It is often an assumption that charities do not have to pay tax, and in many situations charities can benefit from generous tax breaks and reliefs. However it is not the case that charities have a blanket exemption from ever paying tax. So when does a charity have to pay tax and under what circumstances can charities operate as tax free?
The rules surrounding taxation in regards to charities can be extremely complex and there have been numerous cases where charities have fallen foul of taxation rules as a consequence. If your organisation already has, or is looking to gain, charitable status we recommend employing the services of an accountant with specialist knowledge of the charities sector.
Handpicked Accountants can recommend a number of specialist accountants in your area, each of whom has been thoroughly vetted to ensure their expertise, professionalism and value for money. Contact Handpicked Accountants today to find out more.
Are you a recognised charity?
The first issue to address when looking into the taxation status of your charitable organisation is to confirm whether it is actually recognised as a charity by HMRC, otherwise you will not be able to benefit from the available tax reliefs. You can register your charity online as long as you meet the following criteria. Your charity must be:
- based in the UK, EU, Iceland, Liechtenstein or Norway
- registered with the Charity Commission (England and Wales), the Scottish Charity Regulator or the Charity Commission for Northern Ireland
- established wholly for charitable purposes
- run by ‘fit and proper persons’
- recognised by HMRC
Once your charity has been registered and is recognised by HMRC it will then be eligible for a number of tax reliefs and breaks.
Tax reliefs for charities
In general most charities don’t have to pay tax on the majority of their income and gains as long as it can be classed as ‘charitable expenditure’ and is used wholly for charitable purposes. Charities normally won’t pay tax on:
- rental or investment income, e.g. bank interest
- profits from investments etc.
- profits when you sell or dispose of assets, such as property or shares
- when you purchase property
What about trading income?
Any profits that are derived from trading, i.e. raising money through commercial avenues, are not necessarily exempt from tax; however there are a number of exclusions which apply that have the common requirement that any monies gained are used for charitable purposes. For example trading profits could be viewed as tax free if the income is:
- the primary purpose of the charity i.e. the admission fee to a museum
- derived from work carried out by the beneficiaries of the charity i.e. selling goods made or produced by people who are benefitting from the charitable work
- less than 25% of the charities total turnover and less than £50,000. Also any activity with a turnover of less than £5,000 will be tax exempt
- derived from a VAT exempt event such as fundraising
- from a licensed charitable lottery
If none of these exemptions apply, many charities look to setting up a dedicated company in which they own all of the shares and through which all of their trading is conducted. Any profits from the trading company are then donated to the parent company through Gift Aid. This is standard practice and is readily accepted by HMRC.
How does Gift Aid work?
Gift Aid allows charities to reclaim the tax (assumed at the basic rate of 20%) on any monetary donation that given to them. For example if someone donates £100 to your charity, HMRC assumes that that person has already paid 20% on it and allows the charity to reclaim that tax. Thus with Gift Aid a £100 donation is actually worth £125 to the charity.
If the donation comes from a company Gift Aid cannot be applied, as it can only be claimed from an individual’s tax status. However, a company can claim tax relief on the donation when donating directly to the charity.
When do charities pay tax?
Although the tax reliefs and breaks for charities are quite extensive, there are still some circumstances in which charities need to pay tax. For example any income which has not been spent on charitable benefits will be taxable, along with any income that falls outside the remit of the available tax reliefs.
If your charity does have tax to pay this should be done via submitting an annual tax return. Also if your charity has an annual income of over £10,000 you should submit an annual return to the Charity Commission.
In general charities have to follow the same VAT rules as non-charitable companies, however there are numerous goods or services on which special reduced rates of VAT are charged or are zero-rated. Also certain fundraising events can be treated as VAT exempt; however the rules surrounding these and all aspects of VAT for charities are complex.
Most charities find that the rules surrounding VAT are difficult to fully get to grips with, so prefer to engage the services of a specialist accountant who can ensure that their financial affairs are fully compliant, and also that they are taking full advantage of all of the tax breaks and reliefs that they are eligible for.