CHARITIES - Altered state

Most people don’t realise charities pay tax. In reality, theirurrent review of its tax regime but is that just misplaced faith? John Hancock investigates. arrangements are so complex that many, especially the smaller ones, are often not fully aware either of how the system works or of their place in it. In all cases, they have to divert more resources than they would like to the task of managing their tax affairs.

‘In a sector whose income is about #12bn we have calculated that as much as #1bn will be going on tax and the administration of our tax regime after ACT credits have been lost,’ says Stephen Burgess, finance director at Help the Aged, chairman of the Charity Finance Directors Group and vice chair of the Charities Joint Fiscal Working Party.

Perhaps in recognition of this situation, the Chancellor announced a review of charity taxation in his first budget. Dawn Primarolo, financial secretary to the Treasury, went further: ‘Charities contribute a great deal to society and this is reflected in their favourable tax treatment.

‘However, the system can be complex and charities have for some time called for a review to reduce the administrative burden on them, freeing them to concentrate on their charitable activities.’

Such organisations work on the basis of need, not profit. In theory, the savings the government makes by not providing the services itself should be reflected in the tax treatment of those that pick up their slack. ‘When we make our case to the government it is not only based on the social value of charities but on the economic value. Services for which the government would have to pay salaries can be delivered at a lower cost by the voluntary sector,’ Burgess explains.

Oxfam finance director David Nussbaum backs him up: ‘(Charitable) work is valued by the community and government. Private contractors either will not take on such work or will require a profit.’ But because there is no general principle governing the tax treatment of charities, they fall hostage to changes in the fiscal regime, even those not made with them in mind.

Charities have long enjoyed a whole range exemptions. At the moment, they receive favourable treatment in three tax areas. Direct (income and corporation tax), indirect (VAT) and local (business rates). They can reclaim the income tax on donations paid from taxed income through covenants and gift aid. ACT credits allow a similar benefit in relation to pre-paid corporation tax on dividends from shares owned by the charity.

The profits of a subsidiary trading company are taxable but they can be paid back to the charity which then reclaims the corporation tax.

Charitable outputs are exempt from VAT: of course, that means the VAT on inputs cannot be reclaimed. Trading companies are liable but there are a number of other concessions which make VAT in this sector a real minefield. Relief benefits different organisations to varying degrees for reasons that might not always seem logical. Vitold Sawin, who heads the charities section at Cooper Lancaster Brewer, gives an example: ‘While a new hospice building or self-contained annexe would be zero-rated for VAT, an extension to an existing building for the same purpose would incur VAT.’

As if that complex set of arrangements was not enough, there are also five governmental bodies involved: the Charity Commissioners, the Inland Revenue, Customs & Excise, the Department of the Environment (for business rates) and the European Commission.

Review suddenly seems much too mild a term. Though broadly supportive, Liberal Democrat Treasury spokesman Malcolm Bruce is cautious too: ‘Labour has justified recent abstentions on amendments to ease the burden of taxation on charities with the refrain that they “would prefer a comprehensive review”. Now that review is underway, it is to be hoped that it will lead to concrete improvements rather than just being an excuse for delay and inactivity.’

The Charities Tax Reform Group (CTRG) has already secured #200m VAT concessions since it launched (Customs & Excise figures). Administrator Helen Donohue says that, in the longer term the CTRG would like to see ‘a simplified tax regime with changes that address current distortions and recognise modern methods of giving’. These include donations by direct debit and even collecting tins which do not attract tax benefits yet will largely be paid from taxed income. In fact, only 10% of giving is taxefficient yet 92% of charity spend goes on the same areas which the government also supports. Clearly some quid pro quo for this contribution would be welcome.

In fact, the biggest impact the new government has had so far has been through the abolition of ACT credits. It is ‘the first time that charities have been taxed on income,’ says Stephen Burgess. This will hit them harder than most – some estimate to the tune of #350m.

Jane Andrews is policy manager at Customs with responsibility for VAT on charities. She chairs the inter-departmental project group in the review which, she is at pains to explain, is entirely unconnected to the ACT change. ‘It has no blueprint or hidden agenda but seeks to produce a system simple to administer on both sides. It will also help to prepare for consultations on a harmonised VAT regime for Europe.’

Indeed, a review of charity taxation has been in Chris Talbot’s job plans for some time. Talbot is head of VAT social division at Customs, and the logic of his leading the process is that VAT is the most difficult area of charity taxation. It unites the government departments involved, hopefully with the charities and their advisers.

‘Hopefully’ because, until 1 December this year, all parties are urged to submit contributions to the debate: ‘no comment too small; no comment too radical’ is the mantra.

Andrews says: ‘They should grasp the opportunity and make their suggestions for improvement.’ Those who do not participate will have only themselves to blame.

The review group will then prepare a paper for next spring with consultation running throughout the remainder of 1998. The timing of changes will depend upon whether they can be achieved within the present regime, through an act of the UK parliament or in co-operation with the EU.

Different people have different hopes for the review. All seem agreed on the objective of a simpler tax regime, not only to save on administration but also to divert to charitable purposes the opportunity costs of officers poring over tax forms. Most voluntary organisations like to keep their overheads within or below the 10% to 15% range: nobody disputes that up to 1% of costs go on tax management.

Barry Abrahams, head of the charity group at Levy Gee, speaks for many in suggesting, ‘the (mechanics) and treatment of covenants and gift aid could be harmonised and brought into line with current ways of giving’.

He would also like to see the law changed to allow charities to trade without the need to set up a separate company and go through the process of transferring money in order to reclaim the tax. The drafting would have to be tight as such a system could be open to abuse.

David Nussbaum adds: ‘The tax burden has moved from direct to indirect taxes over recent years. Charities’ reliefs are mainly from the direct system so, as direct tax rates have fallen, the value of donations has also fallen.’

John Graham, NSPCC finance director, describes the present system as, ‘like a desk littered with papers from concessions granted over the years to individual events. The concession for the record Candle in the Wind is the latest in a long line. Also, the loss of ACT credits, albeit phased from 1999, will cost charities around #350m. I would not expect the sum value of any new concessions to exceed that figure.’

It’s clear that the tax treatment of charities is overdue for reform and simplification. Whatever the official line, the potential loss from the ending of ACT credits would have attracted a great deal more adverse publicity had it not been accompanied by the announcement of a review.

Charities add value to our society, not only for those they help but also because most of their work saves taxpayers money.

While a zero-tax regime may seem attractive, it might be less so for businesses competing with the charities’ trading arms for consumers’ expenditure. Also, the main issues revolve around VAT on which we have to consult and, ultimately, harmonise with our EU partners. Given all of that, a review looks less like prevarication, more a prudent way to proceed.

And one last point. Remember, remember December the first, if you don’t put your oar in, they might do their worst.

Comments for the review must arrive by 1 December 1997 and should be addressed to: Mary Cooper, HM Customs & Excise, 4th Floor Central, New Kings Beam House, 22 Upper Ground, London, SE1 9PJ.