BN 28 - Charities: Anti – Avoidance Provisions

Who is likely to be affected?

1. Individuals and companies who misuse charitable reliefs through the use of charities they control. Charities with substantial donors. Non-close companies making cash donations to charity and receiving large benefits in return for the gift.

General description of the measure

2. These additional rules will act to protect charitable reliefs from misuse. They will penalise certain behaviours that can reduce the amount of charitable funds that are used for good causes. There are three strands to the action HM Revenue and Customs (HMRC) are taking:

the first strand will restrict the dealings that a charity can have with its substantial donors those giving £25,000 or more in a single 12-month period, or £100,000 or more over a 6 year period and remove tax relief from the charity where the restrictions are breached;
the second strand will provide a direct link between non-charitable expenditure incurred by a charity and loss of tax relief, restricting the income and gains eligible for tax relief by £1 for every £1 of noncharitable expenditure incurred; and
the final strand will make non-close companies subject to the same limits on benefits received as a result of a gift to charity as currently apply for individuals and close companies. Non-close companies will also become subject to the same rules as close companies and individuals that apply when gifts are potentially repayable or are associated with the acquisition of property by the charity from the donor or connected persons.

Operative date

3. The first strand will affect transactions that take place on or after 22 March 2006. The second will have effect in relation to non-charitable expenditure incurred in a chargeable period commencing on or after 22 March 2006. The final strand will affect payments to charity made on or after 1 April 2006.

Current law and proposed revisions

4. Section 505 of the Income and Corporation Taxes Act 1988 ("ICTA") contains a mechanism that reverses tax relief granted to a charity where it incurs (or is treated as incurring) non-qualifying expenditure. The restriction of relief applies when a charity has relevant income and gains (broadly those on which tax relief is granted) of more than £10,000, the charity incurs non-qualifying (non-charitable) expenditure and the charity's qualifying (charitable) expenditure does not equal or exceed its relevant income and gains. Where this is the case relief is restricted on the relevant income and gains that exceed the charity's qualifying expenditure to the extent that non-qualifying expenditure is incurred. The remaining balance of non-qualifying expenditure can be carried back to the preceding 5 years.

5. These changes will remove the £10,000 de minimis limit and reverse the order in which charitable and non-charitable expenditure is set against the charity's tax relieved income and gains. This will mean that for every £1 of non-charitable expenditure incurred by the charity, there will be a corresponding restriction of the income and gains that attract tax exemption. Where there is an excess of non-charitable expenditure over total income in the current year the excess can be carried back to an earlier period.

6. The new rules will place additional restrictions on transactions that can take place between a charity and its substantial donors without the charity's tax relief being restricted. An individual or a company will be a substantial donor if they give to a charity £25,000 or more in any 12-month period or £100,000 over a 6-year period. The donor will be a substantial donor for the chargeable period in which they exceed these limits and the following 5 chargeable periods. The limits will apply only to amounts on which tax relief has been claimed.

7. The new rules will apply to the following transactions unless the transaction is otherwise exempt:

the sale or letting of property, or provision of services by a charity to a substantial donor, or by a substantial donor to a charity;
an exchange of property between a charity and a substantial donor;
the provision of financial assistance (such as the provision of a loan, guarantee, indemnity or financial arrangements compliant with Islamic law) to a charity by a substantial donor, or to a substantial donor by a charity;
payment by a charity of remuneration to a substantial donor apart from a payment for services as a trustee approved by the appropriate charity regulator or the courts; and
investment by a charity in the business of a substantial donor as long as the business is not listed on a recognised stock exchange.

8. Certain transactions by a substantial donor to a charity will be exempt from the new rules. These are transactions that HMRC is satisfied that a charity engages in for genuine commercial reasons, on terms that are no less beneficial to the charity than those that might be expected of an identical arm’s length transaction, so long as the transaction is not part of an arrangement for the avoidance of tax. The exemption will apply to:

financial assistance given to a charity by a substantial donor; or
the sale or letting of property, or the provision of services, where the transaction forms part of the business of the substantial donor; or
transactions that are provided by a charity to a substantial donor in furtherance of the charitable purpose of the charity and which are no more beneficial to the substantial donor than could be obtained on arm’s length terms.

9. The new rules will not apply to a disposal at less than market value by a substantial donor to a charity to which section 587B ICTA (gifts of shares security and real property to charity etc) or section 257 Taxation of Chargeable Gains Act 1992 (gifts to charities etc) applies.

10. The new rules will not apply to transactions that occur after the commencement date where the transaction is the result of a contract entered into by the charity and substantial donor before the commencement of the new rules.

11. Where a charity takes part in any of the transactions that are not otherwise exempt, any payments made by the charity in connection with the transaction will be treated as non-charitable expenditure. Where the transaction is not on arm’s length terms any difference between the actual terms and arm’s length terms, so far as it favours the substantial donor, shall be treated as non-charitable expenditure and the charity will have its tax relief restricted.

12. Section 339 ICTA provides tax relief for companies making a cash donation to charity. No relief is available for close companies (broadly those under the control of five or fewer persons) where the company receives benefits in consequence of making the gift that exceed the limits below:

for donations not exceeding £100, 25 per cent of the gift;
for donations exceeding £100 but not exceeding £1000, £25; and
for donations exceeding £1000, 2.5 per cent of the gift up to a maximum of £250.

Relief is also not available if a gift is made subject to a condition as to repayment or is made as part of an arrangement for the acquisition of property, otherwise than as a gift, from the company or connected persons.

13. The new rules will extend these restrictions and this limit on benefits received in consequence of a gift to charity - which also apply to gifts by individuals - to companies that are not close companies.

Further advice

14. If you have any questions about this change, please contact Adrian Cooper on 020 7147 2782 or John Kington on 0151 472 6019.