HMRC consultation on charity tax compliance
Written by
HMRC has published a consultation and call for evidence on charity tax compliance, running from 27 April 2023 to 20 July 2023.
As the consultation acknowledges, the tax reliefs available to charities play a vital part in supporting charitable causes in the UK. In 2020-21 charities and CASCs (Community Amateur Sports Clubs) received more than £5.5bn in charitable reliefs. The biggest individual tax reliefs were Gift Aid (£1.3bn) and business rates relief (£2.4bn).
However, HMRC is concerned that a small group of charities is obtaining tax relief in ways that are not intended under the rules, in particular in relation to four specific areas, as set out below. The overall thrust of the proposals is to make it easier for HMRC to deal with potential tax abuse in these key areas, and to hold charities to account. The consultation is at an early stage in the legislative process and it presents an opportunity for the sector to give feedback on the policy design.
Although it is focussed on abusive arrangements, the consultation underlines the importance for charities to maintain excellent governance around decisions and record-keeping. There are implications for the wider sector insofar as the proposals seeks to shift the burden of compliance further onto charities, and potentially their donors.
1. Prevention of abuse of Charitable Investment Rules
Background
Charities receive various tax reliefs and exemptions on investment income, provided that the investment falls within certain categories and is used to advance charitable aims. Otherwise, the income is treated as non-charitable expenditure which normally restricts a charity’s tax exemptions. Currently a charity can invest in 11 types of specifically listed investments (including property) which are automatically approved as being for the benefit of the charity. There is a final category which exempts any expenditure made by a charity for a loan or other investment to which an officer of HMRC is satisfied, on a claim, that it is made for the benefit of the charity and not for the avoidance of tax.
HMRC’s concern
HMRC is concerned that, in some instances, these rules are being abused with the result that a charity is able to invest to benefit others without any mechanism for HMRC to challenge that this amounts to non-charitable expenditure.
Options for reform
The proposal is to update the current rules to require charities to justify, on enquiry by HMRC, any investment they make and to demonstrate how this benefits the charity.
2. Closing a gap in non-charitable expenditure rules
Background
When a charity incurs non-charitable expenditure, the charity loses the tax exemption on the equivalent amount of its income and a tax charge is raised against the charity’s ‘attributable income and gains’. If insufficient, the excess non-charitable expenditure is set against the total income and gains of the charity (whether chargeable to tax or not) and if there is still an excess then this can be carried back to previous years. Currently the carry back period is six years.
HMRC’s concern
Currently, certain types of income are excluded from the calculation of attributable income and gains, for example legacy income and donations made outside of the Gift Aid and payroll giving regimes. HMRC is concerned that the rules can give rise to circumstances where they are unable to fully claw back relief where a charity has non-charitable expenditure.
Options for reform
One proposal is for HMRC to review the definition of ‘attributable income and gains’ with a view to extending this definition to other income streams that are currently excluded, in order to allow HMRC greater opportunity to recover tax in respect of non-charitable expenditure. There is also a suggestion to review the suitability of the current six year carry back period, presumably with a view to extending it.
3. Sanctioning Charities that fail to meet filing and payment obligations
Background
To claim tax relief, charities must register with HMRC and must file a tax return if the charity has income that does not qualify for tax relief. If the charity has no tax to pay, completion of a tax return is only required if HMRC requests it, so in practice many charities do not submit annual tax returns. By agreement, most charities are only required to file a tax return every three years or so.
HMRC’s concern
HMRC is concerned that some charities fail to file returns when requested but nonetheless still claim (and are paid) tax reliefs such as Gift Aid. This hampers HMRC’s ability to police the charity sector and to monitor the activities of charities including identifying risk trends.
Options for reform
HMRC are therefore considering withholding payments of Gift Aid and disapplying other tax reliefs from charities that have fallen behind on their reporting and filing obligations until they submit a return. HMRC states that there is no intention to require all charities to file annually.
4. The Tainted Charity Donation Rules
Background
Broadly, these rules are intended to catch circular arrangements, where a donor enters into an arrangement with a charity or a CASC that gives the donor, or someone else involved, a financial advantage in return for the donation. If the rules are engaged, then the donor loses any tax relief that they would have been entitled to claim had the donation not been tainted. The rules do not apply to ‘legitimate arrangements’ such as ordinary Gift Aid donations, or to benefits taken into account when calculating the relief due for donations to a charity of shares, securities, real property or trading stock.
HMRC’s concern
HMRC’s concern is that the current rules are overly complex, which they are, and cumbersome to apply in practice. Further, there are still arrangements which allow a donor to secure a financial advantage from a charity after making a significant donation, and which are not caught by these rules, because technically the charity is earning a commercial return on funds that are for practical purposes returned to donors. The donor has benefited from the transaction, with little real benefit to the charity whose funds are tied up by the arrangement. HMRC gives the example of where a donor makes a significant donation to a charity they control, allowing both the donor and the charity to claim tax relief on the donation. The charity then lends the donation back to the donor charging a commercial rate of interest, but the loan is never repaid and is eventually written off. Another example given is where a donor makes a significant donation to a charity solely so that both the donor and the charity can claim relief on the donation. Following the donation, the charity then invests the donation in a company or fund controlled by the donor. Of course, if a charity has good governance in place, and charity trustees are acting properly, then charities will not make imprudent loans, or invest without the prospect of a proper return.
Options for reform
HMRC put forward a number of proposals for reform. One is to remove and replace the existing rules with a new rule that is ‘fit for purpose’, to ensure that arrangements made in relation to a donation are done to benefit the charity and not the donor. As part of this, HMRC is keen to explore implementing limits on the amount of financial assistance provided by charities to donors, although no detail is given. Other suggestions involve amending the existing rules to make it easier for HMRC to challenge any donation that provides anything more than an incidental benefit for the donor and with the aim of ensuring that charitable funds are used for the charities’ benefit.
