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:
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.
‘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:
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.
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:
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:
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.
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:
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:
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.
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.
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.
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:
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.
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.
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.
The small trading exemption applies to the profits of all trading activities that are not otherwise exempt from tax, provided:
The annual turnover limit is:
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
£20,001 to £200,000
25% of charity's total incoming resources
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.
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:
HMRC Charities will consider any evidence the charity may have to satisfy
the reasonable expectation test.
The type of evidence needed to demonstrate the levels of turnover and incoming resources which were expected might include:
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'