006, the rules for restriction of tax exemption are different. This section gives an overview of the rules for those periods. Where the "relevant income and gains" of a charity are not applied wholly to charitable purposes, the exemptions available may have to be restricted.
10.2 Exemption is restricted when a charity incurs or is treated as incurring non-qualifying expenditure i.e. expenditure not applied wholly to charitable purposes during a chargeable period. Non-qualifying” expenditure is exactly the same as what we now call non-charitable expenditure.
10.3 The definition of 'relevant' income and gains is different from the definition of 'relievable' income and gains. It means:
| relevant income and gains | Amounts (£) |
|---|---|
| Bank Interest | 100,000 |
| Profit | 52,000 |
| Relevant Income | 152,000 |
| Less Charitable expenditure | 80,000 |
| Excess relevant income | 72,000 |
10.4 If the relevant income and gains of a charity in the chargeable period under review are less than £10,000 then the relevant income and gains of the charity cannot be restricted. However, if HMRC Charities considers that two or more charities are acting together to avoid tax, it can give notice that the £10,000 limit is not to be applied.
10.5 Charities are allowed to set qualifying expenditure against relievable income and gains before setting non-qualifying expenditure against it.
10.6 If a charity incurs non-qualifying expenditure before 22 March 2006, then once the charity's relevant income and gains and qualifying expenditure has been ascertained, relief may be restricted. The following examples illustrate how 'old' Section 505(3) operates to restrict relief for accounting periods beginning before 22 March 2006, and the method of carrying back surplus non-qualifying expenditure prior to 22 March 2006.
| Income and expenditure | Amounts (£) |
|---|---|
| relevant income | 15,000 |
| less: qualifying expenditure | 6,000 |
| excess relevant income | 9,000 |
| Income and expenditure | Amounts (£) |
|---|---|
| relevant income | 26,000 |
| less: qualifying expenditure | 15,000 |
| excess relevant income | 11,000 |
| Income and expenditure | Amounts (£) |
|---|---|
| relevant income | 30,400 |
| less: qualifying expenditure | 10,000 |
| excess relevant income | 20,400 |
11.1.1 Where a charity engages in certain transactions with a person who is a substantial donor, which can lead to extraction of value (in cash or in kind) from the charity, those transactions may be treated as non-charitable expenditure, resulting in a restriction of the charity's tax exemption.
11.1.2 This is as a result of anti-avoidance legislation which is designed to restrict a charity's tax exemption where particular transactions result in all or part of a donation being effectively returned to the donor in cash or in kind. These provisions are not intended to hamper legitimate activities of charities or donors, so there are exceptions to make sure the measures do not catch certain arm's length transactions. Most (but not all) transactions that a charity will enter into for charitable purposes and on arm's length terms are excepted from the new rules.
11.1.3 The legislation applies to transactions occurring on or after 22 March 2006, but does not affect transactions entered into as part of a contractual arrangement put in place before that date, unless the contract is varied on or after that date in such a way as to bring it within the scope of these measures. It is only upon entering into a transaction (that is not otherwise excepted), that a potential tax liability may arise.
11.2.1 A person (individual or company) is a substantial donor to a charity in respect of a chargeable period of the charity when:
11.2.2 Once a person is a substantial donor to a charity in respect of a particular chargeable period he is also treated as a substantial donor in respect of the next five chargeable periods.
11.2.3 The disposal of an asset at undervalue to a charity can be taken into account in determining whether a person is a substantial donor (although where such a disposal attracts tax relief it will not be a 'caught' transaction).
For detailed guidance about tax relief for gifts of property to charity see Chapter 5
11.2.4 The definition of “substantial donor” also includes persons connected with the donor as defined by section 839 of ICTA 1988, e.g. the donor's spouse or relative, the spouse of a relative of the donor, or a relative of the donor's spouse (all references to 'spouse' being read as including civil partners). In certain circumstances a company can also be a person connected with an individual or another company.
11.2.5 A person is not a substantial donor to a charity if:
11.2.6 A company which is a wholly-owned subsidiary of one or more charities shall not be treated as a substantial donor in relation to the charity which owns it (or any of the charities which own it). This allows wholly owned trading subsidiaries of charities to Gift Aid their profits to their parent charity without risk of a charge under the substantial donor legislation.
11.2.7 If for any reason a donation does not qualify for tax relief (for example if a donor receives benefits in excess of the statutory 'Gift Aid' benefit limits in consequence of his donation), his donation will not be a 'relievable gift' thus the donor will not be a substantial donor by virtue of that gift alone.
11.2.8 A relievable gift is a donation of cash or property (including non-monetary gifts) to a charity, which qualifies for specified tax reliefs. It includes gifts of:
11.2.9 It does not include gifts where the only relief is from inheritance tax, for instance a donation made in a will.
11.2.10 Relatively few donors will fall within the definition of substantial donor; and many charities will have no substantial donors. All charities will, however, need to keep records of any of their donors who fall (or may fall) within the definition. Most charities will probably already keep records of these donors for the purposes of maintaining an ongoing relationship with them. These records should enable the charity to cross reference any of the specified transactions with those donors or persons connected with them. This is not expected to be an onerous task for most charities that are acting within their charitable objects, as the majority are unlikely to be entering into transactions that are not otherwise excepted by the legislation. Charities that never enter into the types of defined transaction which return value (cash or benefits) to their substantial donors will not be exposed to any tax liability as a result of this legislation.
11.3.1 The chargeable period for a charitable trust is the tax year ended 5 April. For a charity treated as a company for tax purposes, the chargeable period is its accounting period.
11.3.2 The legislation applies to transactions between a person and a charity, made on or after 22 March 2006, which take place in a chargeable period of the charity in respect of which the person is a substantial donor.
11.3.3 A transaction can be caught if it is made at any time in the chargeable period, even if it was not until after the transaction was entered into that the person first satisfied the definition of substantial donor in respect of that period.
11.3.4 To decide which chargeable periods may be affected by the legislation, a charity must identify relievable gifts of at least £25,000 from a donor in a period of twelve months or at least £100,000 in a period of six years.
11.3.5 Note that a donation of £25,000 or more made on a particular date falls both within a period of twelve months ending on that date and also within a different period of twelve months starting on that date. Similarly when a single donation of £100,000 or more is received, a charity must consider the six year periods both ending and beginning with the date of the donation.
11.3.6 If a charity receives two or more relievable gifts from a donor which total £100,000 or more in a six year period, it is necessary to identify the different six year periods in which the gifts are received. This means looking forward six years from the date of the first relevant gift and looking back six years from the date of the last relevant gift. The charity must then identify each of its chargeable periods which fall wholly or partly within each such six year period. If a donor makes regular donations it is possible for each relievable gift to form part of more than one total of £100,000, and so to fall within more than one six year period.
11.3.7 Once a person is a substantial donor to a charity in respect of a chargeable period he is also treated as a substantial donor in respect of the next five chargeable periods.
11.4.1 The transactions covered by this measure are:
11.4.2 “Financial assistance” includes:
11.5.1 If two or more charities are connected in any way relating to their structure, administration or control, they will be treated as a single charity for the purposes of this legislation. This is to prevent circumvention of the legislation, by e.g. fragmenting the activity of a single charity into two or more charities.
11.5.2 It ensures that where a donor makes donations to two or more charities that are connected, the charities are treated as a single charity and the relievable gifts made by a donor to those charities are aggregated for the purposes of this legislation. It also ensures that the legislation applies where a person makes substantial donations to one charity, but enters into specified transactions to extract value from a connected charity.
11.5.3 Transactions between a charity and a person connected with a substantial donor will also be caught. This includes transactions with the donor's spouse or civil partner, a relative, or the spouse or civil partner of a relative of the donor or the donor's spouse or civil partner.
11.6.1 Charities can claim exemption from tax on most sources of income, subject to the income being applied solely to charitable purposes. Where a charity incurs non-charitable expenditure, its exemption from tax is restricted. For detailed guidance about non-charitable expenditure see paragraph 2
11.6.2 Where a charity's transactions with substantial donors (including persons connected with substantial donors) are caught by the legislation, the charity is treated as incurring non-charitable expenditure. This applies in the following circumstances:
11.7.1 It is important to note that there is no exception for the provision of financial assistance to a substantial donor. The provision of financial assistance includes the making of a charitable grant. The amount of any grant paid is treated as non-charitable expenditure if made to a recipient who is (or later becomes) a substantial donor of the charity, or a person connected with a substantial donor. It is expected that such occasions will be very rare, but charities need to be aware of the possibility of liability in these circumstances.
11.7.2 The provision of financial assistance to a substantial donor (or person connected with a substantial donor) includes the payment of the principal amount of a loan granted by a charity to a donor, even if the loan is made on arm's length terms and even if the loan is later repaid in full. If a loan is made to a substantial donor (or person connected with a substantial donor) on less than arm's length terms, for example an interest free loan, the cost to the charity of the non-arm's length terms is also treated as an additional amount of non-charitable expenditure of each chargeable period for which the loan is outstanding.
11.8.1 It is possible for a single transaction to be 'caught' under the rules for both payments to substantial donors and the rules for transactions that are less beneficial to the charity than arm's length transactions. Where this happens there is provision to ensure that there is no 'double taxation' of the charity.
11.8.2 The legislation also applies to 'non-cash' transactions, such as a transfer of property to a substantial donor. The cash equivalent of the deemed value will be treated as non-charitable expenditure and tax relief will be restricted on that amount.
11.9.1 The legislation shall not apply, and there will be no amount treated as non-charitable expenditure by reference to a transaction between a charity and a substantial donor, if HMRC determines that a statutory exception applies to the transaction.
11.9.2 The exceptions applying to each type of 'caught' transaction are summarised in this table:
| Transaction | Exception |
|---|---|
| Sale or letting of property by a charity to a substantial donor | No exception. |
| Sale or letting of property to a charity by a substantial donor | Transaction excepted if it takes place in the course of a business carried on by the substantial donor, on terms which are no less beneficial to the charity than an arm's length transaction, and is not part of an arrangement to avoid tax. |
| The provision of services by a charity to a substantial donor | Transaction excepted if the services are provided in the course of the actual carrying out of a primary purpose of the charity, on terms which are no more beneficial to the donor than those on which services are provided to others. |
| The provision of services to a charity by a substantial donor | Transaction excepted if it takes place in the course of a business carried on by the substantial donor, on terms which are no less beneficial to the charity than an arm's length transaction, and is not part of an arrangement to avoid tax. |
| An exchange of property between a charity and a substantial donor | No exception (however a disposal at an undervalue to a charity, to which S587B ICTA 1988 or S257 TCGA 1992 applies, shall not be a transaction to which this legislation applies). |
| The provision of financial assistance by a charity to a substantial donor | No exception. |
| The provision of financial assistance to a charity by a substantial donor | Transaction excepted if the assistance is on terms which are no less beneficial to the charity than might be expected from an arm's length transaction, and the assistance is not part of an arrangement to avoid any tax. |
| Investment by a charity in the business of a substantial donor | Transaction excepted if the investment takes the form of a purchase of shares or securities listed on a recognised stock exchange |
| Payment of remuneration by a charity to a substantial donor (including the cash equivalent of remuneration paid otherwise than in cash, such as benefits in kind) | Remuneration for services as a trustee will be excepted only where it is approved by the Charity Commission or another regulatory body or by a Court. |
Payments by a charity or benefits arising to a substantial donor from a transaction are disregarded if they relate to a donation by the donor and do not exceed the relevant 'Gift Aid' benefit limits in S25FA90 / S339 ICT88. For detailed guidance about donor benefits see chapter 3 section D
It is important to note that there is no exception for remuneration paid to a substantial donor or any person connected with a substantial donor, other than the exception for approved trustee's remuneration. Payments of remuneration to a substantial donor etc. are caught even if the remuneration is on “arm's length” terms, whereas payments to a self employed substantial donor, which take place in the course of the donor's business, may be excepted if they are on 'arm's length' terms.
11.10.1 Sometimes individuals or companies make donations to charities that they do business with in the normal course of events. As long as the arrangement between the charity and the donor is on the same terms as would be expected if the business was transacted by a person not connected in any way to the charity (a transaction at arm's length), the transactions will be excepted.
11.11.1 Charity trustees need to think carefully about entering into transactions with substantial donors, in order to ensure that the transactions do not have any unacceptable fiscal consequences (especially as many such transactions will not be for the benefit of the charity).
11.11.2 In the case of a person who is nearly, but not quite, a substantial donor in relation to a charity, a relatively small further donation might turn him into a substantial donor. The effect of that might be to expose a number of transactions between that person and the charity, perhaps going back over several years, to analysis which may result in a tax liability on the charity.
11.11.3 Where a charity chooses to enter into such transactions with its donors, the trustees may decide to refuse a donation if it would not be in the charity's interests to accept it i.e. because it would result in a significant tax liability.
11.12.1 HMRC will normally only determine that a transaction or transactions fall within these rules, and the amount of any resulting tax liability, in the course of an enquiry into a Self Assessment tax return. If a charity enters into transactions with a substantial donor, to which none of the statutory exceptions apply, it is expected to complete a tax return showing that it has incurred non-charitable expenditure, and to account for the tax due. If a charity has not received a tax return from HMRC it nonetheless has an obligation to self assess any tax liability so should notify HMRC and request a tax return.
11.12.2 HMRC Charities will not generally clear transactions in advance or consider hypothetical situations. Charities should therefore take care that all transactions they enter into with substantial donors fall within the letter and the spirit of this guidance.
11.12.3 Our publication Clearances and Approvals 1 explains the different ways that HMRC will give information or advice.
