Every charity, large or small, will, at some point, need to consider the issue of investing its funds. The responsibility of investing charitable funds, however, is not as straightforward as it seems.
For those simply depositing money in a bank, there are few issues to consider. But, in the case of larger bodies, where there may be a portfolio of managed investments together with an investment in land or other non-financial assets, the implications are much wider.
Research by Cooper Lancaster Brewers has shown there is confusion over trustees’ responsibilities in the area of investment, especially with regard to the extent they can delegate that responsibility.
Generally, trustees (whether the trust is a charity or not) have a duty to the beneficiaries of that trust to carry out their obligation to the best of their ability. If they do not do so, they are liable to make good any loss. As far as investments go, there are also the provisions of the Trustees Investment Act 1961 to consider.
The basic position of a trustee is that he must not act recklessly and expose the trust to any more risk than he has to. There is an underlying presumption, therefore, that trustees would not normally consider risky investments.
To add to the complexity of a trustee’s position, he must also consider the specific terms of the trust deed establishing the trust or charity, and heed the particular requirements of charities and charity legislation itself. It is not surprising, therefore, that trustees can find themselves daunted by the task.
Clearly, in order to protect the charity’s assets (and themselves) trustees need to obtain professional advice on the management of investments.
It may be tempting for them to simply hand over responsibility to professional fund managers, but this may not always be possible. Trustees have to bear in mind that they have ultimate responsibility for charity assets and that cannot be delegated, even when day-to-day administration may be handed over.
Step one for charity trustees is to formulate an investment policy. This should be based upon the legal requirement and responsibilities of trustees, together with any specific stipulations in the trust deed (or Memorandum & Articles, if the charity is incorporated).
There may also be stipulations with regard to ‘ethical investments’, but trustees should be wary of imposing undue restrictions based on their own ethical views if these are not enshrined in the charity’s constitution.
If by imposing such a restriction, the trustees were to deny the charity its full income earning potential, then they would be acting in breach of trust.
The investment policy, once formulated, needs to be properly and unambiguously set out in writing and then formally approved by the board of trustees. The investment policy should address issues such as the income requirements of the charity in order to satisfy its ongoing business, against tying up funds for unduly long periods, thus frustrating the charity’s work.
Clearly, having formulated such a policy, it needs to be communicated to the stockbrokers or investment advisers. It is important that any agreement with such a broker makes clear reference to the investment policy and not to the general policy of the firm of brokers employed.
Many of the standard agreements with stockbrokers include such items as underwriting of new issues and investment in equities subject to ‘price stabilisation’.
It is important from the trustees’ point of view to exclude any area which exposes trust funds to a necessary risk, and trustees should not be fobbed off with being told that the agreements are standard.
Research has also shown that many charity trustees have not yet come to terms with the phasing out of tax credit refunds on dividends – which will, of course, reduce a charity’s total investment income. The tax credit refunds will be phased out over a five-year period starting 6 April 1999, and the percentage will be gradually reduced from 21% for tax year 1999/2000 to 4% for 2003/2004. Thereafter, there will be no refunds due, and charities will bear the full cost of corporation tax on their dividend income.
Trustees need to address this very serious issue and reconsider their investment policies in the light of this. UK equities might therefore seem less attractive as opposed to other forms of investment.
One investment channel frequently overlooked in the context of an investment policy, is that of an investment in a trading company. Although the investment may be purely nominal, say #100, some charities may not be able to make such an investment if they do not explicitly have the power to do so in their constitution for Memorandum & Articles.
In some cases, therefore, it may be necessary for the subscribers’ shares to be purchased by a third party, such as a trustee, and then gifted to the charity in order to avoid this particular legal problem.
If there is to be a sizeable investment in a trading subsidiary company, then the trustees would be well advised to seek clearance from the Inland Revenue and the Charity Commission with regard to the investment in such a vehicle.
Another area which trustees need to consider when signing an agreement with brokers is that of VAT. With the activity undertaken by a charitable organisation, the impact of VAT can bite in two ways. Are the costs subject to VAT and, if so, can that VAT be reclaimed? In this respect, investment activities are no different.
Charities seem to have a great deal to consider before investing their funds. Not least in respect of the trustees’ ability to fulfil this aspect of their duties. In addition, it is clear that giving some thought to the type of fund management contract entered into, and the resulting VAT implications, can just as easily affect the viability of an investment strategy as decisions over where to invest the portfolio and on what markets.
Witold Sawin is a partner and head of the not-for-profit team at Cooper Lancaster Brewers’ London office.
Simon Neward is a VAT consultant at the firm
VAT RULES ON INVESTMENT ACTIVITIES
Two key European VAT cases, Wellcome Trust and NSPCC, determined that investment activities are normally not considered to be carried out in the course of business. Any VAT incurred on costs of managing or administering the portfolio will therefore be non-recoverable.
This applies even if other activities would enable the organisation to recover a substantial proportion of VAT incurred on overheads. The partial exemption calculations only apply to those costs incurred in the course of business activities.
If the investment activities were considered to be a business activity in their own right, they would likely be largely exempt.
VAT incurred on costs would then be restricted through the partial exemption method and probably could still not be recovered. Therefore, if VAT is incurred in relation to investment activities – in particular, professional fees – it would represent an additional, or unexpected, cost in most cases.
So, what costs are subject to VAT, and can they be avoided? In a typical scenario, a charitable organisation with substantial surplus funds or an existing investment portfolio, may engage a professional fund manager, often on a discretionary basis. If the fund manager charges a periodic fee, this is subject to VAT.
If, however, the contract provides for brokerage commission charges to be made, these are free of VAT. Many fund managers will be willing to discuss terms which offer a mixture of the two, with a lower, fixed periodic fee, plus brokerage commissions.
If non-discretionary, brokerage commissions would be the normal form of charges. These would be free of VAT, but would require the organisation to instruct the broker as necessary.
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