Recent criticism of the effectiveness of gift aid misses the point, says Ian Clark. It forgets the basic principle that giving to charity should not be taxed.
The recent National Audit Office (NAO) report on gift aid made headlines in the sector press when it claimed that there was little evidence that gift aid was an effective tax relief. It was pretty critical of HM Treasury and HMRC for not evaluating the effectiveness of gift aid, both when it was introduced in 1990 and then when it was significantly simplified in 2000.
I think some of the NAO’s criticisms are rather unfair on HMT/HMRC. NAO set out their current criteria for an effective tax relief, but then try and apply them to decisions from 15 and 25 years ago, when evaluation standards were less rigorous. Why didn’t NAO raise the issues then, or when HMRC did its evaluation in 2005? Isn’t hindsight wonderful?!
NAO appear to assume that the main objective of gift aid is to increase the number of donors and their level of giving. I would contend that these are only secondary objectives. Surely the primary objective of gift aid (and the preceding deed of covenant regime) is to provide a mechanism to ensure the gross value of a donor’s gift goes to the charity?
Ever since the first Income Tax Act in 1842 governments have applied a general principle that charitable income should not be taxed. As the NAO helpfully points out in the report summary: “Tax relief on donations reflects a long-held principle, consistently accepted by Parliament, that charitable income should be exempt from taxation where that income is used for charitable purposes”.
But the report does not go on to examine how much of the tax paid by donors actually reaches charities. Rather, it focuses mainly on the lack of reliable evidence on secondary factors like donor numbers, take-up and levels of giving, or operational issues like fraud.
Structural weaknesses in gift aid
I had hoped that the NAO would tackle some of the structural weaknesses in the current gift aid design. From a charity perspective there are two major weaknesses: The first is that charities can only claim gift aid on basic-rate tax paid, not on higher-rate tax. So many higher-income donors can personally claim back their higher rate tax on gifts, giving them a financial incentive or lowering the real cost of their generosity compared to standard rate taxpayers. This is costing charities hundreds of millions of pounds each year in higher rate tax that has been paid on gifts but which cannot be claimed. The problem is getting much worse each year as more people are dragged into paying higher rates through fiscal drag. Interestingly this problem is solved if a higher-rate tax payer uses payroll giving, where the full gross gift is passed to the charity.
In recent years charities have suggested a couple of solutions to this major issue. One would be for a second declaration on gift aid forms signed by higher-rate taxpayers, where they could elect for the charity to claim the higher-rate tax as well as basic rate, confirming that they would not claim it as a personal benefit. This would leave the decision about where the higher-rate tax went to the donor. Charities would claim the higher-rate element after the end of the tax year, when HMRC could verify the higher-rate tax status of the donor.
The Irish example
An alternative, more radical suggestion has recently been adopted by the Irish government. It has calculated average rate of tax paid on all donations, which is a composite between the standard and higher income tax rates, and pays this higher composite rate on all eligible gifts. This would benefit thousands of smaller charities who rarely get large gifts from wealthy donors, though it might cause problems for some charities that are very reliant on a few major gifts.
The other major design problem with the current version of gift aid is the sheer amount of red tape that has to be mastered to check the eligibility of different types of donations. As a result the majority of smaller and micro-charities do not even bother to register with HMRC to benefit from the available tax reliefs, as the cost in extra paperwork and volunteer admin time is too great. Some kind of “gift aid lite” scheme is needed for small charities, similar perhaps to the simplified VAT schemes for small businesses. Instead of having to claim on every eligible donation, these charities could claim once a year based on the eligible voluntary income shown in their latest annual report and accounts, duly certified by an independent auditor.
The NAO report contains useful recommendations for future improvements in HMT/HMRC operations, many of which are already in train. But it fails to identify some of the major design flaws, or suggest ways in which the basic system should be reformed. Like payroll giving, both schemes need to be totally re-designed to be fit for the 21st century methods of giving, to ensure that Parliament’s principle that charities should get all of the gross value of charitable gifts is actually put into practice.
Ian Clark is a retired fundraising director
