Charities could benefit from tax reform as cash reserves fall

During a recent webinar hosted by us and attended by several hundred UK charities, it was noted that nearly 60% of charities advised us that they had suffered a marked fall in their reserves – crucial to the financial health and survival of any charity.

Whilst the government’s commitment to extend over £1 billion of funding support to charities was a welcome move, we are concerned that financial issues could continue to impact the sector, in particular charity reliefs and VAT.

Despite successive governments promising to streamline, simplify and consolidate the tax system, tax reliefs appear to have been the only output. At present over 1100 different reliefs are currently available and the administration associated with tax reliefs can cause more problems than they solve and often overcome the original objective.

Tax reliefs in the Charity sector are a good example of this. Since being implemented some 20 years ago, charity relief rules are now considered to be arcane, bureaucratic, inefficient and expensive to operate. They passed their sell-by date several years ago! In view of the role of charities in the COVID crisis and the financial position many will face as we all come out of COVID the Government must consider improvements to the tax position of charities as a matter of priority.

The VAT reliefs currently available to charities are too narrow and do not reflect the broad and important role charities have in modern society. They should be widened and made more efficient. Some still involve paper-based administrative processes that often cost more money to manage than they save.

In many areas the VAT rules that apply to charities are confusing and open to interpretational differences. This has led some charities to suffer unbudgeted VAT costs or incur significant internal and external costs to defend a position. In a number of cases VAT rules do not reflect current government policy or the position charities have in society these days. Furthermore the majority of charities are unable to recover all of the VAT they incur. Charities therefore use hard earned funds or may receive Government funding to cover the cost of irrecoverable VAT – and this is promptly collected and repaid to Government. If the rules on the recovery of VAT by charities were changed donations given by the public to charities and Government funding itself could be used for the purpose it was originally intended.

Public sector bodies and some charities have a special VAT status that allows them to recover the VAT they incur on free of charge non-business activities. If this status was extended many charities could be in a much better financial position and would not result in a loss of revenue to the Government. The same value of public sector funding could be given to more charitable bodies and concerns. There are examples of situations where the cost of VAT is stifling charities ability and willingness to innovate, invest, employ staff and develop progressive new services. It is also having an impact on the services received by vulnerable sectors in society. Following Brexit the Government has the power to make changes that would make the tax position of charities simpler and more efficient.

It is estimated that there are about 210,000 charities in the UK. The review of charity taxation undertaken last year by Sir Nicholas Montagu highlighted a series of important changes that would start to bring charity tax reliefs into the digital age. These included:

  1. Rates – extend reliefs to trading subsidiaries
  2. Gift Aid – redirect higher rate relief to charities and help recover more than £560m of unclaimed Gift Aid
  3. Declarations – establish a universal database needing one registration
  4. Payroll giving – mandatory for larger businesses
  5. Trading rules – extend rules to all trading activities e.g cafes
  6. Wills – remove VAT charges from wills and testaments
  7. VAT – undertake a comprehensive review of charity VAT

The report and recommendations by Sir Nicholas Montagu represented a small step in the right direction but is essentially disappointing in its reach and ambition.

we decided to benchmark the views from the charity sector and undertook our own piece of research to see what the charities would like changed. It would be helpful if the policy makers did likewise. The suggestions we received focused on eliminating unnecessary rule, securing full rather than partial VAT recoveries and cutting costs and bureaucracy. They included:

  1. Create a £10m nil rate band for trading subsidiaries
  2. Apply the zero rate VAT to all supplies by charities – this would allow all VAT on expenditure to be recovered
  3. Confer a ‘Special VAT recovery Status’ on charities that allows them to recover the VAT incurred on expenses in the same way as public sector bodies.
  4. Remove VAT on charges between charities
  5. Remove the VAT reverse charge procedure on overseas services for registration purposes for all charities. This would remove unnecessary VAT registrations and additional irrecoverable VAT costs.

Tax and VAT. Three short words, three letters – but a major headache for charities that is expensive to administer and manage. The government really needs to restructure charity taxation and in so doing free up charities and their people to focus on their core businesses – making a difference.

If you have any questions or would like to discuss the impact of Coronavirus on your organisation, please get in touch with your local Baldwins contact.

The information in this update should not be regarded as financial advice. This is based on our understanding on 15 June 2020. Laws and tax rules may change in the future.