Charities must be alert to the dangers of the new regime, cautions Ann Phillips.
A perceived haemorrhage of tax revenues through exploitation of charities led to the introduction of the substantial donor rules in 2006. They are sweeping but complex and capable of producing arbitrary results. Unfortunately, it is charities, not donors, that are penalised.
Transactions between charities and their substantial donors entered into after 22 March 2006 are covered. Substantial donor status however can result from donations made at any time, even before the introduction of the new rules. A substantial donor (which includes anyone connected with him or her) is linked to the charity and any connected charities for the purposes of these rules. Any payment made under any prescribed transaction between the substantial donor/connected persons and the charity/connected charities, is then potentially non-charitable expenditure for tax purposes, unless one of the exceptions applies. The exceptions generally exclude arm’s length transactions – but not always.
A charity’s substantial donors in an accounting period are individuals or companies that have made relievable gifts to the charity (including other charities connected by structure, administration or control) exceeding £25,000 over a 12-month period (both the 12 months starting and ending with the date of donation) covering any part of the accounting period; or £100,000 over a six-year period (both the six years starting and ending with the date of donation) covering any part of the accounting period.Substantial donor status then survives for the charity’s next five accounting periods. Donors making gifts of £25,000 will be substantial donors for at least seven years. A donor making a single £100,000 gift acquires substantial donor status for at least 17 years.
Gift aggregation
To make matters worse, a substantial donor includes connected persons, defined as an individual and his or her spouse or civil partner and the relatives of them both (brother, sister, ancestor or lineal descendant) and their spouses or civil partners. Business associates, companies and trusts can also be included. Gifts made by connected persons all form part of the tally of relievable gifts. It is easy to see how the limits might be exceeded where donations are made by a number of family members, say in response to a family tragedy. This aggregation of gifts is not clearly explained in HMRC guidance, although having drawn this to its attention, we understand this will now be addressed.
A company that is a wholly-owned subsidiary of one or more charities is excepted from the definition of substantial donor. A standard trading subsidiary arrangement will therefore be excluded but not a joint venture vehicle with non-charities.
The relievable gifts which bring the rules into play are gifts which qualify for specified tax reliefs, of which perhaps those most likely to be encountered are gifts under gift aid and gifts of assets on which the donor is eligible for capital gains tax relief. It does not include gifts where the only tax relief attracted is inheritance tax relief, even where property is redirected to a charity from an estate by a variation made within two years of a death. The rules apply where a charity enters into a transaction with a substantial donor under which it makes a payment to the substantial donor or accepts terms that HMRC judges to be less than might be obtained at arm’s length. Despite exemption for some transactions at arm’s length, there is no exemption whatsoever for the sale, exchange or letting of property by a charity to a substantial donor, even where land is sold for full value satisfying section 36 of the Charities Act 1993. In addition, the sale or letting of property to a charity will only be covered by the arm’s length exemption if it takes place in the usual course of the donor’s business. Paradoxically, a sale at an undervalue to a charity is not a transaction caught by the rules. Again, irrespective of any benefit received in return, a charity’s payment of remuneration is caught unless it is a duly authorised payment for trustee services. Another potential hazard is the provision of financial assistance, including a charitable grant or loan, to a substantial donor, which will be caught even if properly made under the charity’s objects and powers.