II.1.1 Where a charity's income and gains are not applied solely to charitable purposes, its exemption from tax may be restricted (see paragraphs II.5.1 to II. 5.2on restriction of relief).
This restriction of relief may apply where:
II.2.1 If expenditure is clearly of a charitable nature, but it is not authorised by the terms of the governing document of the charity, it will not necessarily be refused for tax relief.
II.3.1 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".
II.3.2 IR Charities will not challenge accumulations of income except in the rare cases in which it is:-
or
II.4.1 Section 506(3) of the Income and Corporation Taxes Act 1988, states that "A payment made (or to be made) to a body situated outside the United Kingdom shall not be qualifying expenditure by virtue of this section unless the charity concerned has taken such steps as may be reasonable in the circumstances to ensure that the payment will be applied for charitable purposes."
II.4.2 The legislation makes it clear that payments to bodies situated outside the UK are not qualifying expenditure, unless the trustees take steps to ensure that the payments will be applied for charitable purposes.
II.4.3 The first requirement is that the charity must take "such steps as are reasonable in the circumstances". The charity trustees must be able to describe the steps they have taken, demonstrate that the steps taken were reasonable and produce evidence that the steps were, in fact, taken.
II.4.4 When considering whether the steps taken by the charity were "reasonable in the circumstances", the Inland Revenue will have regard to:
Trustees are expected to make adequate enquiries to find out such information as is reasonably available about the overseas body and what evidence will be provided by that body to show that payment(s) will or have been applied for charitable purposes.
II.4.5 The nature of the steps will depend upon the scale of operations and size of the sums involved.
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:
More thorough work by the trustees will be required where the sums involved are large or where a transfer forms part of an ongoing commitment. This might include independent verification of the overseas body's status and activities, and 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.
II.4.6 The steps taken are to "ensure" that the payment will be applied for charitable purposes. If the recipient body overseas is not bound by its own domestic law to apply all of its income for charitable purposes, then the UK charity should consider seeking a legally binding agreement to ensure that their payment will be applied charitably. If the overseas body declines to enter into such an agreement, the trustees may have difficulty ensuring that the payment is applied for charitable purposes. If an agreement is entered into the UK charity will need to have a means of establishing whether the agreement has been complied with.
II.4.7 "Applied for charitable purposes" means applied for purposes, which are regarded as charitable under UK law. It is not sufficient for the charity to establish that the overseas entity is a charity under its domestic law.
II.4.8 Where a charity makes a series of payments to the same overseas recipient for the same charitable purpose, it is not necessary for fresh "steps" to be taken in respect of each new payment. If the trustees have just reviewed the bona fides of the overseas body and are satisfied that they are bound to apply payments from the charity for charitable purposes then, it is not unreasonable for them to rely on the results of this review for a payment shortly thereafter.
II.4.9 However, this reliability 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.
II.4.10 When reviewing payments made to overseas bodies the Inland Revenue will generally ask the charity trustees to provide information about:
If the Inland Revenue is not provided with sufficient evidence it is unlikely that the expenditure will be accepted as qualifying and this may give rise to a liability to tax.
II.4.11 There is no requirement for a charity to make application to the Inland Revenue for advance clearance in respect of overseas donations.
II.5.1 Where the income of a charity is not applied wholly to charitable purposes, the exemptions available may have to be restricted.
II.5.2 Section 505(3), Income and Corporation Taxes Act 1988 provides for restriction of tax relief 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.
II.6.1 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.
II.7.1 Qualifying expenditure is expenditure 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 qualifying expenditure does not include investments that the charity has made or loans which are accepted as qualifying loans or investments for the purposes of Schedule 20 (see Annex III).
II.8.1 Relevant income and gains means income and gains which would be chargeable to tax on the charity were it not for the exemptions available to it. It also includes any income and gains which are chargeable to tax because they are outside of the exemptions available.
II.8.2 If the relevant income and gains of a charity in a period under review are less than £10,000 then the charity is outside the scope of Section 505(3). However, if the Revenue consider 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 (the legislation providing for this notice to be given is at Section 505(7)).
II.9.1 Non-qualifying expenditure can simply be described as:
II.9.2 If the charity incurs non-qualifying expenditure and its relevant income and gains are more than £10,000 and its relevant income and gains exceed its qualifying expenditure then relief on the relevant income above the level of qualifying expenditure will be restricted to any excess over the non-qualifying expenditure.
II.10.1 If a charity has incurred non-qualifying expenditure, then once the charity's relevant income and gains and qualifying expenditure has been ascertained, the following example illustrates how Section 505(3) may operate to restrict relief.
In a chargeable period a charity has gross income of £15,000, from Gift Aid payments and public donations of £2,000.
£6,000 is spent on charitable application and administration costs
of the charity and it makes a qualifying loan of £3,000. The charity
also makes a non qualifying loan of £5,000.
The relevant income amounts to £15,000 (the public donations are ignored
as they are not taxable). The relevant income and gains exceed £10,000,
therefore, it needs to be established if the relevant income exceeds the
qualifying expenditure.
relevant income less: qualifying expenditure excess relevant income
As the excess relevant income of £9,000 exceeds the non- qualifying expenditure of £5,000, the tax relief available to the charity is restricted by the full amount of the non-qualifying expenditure of £5,000. The charity will, therefore, receive repayment on only £10,000 of its Gift Aid income (£15,000 less £5,000).
II.11.1 In some instances the amount of qualifying and non-qualifying expenditure of a charity in a chargeable period may be greater than the relevant income and gains in that period. The legislation provides for relief to be restricted where income has been accumulated and is ultimately used for a non-qualifying purpose. This is done by applying the restriction of relief to income of a chargeable period within the previous six years.
II.11.2 The method of carrying back the restriction is best illustrated by the following example.
In its chargeable period a charity has gross Gift Aid income of £20,000 and gross bank interest of £6,000. £15,000 is spent in charitable grants and administration.
relevant income less: qualifying expenditure excess relevant income
As there was no non-qualifying expenditure in this year no restriction to the relief available is necessary.
The charity has gross Gift Aid of £25,000, and gross bank interest of £5,400. £10,000 is spent on charitable grants and administration. The charity makes a non-qualifying loan of £25,000.
relevant income less: qualifying expenditure excess relevant income
The charity's relief is lost on £20,400 of its income and the balance of non-qualifying expenditure (£4,600) is carried back to 1999/2000 and is treated as non-qualifying expenditure in that year.
In the above example, if the excess relevant income in the year 2000/2001 had been £10,000, the balance of non-qualifying expenditure to carry back would have amounted to £15,000. As the excess relevant income in 1999/2000 was only £11,000 it would be necessary to carry the balance of £4,000 back to 1998/1999 or perhaps beyond in order to restrict relief.
