Tax exemptions

Contents

11. Tax. Statutory exemption from tax for charity's trading profits

The Taxes Acts provide for a limited exemption from tax for the profits of trades carried on by charities. To qualify for exemption the profits must be used solely for the purposes of the charity. In addition the trade must satisfy one of these three conditions:

  • Paragraph 10 (a) and (d) - the trade must be exercised in the course of the actual carrying out of a primary purpose of the charity (a "primary purpose trade") or is ancillary to this primary purpose trade see the guidance at Paragraph 12), or
  • Paragraph 10 (b) and (f) - the work in connection with the trade must be mainly or partly carried out by beneficiaries of the charity see the guidance at Paragraph 16, or
  • The non-primary purpose trading turnover falls below certain limits (see Para 20).

If a trade does not satisfy one of the above conditions, the profits of the trade will not be exempt from tax regardless of whether or not they are used for the purposes of the charity. Some fund-raising events may qualify for concessional relief under an extra statutory concession (ESC). See the guidance at Paragraph 36 et seq.

12. Tax. Primary Purpose Trading

‘Primary purpose trading’ is exercised in the course of the carrying out of the primary purposes or charitable objects of the charity. The profits are exempt from tax, as long as they are used for the purposes of the charity. A charity’s purposes or objects can be identified from the charity's trust deed, constitution or other governing document.

Some trading undertaken by charities may, in itself, amount to a primary purpose activity and therefore qualify for exemption. Examples of such trading include:

  • the provision of educational services by a school or college in return for course fees
  • the holding of an exhibition by an art gallery or museum in return for admission fees
  • the sale of tickets for a theatrical production staged by a theatre
  • the provision of health-care services by a hospital in return for payment
  • the provision of serviced residential accommodation by a residential care home in return for payment
  • the sale of certain educational goods by an art gallery or museum.

In each of these examples the organisation carrying on the activity is a charity and it is part of the organisation's charitable objects to undertake the activity described.

Charities should be aware that in the unusual situation in which trading takes place which is of a charitable nature but which falls outside the charity’s objects or “primary purpose”, a liability to tax can arise.

13. Tax. Trading which is ancillary to the carrying out of a primary purpose

The exemption from tax can also extend to other trading, which is not overtly primary purpose in nature but which is ancillary to the carrying out of a primary purpose. This trading can still be said to be exercised in the course of the carrying out of a primary purpose. It is therefore part of the primary purpose trade. Any impression that it is a separate category is incorrect.

Examples of trading which qualifies as primary purpose because it is ancillary to the carrying out of a primary purpose are:

  • the sale of relevant goods or provision of services, for the benefit of students by a school or college (text books, for example)
  • the provision of a crèche for the children of students by a school or college in return for payment
  • the sale of food and drink in a cafeteria to visitors to exhibits by an art gallery or museum
  • the sale of food and drink in a restaurant or bar to members of the audience by a theatre
    the sale of confectionery, toiletries and flowers to patients and their visitors by a hospital.

14. Tax. Trading which is not wholly primary purpose

As mentioned earlier, charities will usually only have one trade. For some charities the trade may be partly primary purpose and partly non-primary purpose. For example, the trade might deal in a range of goods or services only some of which are within, or ancillary to, a primary purpose. Or the trade might deal with some customers who cannot properly be regarded as beneficiaries of the charity. Examples of such trading include:

  • a shop in an art gallery or museum which sells a range of goods, some of which are related to a primary purpose of the charity (i.e. education and the preservation of property for the public benefit e.g. direct reproductions of exhibits and catalogues), and some of which are not (e.g. promotional pens, mugs, tea towels, stamps, etc)
  • the letting of serviced accommodation for students in term-time (primary purpose), and for tourists out of term (non primary purpose), by a school or college
  • the sale of food and drink in a theatre restaurant or bar both to members of the audience (beneficiaries of the charity) and the general public (non-beneficiaries).

In these circumstances, S505 (1B) ICTA 1988, (introduced by S56 FA 2006), deems the primary purpose and non-primary purpose parts of the trade to be two separate trades. The primary purpose deemed trade is exempt, as long as its profits are used for charitable purposes. The non-primary purpose deemed trade is taxable, although the exemption for small trading can apply to this trade see the guidance at paragraph 19. Any receipts or expenses relating to the overall trade should be apportioned to the separate trades on a reasonable basis.

This applies for chargeable periods (that is tax years for charitable trusts and accounting periods for other charities) beginning on or after 22nd March 2006. Charities will find it extremely helpful if their accounting systems are set up to permit the identification of primary purpose and non-primary purpose trading, and the proper allocation of costs to each.

15. Tax. Chargeable periods beginning on or before 21st March 2006, where all the trade does not qualify as primary purpose

For chargeable periods beginning on or before 21st March 2006, where the whole trade might not qualify as a primary purpose trade because part of the trade is not related to a primary purpose, HMRC will, in practice, accept that all of the profits of the trade will be within the exemption from tax if:

  • that part of the trade which is not within a primary purpose is not large in absolute terms, and
  • the turnover of that part of the trade is less than 10% of the turnover of the whole trade.

A turnover (for the part of the trade which is not primary purpose) of £50,000 per annum or less would be considered ’not large' for the purposes of the first part of this test. So, a mixed trade with a non-primary purpose turnover of less than £50,000 per annum and representing less than 10% of the total trade turnover would satisfy this test.

Where the profits of a trade cannot be exempted because part of the trade is not related to a primary purpose and:

  • its turnover represents 10% or more of the turnover of the whole trade; or
  • the non primary purpose turnover is greater than £50,000 per annum

the whole of the profits may be liable to tax, including that part which is related to a primary purpose.

The following examples illustrate this:

Example 1:

Charity A carries on a trade with an annual turnover of £60,000. Of this, £55,000 is primary purpose and £5,000 is not. Because the non-primary purpose turnover is less than 10% of the total and less than £50,000, the whole trade is treated as primary purpose.

Example 2:

Charity B carries on a trade with an annual turnover of £100,000. Of this, £85,000 is primary purpose and £15,000 is not. Because the non-primary purpose turnover exceeds 10% of the total, the whole trade is treated as non-primary purpose.

16. Tax. Trading where the work is carried out by beneficiaries of the charity

Charities can claim exemption from tax on the profits of a trade where the work in connection with the trade is mainly carried out by beneficiaries of the charity, referred to for convenience as a ‘beneficiary trade’. Where work carried out by the beneficiaries has a therapeutic, remedial or educational value, the profits from the trade may qualify for exemption from tax, as long as they are used for the purposes of the charity. Where the work is mainly carried out by beneficiaries, the trade itself need not be a primary purpose trade.

Examples of trades carried on by charities where the work is mainly carried out by beneficiaries are:

  • a farm operated by students of an agricultural college
  • a restaurant operated by students as part of a catering course at a further education college
  • the sale of goods manufactured by disabled people who are beneficiaries of a disability charity.

17. Tax. What if not all the work is carried out by beneficiaries?

Some of the work of a trade may be carried out by employees, contractors or volunteer workers who will not rank as beneficiaries of the charity. In these circumstances exemption under S505 (1)(e)(ii) will still be available provided it can be shown that the greater part of the work in connection with the trade is carried out by beneficiaries of the charity.

For chargeable periods beginning on or after 22nd March 2006, S505 (1B)(b) ICTA 1988 extends the exemption where the work is carried out partly but not mainly by beneficiaries. The part carried out by beneficiaries is deemed to be part of the charity’s exempt beneficiary trade. Receipts or expenses relating to the overall trade should be apportioned to the separate parts on a reasonable basis

18. Tax. What happens if the beneficiaries are also paid employees?

A charity may wish to pay salaries to beneficiaries who work in a trade carried on by the charity. This will mean that the beneficiaries will become employees of the charity. Provided that they can still properly be regarded as beneficiaries of the charity, the exemption of the trading profits will not be affected. PAYE must be operated on the earnings of beneficiaries who are employed by a charity in the same way as for other employees, and National Minimum Wage rules applied.

19. Tax. Exemption for small trading

From April 2000 there is a statutory exemption for the profits of ‘small trading’ carried on by a charity that are not otherwise already exempt. Before charities consider whether this particular exemption applies, they may first want to consider whether the Extra Statutory Concession (ESC C4) for fund-raising events applies. See Paragraph 36.

20. Tax. How does the small trading exemption apply?

The small trading exemption applies to the profits of all trading activities that are not already exempt from tax, provided:

  • the total turnover from all of the activities does not exceed the annual turnover limit, or
  • if the total turnover exceeds the annual turnover limit, the charity had a reasonable expectation that it would not do so, and
  • the profits are used solely for the purposes of the charity.

VAT. The small trading exemption does not apply to VAT.

21. Tax. Calculation of the annual turnover limit

The annual turnover limit is:

  • £5,000, or
  • if the turnover is greater than £5,000, 25 % of the charity's total incoming resources, subject to an overall upper limit of £50,000.

This table illustrates the application of these rules:

 
Total incoming resources of the charity Maximum permitted turnover
Under £20,000 £5,000
£20,001 to £200,000 25% of charity's total incoming resources
Over £200,000 £50,000

For the purpose of this limit, "total incoming resources" means the total receipts of the charity for the year from all sources (grants, donations, investment income, all trading receipts, etc), calculated in accordance with normal charity accounting rules (whether the income would otherwise be taxable or not).

Examples

A charity sells Christmas cards to raise funds. This trading is not primary purpose nor does it fall to be considered under ESC C4 because it is not raising income from a fund-raising event

Example 1

  • Assume this is the only taxable trading activity.
  • The turnover from the Christmas cards amount to £4,500 in the year.
  • Any profits will be exempt from tax, because the turnover does not exceed £5,000.

Example 2

  • A charity has a turnover from non-primary purpose trading of £40,000 for the year.
  • Its total incoming resources for the year are £160,000 (including the £40,000 turnover).
  • Profits will be exempt from tax because the turnover from the non-exempt trading does not exceed either:
    • 25% of the total incoming resources (£160,000 @ 25% = £40,000), or
    • the overall upper limit of £50,000.

Example 3

  • A charity has turnover from non-primary purpose trading of £40,000 for the year
  • Its total incoming resources only amounted to £150,000.
  • The £40,000 turnover exceeds the annual turnover limit (£150,000 @ 25 %= £37500).
  • However, the profits on sales may still be exempt from tax for this year if the charity had a reasonable expectation at the start of the year that the turnover would not exceed the limit.

Example 4

  • A charity has turnover of £60,000 for the year
  • Its total incoming resources only amounted to £150,000
  • The turnover exceeds the overall upper limit of £50,000
  • the profits on sales may still be exempt from tax for this year if the charity had a reasonable expectation at the start of the year that the turnover would not exceed that limit.

22. Tax. The reasonable expectation test

If the total turnover of taxable trading does exceed the limits, profits may still be exempt if the charity can show that, at the start of the relevant accounting period, it was reasonable for it to expect that the turnover would not exceed the limit. This might be because:

  • the charity expected the turnover to be lower than it turned out to be, or
  • the charity expected that its total incoming resources would be higher than they turned out to be.

HMRC Charities will consider any evidence the charity may have to satisfy the reasonable expectation test.

Example:

  • the charity may have carried on the activity for a number of years and may therefore be able to show that the turnover increased unexpectedly compared with earlier years
  • the charity might have started carrying out the trading activity during the year in question and might be able to show that the turnover was higher than it forecasted
  • the charity's total incoming resources might be lower than it forecast, for example, because the charity did not receive a grant for which it had budgeted.

The type of evidence needed to demonstrate the levels of turnover and incoming resources which were expected might include:

  • minutes of meetings at which such matters were discussed,
  • copies of cash flow forecasts,
  • business plans and previous years' accounts.

If the charity expects to be regularly trading at or around the small trading exemption limits, it might be better for the charity to consider using a trading subsidiary company see the guidance at paragraph 56 using a trading company.