It is a common misconception that charities don’t pay tax and so don’t need to prepare and submit tax returns to HM Revenue & Customs (HMRC).
This means some charities may get a shock when they receive a letter from HMRC asking them to submit a tax return – a situation which seems to be on the rise.
Contrary to popular belief, charities are subject to tax: either income tax or corporation tax (the exact tax being dependent on how your charity is constituted). Being subject to tax does not mean that you will have a tax liability though, as charities do have some tax exemptions. These charity tax exemptions are not blanket exemptions and if charities do not meet certain conditions, they may have taxable income which needs to be reported on a tax return.
In this article, I will outline some of the common situations where charities will need to prepare and submit a tax return to HMRC.
1. If HMRC asks you to
HMRC can, and does, periodically ask charities to complete tax returns, even when charities do not have any tax liability. We have recently seen examples of HMRC insisting that charities prepare and file annual charity tax returns, and we have certainly seen an increase in the number of charities being asked to prepare a one-off charity tax return this year.
If HMRC writes to your charity and asks you to submit a tax return you must do so by the relevant deadline. The specific deadline for your charity will be on the letter from HMRC.
2. If you have any taxable income
It is possible for charities to have taxable income. The question of whether or not an activity constitutes taxable trading is sometimes a complex one and will depend on the specific situation. Generally, the following income streams will be exempt from income or corporation tax:
- if the charity undertakes trade activities which further its charitable objectives; and
- investment income that is used for furtherance of the charity’s objectives
- Rental income and other trade activities not directly linked to the charity’s objectives may not necessarily be exempt from income or corporation tax.
Charities can undertake a small amount of non-charitable trading, which must be covered by the charity’s small trade exemption in order to be exempt from tax. The small trade exemption is 25% of the charity’s income (note that we are talking about income and not profit here), subject to a maximum of £80,000 and a minimum of £8,000. When the small trade limit is breached, all non-charitable trading is taxable; not just the amounts over the small trade exemption.
Charities need to exercise care if they receive management charge income from their trading subsidiaries and this income is not covered by the small trade exemption. Whilst normally these management charges will be at cost and no tax liability will arise, if the income is above the charity’s small trade exemption a charity tax return will still need to be prepared.
3. If you have any non-charitable expenditure
If your charity makes any payments which are not related to advancement of the charity’s objectives, the charity loses the exemption £1 for £1 on its otherwise exempt income. Expenditure on the general running of the charity (e.g. accountancy fees, staff salaries, heat, light, rent etc) are all examples of charitable expenditure and will not be caught by this. For example, payments made to overseas bodies where the charity does not take steps to ensure that payments are applied for UK charitable purposes will come within the heading of ‘non-charitable expenditure’.
How does this work?
Suppose a UK charity makes a grant of £10,000 to another charity which is based and operates in France. The UK charity does not take steps to ensure that this grant is applied for UK charitable purposes. This £10,000 will be non-charitable expenditure and the UK charity will lose £10,000 of exemptions on its otherwise exempt income and will be subject to tax on £10,000.
4. If you have any non-qualifying charitable investments
Non-qualifying charitable investments can come under the heading of non-charitable expenditure (this is a complex area and warrants separate consideration). In tax legislation, there is a list of all types of approved charity investments which are exempt from tax: this includes bank deposits and shares in companies listed on a recognised stock exchange. Charities can stumble upon issues where they give loans to their trading subsidiaries. These types of loans do not come under any of the specific items listed as qualifying charitable investments so on the face of it these loans may be taxable for the charity. However, the legislation has a catch-all which states that investments which are incurred for the financial or charitable benefit of the charity are qualifying charitable investments and are therefore exempt from tax.
Generally, loans to a charity’s trading subsidiary will need to bring financial benefit to the charity to be exempt from tax. Broadly, this means that the loan should have reasonable repayment conditions, be physically repaid, have security (if possible) and carry a commercial rate of interest.
How does this work?
Suppose a UK charity makes a loan of £15,000 to its trading subsidiary. The loan is interest free and does not have any repayment terms or security and there is no documentation for this loan. This £15,000 will be a non-qualifying charitable investment and the UK charity will lose £15,000 of exemptions on its otherwise exempt income and will be subject to tax on £15,000.
The above points should serve to give you an indication of whether your charity should be submitting a tax return but cannot replace advice from your tax adviser. If your charity has been asked to complete a charity tax return, or you think your charity should be completing tax returns, please get in contact with us on firstname.lastname@example.org.