Tax exemptions

Contents

5. Statutory exemption from tax for charity's trading profits

The Taxes Acts provide for a limited exemption from Income Tax or Corporation Tax for the profits of trades carried on by charities. To qualify for exemption the profits must be used solely for the charitable purposes of the charity and the trade must satisfy at least one of the following three conditions:

  • The trade is a charitable trade (either primary purpose or mainly carried out by beneficiaries - paragraph 6) or is ancillary to carrying out a primary purpose of the charity (see paragraph 7).
  • The non-charitable trading turnover falls below the charity’s small trading turnover limit (see paragraph 14).
  • The trading activity is a VAT exempt fund-raising event (paragraph 29).

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 the profits are used for the purposes of the charity.

6. Primary purpose trading

‘Primary purpose trading’ is trading carried out by a charity in the course of carrying out  its primary purpose(s). A charity’s purposes are stated in its governing document (trust deed, constitution, memorandum and articles of association, etc.).
Examples of such primary purpose 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 charity is carrying out an activity that is a stated charitable purpose of the charity. HM Revenue & Customs (HMRC) has endorsed guidance on the Corporation Tax Treatment of Universities (Opens new window) issued by the British Universities Finance Directors Group. Other charities may also find this guidance helpful.

More information about the tax treatment of affordable home ownership can be found in Annex VII of the detailed guidance notes.

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

Exemption from tax is also extended to other trading which, although not overtly primary purpose in nature, is ancillary to the carrying out of a primary purpose of a charity. This trading can still be said to be exercised in the course of the carrying out of a primary purpose of a charity and is, therefore, part of a primary purpose trade. 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 (although sale to the general public, as opposed to exhibition visitors, is non-primary purpose trading)
  • the sale of food and drink in a restaurant or bar to members of the audience by a theatre (although sale to the general public, as opposed to the audience, is non-primary purpose trading)
  • the sale by able bodied staff of items produced by the disabled in a disabled workshop
  • the sale of confectionery, toiletries and flowers to patients and their visitors by a hospital

8. Trading which is not wholly charitable trading

Under general case law charities will have only one trade. For some charities the trade will be a combination of a charitable trade (primary purpose or carried out by beneficiaries) and partly non-charitable trade (non-primary purpose and not carried out by beneficiaries). 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 (direct reproductions of exhibits with no other function, (therefore excluding for example, mugs and postcards), catalogues, etc), and some of which are not (promotional pens, mugs, tea towels, stamps, all postcards, 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 - ancillary) and the general public (non-beneficiaries - not ancillary)
  • the operation of a café by a ‘relief of the disabled’ charity where only 50 per cent of the staff are disabled (beneficiaries) and the other 50 per cent are not charitable beneficiaries

In these circumstances, the charitable part and the non charitable part of the trade are deemed to be two separate trades - sections 479(2) and (3) CTA 2010 (for corporate charities) and sections 525(2) and (3) ITA 2007 (for charitable trusts) apply. The profit from the deemed charitable trade is exempt from tax, as long as it is used for charitable purposes. The profit from the deemed non charitable trade is taxable unless it is exempt under the small scale trading exemption (see paragraph 13).

Any receipts or expenses relating to the overall trade should be apportioned to the separate trades on a reasonable basis.
These rules apply for chargeable periods, that is, tax years for charitable trusts and accounting periods for other charities, beginning on or after 22 March 2006. Charities should ensure they have accounting systems that permit the identification of charitable and non-charitable trading, and the proper allocation of receipts and expenses to each.

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

For chargeable periods beginning on or before 21 March 2006, where the whole trade might not qualify as a primary purpose trade because part of the trade was 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 per cent 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 per cent 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 per cent 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 one

Charity A carried on in the year ended 5 April 2005 a trade with an annual turnover of £60,000. Of this, £55,000 was primary purpose and £5,000 was not. Because the non-charitable purpose turnover (£5,000) was less than 10 per cent of the total (£6,000) and less than £50,000, the whole trade is treated as charitable.

Example two

Charity B carried on a trade in the year ended 5 April 2005 with an annual turnover of £100,000. Of this, £85,000 was primary purpose and £15,000 was not. Because the non-charitable turnover exceeded 10 per cent of the total (£10,000) the whole trade is treated as non-charitable.

10. 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 and the profits from the trade are used for the purposes of the charity.

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

11. 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 tax exemption will still be available for the whole profit arising from the trade 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.

However, where the work is carried out partly but not mainly by beneficiaries only the profit arising from the part carried out by beneficiaries is deemed as arising from a charitable trade and is eligible for tax exemption. The profit from the other part of the trade remains taxable unless exempt under the small scale exemption. Receipts or expenses relating to the overall trade should be apportioned to the separate parts on a reasonable basis.

12. 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 means that the beneficiaries are employees of the charity. 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 must be applied.

The payment of wages to a beneficiary does not affect the balance between charitable and non-charitable trading. For example, if a charity for the relief of disabled people pays disabled people for the manufacture of goods the trade will still be a charitable trade.

13. Exemption for small scale non-charitable trading

There is a statutory exemption from Income Tax or Corporation Tax for the profits of small scale trading carried on by a charity that is not charitable trading.

14. How does the small trading exemption apply?

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

  • the total turnover from all of the activities does not exceed the small scale trading 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

15. Calculation of the annual turnover limit

The annual turnover limit is:

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

For the purpose of this limit, ‘total incoming resources’ means the total receipts of the charity for the year from all monetary sources (grants, donations, investment income, all trading receipts, etc), calculated in accordance with normal charity accounting rules (whether the income is taxable or not). It does not include capital receipts (for example, from the sale of shares or a property).

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

Examples

A charity sells greetings cards to raise funds and applies all its income charitably. This is not charitable trading, but the sale of cards. The message on the cards does not alter this and so for example, a Christian church, selling cards with a religious message would still be carrying out a non-charitable trade.

Example one

  • Assume this is the only taxable trading activity.
  • The turnover from the cards amounts to £4,500 in the year.
  • Any profits will be exempt from tax, because the turnover does not exceed £5,000 (the minimum small scale trading turnover limit).

Example two

  • A charity has a turnover from non-charitable trading of £40,000 for the year.
  • Its total incoming resources for the year are £160,000 (including the £40,000 turnover).
  • The income from non-charitable trading (£40,000) is not more than 25 per cent of total income (£160,000) and less than £50,000.
  • Profits are exempt from tax because the turnover from the non-charitable trading does not exceed the small scale trading turnover limit.

Example three

  • A charity has turnover from non-charitable trading of £40,000 for the year
  • Its total incoming resources are £150,000 (including the £40,000 turnover).
  • The £40,000 turnover exceeds the annual turnover limit (£150,000 @ 25%= £37,500). So profit from the whole of the £40,000 is taxable.
  • However, the profits on sales may still be exempt from tax for this year if the charity could demonstrate that it had a reasonable expectation at the start of the year that the turnover would not exceed the small scale trading limit.

16.The reasonable expectation test

If the total turnover of taxable trading exceeds the small scale trading limits, profits from a non-charitable trade may still be exempt if the charity can clearly demonstrate 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 from the non-charitable trade 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.
Examples:

  • 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 forecast
  • 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 paragraphs 45-50 'using a trading company'