A charitable trade?
Pesh Framjee reminds charities that earned income can trigger a tax liability, however altruistic the enterprise may be
Contrary to popular misconception, charities are liable to tax unless their income falls within certain exemptions. In practice many charities have earned income streams arising from fees and sales of products and services.
Indeed, earned income is a significant proportion of the income of the UK charity sector. Charities are providing products and services for a fee on a regular basis and these arrangements often leads to the dreaded ‘trading’ with its consequent charity law and tax implications.
As charities widen the range of their income generation efforts, the incidence of trading increases and income generation activities come under close scrutiny to establish what is behind the transaction.
The basic exemptions
The aim of charity trading is usually to generate income and profit and it is important to avoid having to pay tax on that profit. Charities are not automatically exempt from tax. The trading exemptions are restrictive and often difficult to fall within.
If a charity is trading and the trade does not fall within the tax exemptions discussed below the profits can be sheltered by using a trading subsidiary that transfers profits to the charity using Gift Aid. It is important to recognise that there are different rules for corporation/income tax and value-added tax (VAT).
The discussion below relates to direct tax (corporation tax or income tax). Compared to the considerable tax privileges that charities enjoy under the direct tax regime, the VAT treatment imposes significant burdens on charities. The basic requirements of the VAT legislation apply equally to charities as they do to commercial businesses.
The term exempt has very different meanings for direct and indirect taxes. For VAT purposes there is some established guidance as to what constitutes a trading or business activity. As a generalisation, business activity is anything that is carried on for a consideration. For this reason, activities that are trading for direct tax purposes are likely to be business activities for VAT.
In most cases where a charity supplies goods or services for a consideration it is in the same VAT position as a commercial organisation. Generally such supplies will be subject to the standard rate of VAT. However, some supplies made by charities benefit from the reduced rate, the zero rate or are VAT exempt.
What is trading?
What, then, is trading? A dictionary definition is: ‘the practice of some occupation, business, or profession habitually carried on especially when practised as a means to a livelihood e.g. shop keeping, commerce, buying and selling.’
However our everyday understanding is considerably widened by s.832 of the Taxes Act 1988 which states that a trade includes, ‘every trade, manufacture, adventure or concern in the nature of trade’. It does not cease to amaze me how unhelpful this circular definition, which originates almost 200 years ago, is.
Consequently, the courts have on several occasions had to scrutinise activities to decide whether they fall within the definition of trade. Some of the income generation activities of charities are easily recognisable as traditional charity trading – the purchase and sale of goods, such as Christmas cards for example. In addition, more and more charities are being enmeshed in the trading net for activities that they had thought were part of their normal fundraising effort.
So, for example, many corporate sponsorships where a charity offers the sponsor something in exchange or allows the use of the charity’s logo can lead to tax implications if not structured well (see the decision tree in figure 1). Not all trades are subject to income or corporation tax and there are certain statutory and extra statutory concessions available to charities.
Primary purpose trading
Section 505 of the Income and Corporation Taxes Act 1988 (ICTA 88) gives exemption for trading profits which are used solely for charitable purposes providing: the trade is exercised in the course of the actual carrying out of a primary purpose of the charity.
The Charity Commission’s guidelines (see CC11:Trustee and expenses payments) also recognise these categories of trading as acceptable and a charity trading on this basis will not normally endanger its charitable status.
Nevertheless, it must be appreciated that when considering primary purpose trading, a distinction must be made between activities which are directed to the achievement of the objectives and activities, which although they help the charity, cannot be described as carrying out or carrying out part of its charitable purposes.
For example, a church that may have charitable status with the objective of advancing religion would find that the sale of religious books qualifies as part of its primary purpose although the sale of other books would not. This is despite the fact that the profits from both types of sales are used exclusively for its charitable objects.
Trades carried out by beneficiaries
Beneficiary trading encompasses trades which are non primary purpose but are carried out mainly by beneficiaries. The sale by a charity, for the disabled, of goods produced in a workshop staffed by the beneficiaries would qualify under this category.
The sale by an international aid charity of goods produced by its beneficiaries in developing countries would also qualify. In certain cases the trade may be carried out by both beneficiaries and others.
So, for example, paid employees may be used to manage or help the beneficiaries. In such cases there are two scenarios to consider:
1) In situations where it can be shown that the greater part of the work in connection with the trade is carried out by beneficiaries of the charity the tax exemption will apply.
2) In situations where the work is carried out partly but not mainly by beneficiaries. The part carried out by beneficiaries is deemed to be part of the charity’s exempt beneficiary trade and the part carried out by the non beneficiaries will be taxable. Income and expenditure relating to the overall trade should be apportioned to the separate parts on a reasonable basis and there may be an opportunity to use the small trades exemption discussed below.
If the beneficiaries are also employees because the charity pays them a wage, the exemption will still apply as long as they can still properly be regarded as beneficiaries of
the charity.
Small trades
From April 2000 there has also been a relief for small trades. The relief is from tax on profits where there is a reasonable expectation that turnover is either below:
- £5,000, or the lower of
- £50,000, and
- 25 per cent of the charity's total incoming resources
If a charity inadvertently breaches the thresholds it will have to establish that the trading turnover and/or total incoming resources were different to its ‘reasonable expectation’.
HMRC has explained that it will consider the circumstances to establish whether the charity had reasonable grounds to consider that it would not fall outside the exemptions.1 For example, this could be established by budgets and forecasts or past trends.
Trades that are partly primary purpose (mixed trades)
Charities also carry out trading which is not part of the primary purpose of the charity but which is typically undertaken to raise funds to be applied for charitable purposes (e.g. sales of promotional items or commercial sponsorships).
Where a charity's trade is carried out partly in the course of carrying out a primary purpose of the charity, and partly for non-primary purposes, s. 505 (1B) ICTA 1988 deems each part as a separate trade for tax purposes.
The charity’s non-primary purpose deemed trade is not exempt from tax, unless the work is carried out mainly or partly by beneficiaries – or the small trading exemption applies (see above).
HMRC has explained that this would apply in cases where the trade might deal in a range of goods or services only some of which are within, or ancillary to, a primary purpose.
Another instance is where the trade deals with some customers who cannot properly be regarded as beneficiaries of the charity. Examples of such trading cited in HMRC guidance2 include:
- a shop in an art gallery or museum which sells a range of goods, some of which are related to a primary purpose of the charity (i.e. education and the preservation of property for the public benefit such as direct reproductions of exhibits and catalogues), and some of which are not (e.g. promotional pens, mugs, tea towels, stamps, etc);
- the letting of serviced accommodation for students in term-time (primary purpose), and for tourists out of term (non primary purpose), by a school or college; and
- the sale of food and drink in a theatre restaurant or bar both to members of the audience (beneficiaries of the charity) and the general public (non-beneficiaries).
Ancillary income
I continue to see situations where charities are following guidelines that have been superseded. In the past HMRC adopted a rule of thumb and, if the trade was seen to be part of a single trade and the turnover of the non-exempt part amounted to less than 10 per cent of the total trade, it was disregarded as de minimis so long as it was not large, then defined as £50,000.
Following the Finance Act 2006 this guidance has now been superseded by the guidance below and HMRC will either apply the mixed trade rules discussed above or in certain cases will allow trade to be treated as ancillary.
This treatment extends the exemption from tax to other trades, which in themselves are not primary purpose but which are ancillary to the carrying out of a primary purpose. Such trades will qualify as primary purpose trades. HMRC has explained: 3
‘The exemption from tax can also extend to other trading, which is not overtly primary purpose in nature but which is ancillary to the carrying out of a primary purpose. This trading can still be said to be exercised in the course of the carrying out of a primary purpose. It is therefore part of the primary purpose trade. Any impression that it is a separate category is incorrect.
‘Examples of trading which qualifies as primary purpose because it is ancillary to the carrying out of a primary purpose are:
- the sale of relevant goods or provision of services, for the benefit of students by a school or college (text books, for example);
- the provision of a crèche for the children of students by a school or college in return for payment;
- the sale of food and drink in a cafeteria to visitors to exhibits by an art gallery or museum;
- the sale of food and drink in a restaurant or bar to members of the audience by a theatre; and
- the sale of confectionery, toiletries and flowers to patients and their visitors by a hospital.’
One-off fundraising events exemption
In recognition of the fact that ICTA 88 s. 832’s unsatisfactory definition of trading would catch a number of activities that have traditionally been associated with charity fundraising, (such as bazaars, jumble sales, dinners etc) There is an exemption for fund-raising events.
In essence the events must be of a certain type and run on an infrequent basis. Social events which incidentally make a profit do not fall within the exemption. Neither do events which a charity holds as part of its charitable activities.
The latter would normally fall within the primary purpose trading exemption.
This area is complicated and is covered in more detail in the guide we have written for CFDG: The Tax Implications of Charity Trading.4
Public benefit
When considering the issue of what trading is allowable there is a need to consider the issue of the public benefit test as enshrined in the Charities Act 2006. The Act has for the first time set out in legislation charitable objectives and established the over-arching requirement to demonstrate that the activities provide public benefit.
The law requires charities which advance education, religion or relieve poverty to demonstrate explicitly they deliver public benefit.5
The Charity Commission has emphasised that there is a particular focus on fee charging and this is of relevance when considering the issue of trading. It states that charities which charge relatively high fees must demonstrate accessibility to those facilities or services.
Note
This article is based on material first written for Charities and Trading: Law, Accounting and Tax Issues (a book published by Charity Advisory Trust in 1996. It has since been updated as a Guidance note: Trading – a Survivors Guide.
1.www.hmrc.gov.uk/charities/guidance-notes/annex4/sectionb.htm#19
2. www.hmrc.gov.uk/charities/guidance-notes/annex4/sectionb.htm#12
3 www.hmrc.gov.uk/charities/guidance-notes/annex4/sectionb.htm#12
4.Available from www.cfdg.org.uk
5.See ‘A nettle ungrasped?’ in Caritas, September 2009, issue 22, pages 23 to 25.
Author: Pesh Framjee
Pesh Framjee Pesh Framjee, Head of the non-profit unit at Crowe Clark Whitehill is Special Adviser to CFDG and is a member of the Charity SORP Committee. He has worked with charities for over 35 years and advises charities on financial, governance and strategic matters.
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