This section does not apply in relation to VAT. VAT liability relates to taxable supplies and is not based on profit or loss.
Trading receipts should be allocated to the sources listed in paragraph 4 above on a reasonable basis. The profits of taxable non-charitable 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 trading expenditure to a non-charitable or deemed non-charitable trade. Any such apportionment will apply only for tax purposes.
For most charities the challenge will be to maintain adequate accounting systems to properly identify the separate charitable and non-charitable deemed trades, in order 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 charitable or non-charitable. Alternatively, there might be a 'middle level' approach of, for example, identifying particular contracts or projects, or the work of individuals as charitable or non-charitable. At the most detailed level, charities might identify each individual piece of work done, flag it charitable or non-charitable in the accounting system, and allocate costs accordingly.
HM Revenue & Customs' (HMRCs) 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 charitable or wholly non-charitable. However, this approach would be inappropriate for mixed charitable/non-charitable activity. In HMRCs view, a detailed or 'low level' approach to accounting for charitable and non-charitable 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 charitable 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.
For a non-charitable trade, section 479(4) CTA 2010 and section 525(4) ITA 2007 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-charitable trading activity is the charity’s only trading activity, is carried on in the charity's premises and takes 30 per cent of the floor area, it might be proper to allocate to the non-charitable trade 30 per cent of the costs of the premises such as:
Apart from the use of premises, other indirect overheads that may be partly attributable to the trade are:
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:
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:
Where a charity (but not a charity subsidiary company) receives 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
412030 and INTM
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 £150,000 in a period of six years.