Calculating the profits of the trade

Contents

47. VAT. Does this section apply for VAT purposes?

This section does not apply in relation to VAT as the VAT system is based on taxable sales turnover rather than profit or loss. A charity can offset the VAT it has to account for on its taxable sales by claiming back, on its VAT return, subject to the normal rules, VAT incurred on its costs.

48. Tax. What profits are taxable?

Trading receipts should be allocated to the sources listed in paragraph 10 above on a reasonable basis. The profits of taxable non-primary purpose trading, including capital allowances if applicable, should be calculated in the same way as for any other trader. This may involve apportioning what was originally charitable primary purpose expenditure to a non-primary purpose or deemed non-primary purpose trade. Any such apportionment will only apply for tax purposes.

For most charities the challenge will be to maintain adequate accounting systems to properly identify the separate primary purpose and non-primary purpose deemed trades, to allocate and where necessary apportion costs to each. Charities are strongly recommended to do this. The approach may vary. For example, there could be a ‘high level’ approach of identifying the trading activity of a particular department, division or building, etc. as primary or non-primary purpose. Alternatively, there might be a 'middle level' approach of, for example, identifying particular contracts or projects, or the work of individuals as primary or non-primary purpose. At the most detailed level, charities might identify each individual piece of work done, flag it primary purpose or non-primary purpose in the accounting system, and allocate costs accordingly

HMRC’s view is that a high or medium level approach may be justified on the facts – a department or a project may be identifiable as wholly primary purpose or wholly non-primary purpose. However, this approach would be inappropriate for mixed primary/ non-primary purpose activity. In HMRC's view, a 'low level' approach to accounting for primary and non-primary purpose activity will be more appropriate. This will give the greatest accuracy and take the least risks with charity law, which places a responsibility on trustees to identify non-primary purpose trading carried on by the charity for which they bear responsibility.

There are further factors, discussed below, that may be particularly relevant when calculating the profits of a trade carried on by a charity.

49. Tax. Allocation of Indirect Overheads and Costs

For a non-primary purpose deemed or part-beneficiary trade, S505 (1B) ICTA 1988 now requires that there be a ‘reasonable apportionment of expenses and receipts’. This will involve taking into account direct expenditure and a reasonable proportion of indirect expenditure such as overheads, whether or not these were originally incurred for charitable purposes.

For example, if a non-primary purpose trading activity is the charity’s only trading activity, is carried on in the charity's premises and takes 30% of the floor area, it might be proper to allocate to the non primary purpose trade 30% of the costs of the premises such as:

  • heat and light
  • rent
  • building repairs and maintenance.

Apart from the use of premises, other indirect overheads that may be partly attributable to the trade are:

  • employee salaries
  • computer costs
  • telephone charges
  • postage costs
  • accountancy and legal fees
  • general administration.

The proper basis of apportionment of indirect costs will depend on the facts. In the case of the use of premises, the apportionment might be based on:

  • the size of floor space allocated to the trade.
  • where student accommodation is let to tourists out of term, the number of days in the year when the premises are allocated to the trade, and actively marketed.
  • in the case of employee salaries, the amount of employee time devoted to the trade compared to total employee time.

50. Tax. Goods or services provided at undervalue

It is common for charities to receive goods or services in their trades at no cost, or at less than their full market price. For example:

  • a supplier might sell trading stock or equipment to a charity at cost price
  • a professional adviser might provide services for no charge
  • helpers and beneficiaries might do work on a voluntary basis.

Where a charity (but not a charity subsidiary) has received goods or services free, or at less than their full market price, the charity may deduct a notional cost/ market price when computing the profits of the trade. Notional costs/market price should be calculated on a reasonable basis. For example, were a celebrity to act as a volunteer waiter at a gala dinner, the notional cost would need to be restricted to the going rate for the employment of a waiter, not that of the celebrity. Market price will be the wholesale or trade price at which the charity could reasonably have expected to buy the goods or services in, not the retail value of those goods or services.

There is guidance about charities and transfer pricing in the International Manual at INTM 432090 and INTM 432120.

There can be adverse tax consequences for a charity if it has a transaction or transactions with a “substantial donor”. A “substantial donor” is a person making gifts to a charity of at least £25,000 in a period of 12 months, or £100,000 in a period of six years.