Just like a business, charities require careful planning to set up and run in a way that ensures their long-term sustainability. It’s vitally important to manage your financial arrangements so that funds are not reduced by unnecessary exposure to taxation.
While charities do enjoy a variety of reliefs, it’s a common myth that charities are automatically exempt from all VAT and tax requirements. Over the years we’ve been asked to advise on variety of accounting issues within the charity sector. In order to provide some guidance around the topic, here are some of the questions we’re most often asked.
Do I need charitable status?
The first step for your charity to benefit from tax relief is to be recognised as a charity by the HMRC.
To do this you’ll need a registration number, governing document and to define your charitable purpose. Your charitable purpose includes activities that contribute towards:
- The prevention or relief of poverty
- The advancement of education
- The advancement of religion
- The advancement of health or the saving of lives
- The advancement of citizenship or community development
- The advancement of the arts, culture, heritage or science
- The advancement of amateur sport
- The advancement of human rights, conflict resolution or reconciliation or the promotion of religious or racial harmony or equality and diversity
- The advancement of environmental protection or improvement
- The relief of those in need by reason of youth, age, ill-health, disability, financial hardship or other disadvantage
- The advancement of animal welfare
Your governing document (or constitution) sets out what you want to achieve, how you will achieve these objectives and ultimately whom it will benefit.
Do charities pay tax on income and gains?
Generally speaking most of the income and gains received by a charity will be exempt from Income Tax and Corporation Tax, under the proviso that the money is used to help advance the main objectives of the charitable purpose.
Charities will typically be exempt from tax on any income generated by:
- Capital gains
- Rental income from lettings
- Income from non-trading intellectual property rights
- Gift aid
- Lottery income
- Interest from annual payments and royalties
- Trading profits in certain circumstances
Are trading activities tax-exempt?
In order for charities to raise funds that further their objectives, they often engage in trading activities through the sale of goods or services. Charities can often set-up charity shops, commercial sponsorship and a range of other activities in order to generate income.
These activities can develop into trades and charity law imposes a number of restrictions on the types of trading activities that can be carried out.
The definition of whether the sale of goods & services is classified as trade depends on:
- The number and frequency of transactions
- The nature of the goods or services being sold
- The intention of the charity in acquiring the goods which are to be sold
- Whether the goods are capable of being used and enjoyed by the charity
- The presence or absence of a motive for profit
Whether you’re liable for corporation tax will also depend on the type of trade. There are essentially two types: primary purpose trading and non-primary purpose trading.
Primary purpose trading
Primary purpose trading contributes directly to the charity purpose as set out in your governing document. If your charity aims to advance education, charging course fees would be regarded as primary purpose trading.
These sales however will be deemed as a business activity for the purposes of determining VAT liability (covered below).
Non-primary purpose trading
Non-primary purpose trading refers to trades outside the specific objectives in a charity’s constitution. It also includes trading with the sole intention of raising funds for the charity.
While there are no general exemptions from corporation tax on the profits of non-primary purpose trading, there is some relief under the ‘lotteries exemption’ and the ‘small-scale trading tax exemption’.
Small-scale trading tax exemption
The small-scale exemption is an exemption from corporation tax on the profits from non-primary purpose trading that falls below a particular threshold.
If your annual turnover is below £5,000, or, if your trading turnover is one quarter of the charity’s total income in that year (up to a maximum of £50,000) you can qualify for corporate tax exemption.
Ultimately most charities can carry out small-scale, non-primary purpose trading and be exempt from corporation tax, but again the profits will need to be applied to the main purpose of the charity.
When do I need to set up subsidiary for trading?
If trading involves a significant risk to a charity’s assets, it’s advisable to consider trading through a subsidiary.
A significant risk may constitute:
- The size of the charity
- The type of trading activity being conducted
- The expected income, expenditure and turnover
- The sensitivity of profitability to market and economic
It’s not uncommon for a charity to run trading activity through a subsidiary and usually the subsidiary is wholly owned by the charity, creating a separate administrative unit in order to reduce tax liability.
Because the trading subsidiary is not in itself a charity there are no limits on how much it can trade and any commercial risks are isolated in a separate legal entity.
The trading subsidiary will usually gift all or most of its profits to the charity resulting in taxable profits that are either zero or very low.
What’s Gift Aid?
Gift Aid is a scheme that provides tax relief for both companies and individuals when making gifts to charities. Companies donating its taxable profits to a charity receive a tax deduction equal to the amount of the profits donated.
Until recently the Charity Commission’s deemed that it was acceptable to donate all taxable profits from a subsidiary to the parent charity, even in cases where this amount exceeded the profits available for distribution.
However, recent changes from the Charity Commission state that if the accounting profit is higher than the value calculated for distributable profits, only the lower figure can be paid across under Gift Aid.
Any taxable profits of the trading subsidiary that are greater than its distributable profits, may now be subject to tax liability.
Is there tax relief on income from land and property?
A charity is exempt from tax on any income received from renting out land or property that it holds for charitable purposes, but there is no tax exemption for any profit made from developing this land or property.
The topic of VAT payments for charities can often be complicated, and it’s always best to seek the advice of experience professionals for detailed answers relating to your business.
However, the requirements of VAT payments for charities – in general – are similar to that of commercial businesses.
There are some concessions in the form of reduced or zero rating, and fees received for the care, treatment or instruction of children, the elderly, the sick and the disabled are all exempt from VAT.
When should a charity register for VAT?
If a charity’s turnover from non-exempt business activities exceeds the VAT registration threshold of £83,000 then a charity must register for VAT.
Many charities will not have to register for VAT because their income comes from grant funding that is outside the scope of the VAT system.
While this information is intended to provide some general principals to Tax & VAT within the charity sector, for any specific queries please get in touch with one of our charity experts and we’ll be happy to help. Header image courtesy of NY Photographic.