Barry Leigh, Partner, Cohen Arnold, reflects on the increasing scrutiny by the HM Revenue & Customs into the affairs of UK registered charities.
Business is attempting to come to terms with Brexit; in general, the forecasts are rather gloomy. It is therefore unsurprising that HM Revenue & Customs (HMRC) is anxious to ensure that everyone pays their ‘fair’ share of tax. HMRC has targeted the charity sector along with many other taxpayers.
Of relevance to charities will be the kind of queries being raised by HMRC. Broadly speaking, UK charities are exempt from tax on certain profits on condition they are solely applied for qualifying charitable purposes. The exemption covers investment income, capital gains and donations received. HMRC will scrutinise the charity’s application of funds to confirm that they meet the required conditions. If it can be shown that the charity’s expenditure did not meet the requirements, tax will be due on a corresponding amount of the charity’s income.
HMRC focus on two common forms of expenditure to ascertain whether they qualify as being made for charitable purposes.
UK charities making interest bearing loans
Charities often invest to realise an attractive income stream in the medium term and capital growth in the longer term. In general, UK law encourages this, but there are obviously rules and conditions. Making a loan can be an investment, but a charity cannot simply decide to make a loan, even one with an attractive interest rate unless it has undertaken due diligence on the borrower and its anticipated ability to repay the loan and interest. The Trustees are strongly advised to seek adequate security against any loans advanced and to obtain independent financial advice as to whether the loan advanced would be in the best interests of the charity.
It is necessary to document the decision-making process on making the loan; commonly in a Board Minute. There should be formal loan agreements and security documentation. The Trustees are expected to monitor the borrower’s repayments under the terms of the loan agreement.
A charity may seek to lend to its subsidiary. It could be argued that a charge over the subsidiary’s asset is insufficient as the charity already owns its subsidiary. Whilst security would be sensible, HMRC expect that greater due diligence is taken by the Trustees to satisfy themselves that the subsidiary’s cashflow forecasts are reasonable.
UK charities making donations to overseas institutions
Assuming that UK charities can simply make donations to overseas institutions and beneficiaries is dangerous. Whilst this can be done, it must be subject to proper steps being in place to ensure that the ultimate application of the funds is in a form that would qualify as charitable expenditure.
The legislation makes it clear that even if the overseas institution applies the donation received from the UK for charitable purposes, the payment by the UK charity is unallowable unless HMRC is satisfied – a fairly subjective test! – that the UK charity had proper steps in place to ensure that the overseas charity would apply the funds correctly.
HMRC acknowledges that the measures required for a large charity heavily involved with overseas work will differ to those for a smaller charity making modest overseas donations only every so often.
All overseas donations must be fully documented. The actions in place must span the donation lifecycle from the donation request from the overseas charity, to the decision to make the donation, to documenting and ratifying the donation in a Board Minute, and communicating with the recipient to ensure the funds have indeed been applied for charitable objectives.
Obtaining a receipt for the donation will not suffice. File notes and correspondence on the application of the funds should be maintained. Visits, telephone calls and meetings with the overseas charity should be undertaken and recorded. In some cases, the overseas recipient should be asked to formally confirm the manner in which it will utilise the donation; this would be relevant if significant donations are made for a specific project. Where a donation is made to fund an overseas charity which makes small grants and donations to those in poverty and is featured on a ‘needy-list’, the trustees should ask for a copy of the list and the criteria set for inclusion on the list.
Those making loan investments and overseas donations should ensure they obtain advice and keep proper records. It is very important that there is regular, contemporaneous and comprehensive recording of material decisions as they are taken. Board Minutes, file notes and diaries should be maintained accordingly. It is fundamental that all decisions are taken for the absolute benefit of the charity so that it may carry out its charitable objectives, and appropriate procedures and documentation must be the standard.
The reader of the above should not rely on the contents of this article without seeking specific advice on any relevant matters.