Confused by the tax relief cap and how it will affect donations by higher-rate taxpayers? The British Red Cross provides a breakdown of the numbers.
Under the current system a donor receives a tax relief on donations that they have made to charities. Note that this is a tax relief and not a tax reclaim. This means that it reduces the amount of income that they pay tax on, they do not make a ‘reclaim’ in the way that charities do to get their element of the gift aid benefit. A donor has no personal tax benefit from making a donation as the relief is directly linked to the donation made. The aim of the relief is to ensure that people are not additionally disadvantaged by making a donation by having to pay tax on the money that they no longer have and have not benefited from as it has been given to charity.
In the case of giving of shares, the donor receives relief on the total amount given to the charity so the full amount donated is removed from their income before the tax calculations are made.
In the case of donations made under gift aid, the situation is a little more complicated as the charity has already claimed the tax at basic rate paid by the donor so this amount is removed from the relief provided to the donor as otherwise the Treasury would be disadvantaged by the tax being double-counted in the reclaim by the charity and the donor relief. This means that the donations are effectively being made partly out of the donor’s gross income and partly out of their net income.
Here is an example. A 45 per cent taxpaying donor makes a gift to charity of £1m under gift aid:
Charity claims in gift aid
£1m gift x 20/80 (basic rate tax – see figure 1 below for how this is calculated)
£1m gift + £250,000 reclaimed
Donor gets relief of
£1,250,000 x 25 per cent (45 per cent – 20 per cent already claimed by charity)
Net cost to the donor
£1m - £312,500
The cost to the donor is £687,500 for making a donation to charity of £1,250,000 (ie 55 per cent of the amount the charity has received).
Prior to April 2012, donors were able to donate their tax relief to charity through their tax returns. If they did this then the cost to the donor would have been £1m and the charity would have received £1,562,500 (£1m donation + £250,000 gift aid reclaim + £312,500 in relief donated by the donor). The facility to donate this tax relief has now been removed from the tax return system so the donor has to make another donation under gift aid if they want to donate the relief in this way. In theory, the charity could then claim gift aid on this donation and the process above would be repeated in the same way with the donor receiving relief again.
This is made from the net income, so instead of multiplying by 20 per cent it is necessary to multiply by 20/80 or 25 per cent. £250,000 tax is 20 per cent of £1,250,000 (gross) but to get from £1m (net) to £1,250,000 (gross) it is necessary to add 25 per cent to the net
The current system has been challenged – partly due to the complications in calculations, partly due to difficulties for higher-rate taxpayers who do not complete tax returns to receive relief because they pay tax via PAYE, and most recently with the suggestions of tax avoidance through giving with the proposal of a new cap on donations relief in the 2012 Budget.
If the framework is changed so that all donations are made from the net income (ie after the donor has already paid tax) and the charity is able to reclaim all the tax paid then there are no risks of tax avoidance, but donors are still able to give without being disadvantaged beyond the cost of the transaction – but the charity will receive the full gross donation amount. This would simplify tax returns as donations would effectively be taken out of the self-assessment system.
In this case, using the example previously, the donor could make a gift of £687,500 and the charity could then claim £562,500 (£687,500 x 45/55 – see figure 2 below for how this is calculated) which would make the donation received by the charity £1,250,000. Alternatively if the donor made a gift of £1m then the charity would claim £818,181 which would make the donation received by the charity £1,818,181.
As with the previous example for the basic rate calculation in figure 1, 45/55 is the calculation for the tax reclaim for a 45 per cent donor on a net donation to make it the value of a gross donation.
There are already mechanisms in place and tight auditing of charity gift aid claims so tax avoidance should not be an issue. The only challenge is then to find the best mechanism for the notification of higher-rate taxpayers and process for managing the claims and processing. This needs further development to identify the most efficient process for HMRC and charities to manage. Consideration also needs to be given as to the treatment of donations of shares which are currently outside the gift aid scheme.