A taxing relationship
April 2008
Pesh Framjee explains the tax planning issues in fundraising partnerships and sponsorships...
Corporate donors support charities in many ways; sometimes it is pure altruism with others expecting to get some form of publicity or other marketing benefit in return for their support. This is perfectly acceptable as long as both parties understand the expectations and also understand that there may be tax ramifications. In practice many innovative means of raising funds can have unplanned tax implications if the arrangements are not properly structured and planned.
Payments by a ‘business’ to a charity will only be tax effective if they are made as a Gift Aid payment or they are seen as a genuine business expense that is tax deductible.
However, payments relating to advertising or providing publicity services by the
charity to the sponsor will usually not be treated as a donation and could be taxable in the hands of the charity. In essence, if a charity in return for some form of support or sponsorship offers publicity for the corporate organisation, then it is quite likely that it could be considered that the charity is trading and carrying out a business activity. . There are then two taxes to consider Direct tax (corporation or income tax) and Indirect tax (VAT) HMRC’s view is that if the payments are made in exchange for something, such as advertising of the sponsor by the charity, the payment is often no longer treated as a pure donation. In some cases, what the charity is providing in exchange is a mere acknowledgement; here the payment can be treated as a donation and therefore does not give rise to a tax liability.
HMRC has provided useful guidance on www.hmrc.gov.uk/charities. Most of the relevant material relating to sponsorships can be found in the detailed guidance in Annexe IV sections 27 – 34. More guidance on VAT can be found in HMRC’s Reference Notice 701/41 and this article is based on the prevailing guidance.
When looking at sponsorship arrangements HMRC will examine the substance of the transaction and may conclude that the charity may be selling advertising services or providing a marketing benefit to the sponsor. HMRC has stated that references to a sponsor which amount to advertisements will cause the payments to be treated as trading income and they will regard a reference to a sponsor as an advertisement if it incorporates any of the following:
- large and prominent displays of the sponsor's logo;
- large and prominent displays the sponsor's corporate colours; or
- a description of the sponsor's products or services.
The key principle to treat a payment as a donation is that if the charity should not provide goods or services in return for the payment. The fact that the business sponsor takes steps to publicise or exploit the affinity with the charity will not change the treatment of the payments in the hands of the charity, unless the charity also publicises the affinity itself or has provided some other benefit to the sponsor.
Some of the examples provided by HMRC as leading to a potential taxable situation may seem to be fairly innocuous. They include
- use of the charity's mailing list;
- use of the charity's logo;
- endorsement of the sponsor's products or services;
- links to the sponsor’s sales website from the charity’s own website; and
- exclusive rights to sell goods or services on the charity's premises.
Sponsorships can also lead to the taxation of intellectual property, in particular the use of a charity’s name and/or logo. The marketing by charities of their name and logo to commercial organisations that then advertise their support for the charity could constitute a trading activity leading to taxable income.
It could also be interpreted as a supply of a trademark or sale of copyright. It is unlikely that the use of a name or logo for a single fundraising event would give rise to tax liability. On the other hand, if there is a form of contract governing the use of the charity’s name and its provision of promotional services to commercial organisation, then the income may be assessable as trading income and would not be exempt.
The rules are not altogether straightforward and HMRC has explained that where the logo came into existence prior to 1 April 2002, a one-off payment (received without any deduction of tax) is charged to tax as miscellaneous income and no exemption is available apart from the small trading exemption.
For charitable companies, where the logo came into existence on 1 April 2002 or later, it is treated as an 'intangible fixed asset'. Non-trading gains on intangible fixed assets received by charitable companies are exempted from tax as long as the gains are applied charitably.
There are also tax exemptions for income which meets the criteria of an ‘annual payment’ and this will apply where a commercial organisation makes annual payments solely for the use of a charity's logo. Such arrangements need to be structured carefully to ensure they meet the definition of an annual payment. The organisation making it has to deduct tax at the basic rate from the payment and the charity can reclaim the tax. However, where the payer is a UK company, payment can be made without this deduction of income tax. To qualify, the payment must be:
- applied solely for charitable purposes;
- made under a legal obligation;
- recurring (the payments must be capable of recurring each year but the obligation may be contingent); and
- treated as pure income profit in the hands of the charity (a sum is ‘pure income profit’ if it comes to the charity without the charity having to do anything in return).
The VAT position is somewhat different – see below for an explanation of this.
Sponsoring a primary purpose trade
In tax terms trading involves the provision of goods or services to customers on a commercial basis. Simply because the provider of goods or services for a fee is a charity or is one-off or occasional does not mean that it will not be treated as trading for tax purposes. However, some trades are exercised in the course of the carrying out of the primary purposes or charitable objects of the charity. For example:
- a theatre charity selling tickets for a stage production;
- a charity for a the support of young artists selling their artworks;
- an arts charity charging a fee for attendance at exhibitions;
- an awards ceremony which is seen to be a primary purpose activity where the audience pay to buy a ticket;
A sponsor might wish to support such a trade and the question is whether such sponsorship receipts are taxable in the hands of the charity.
HMRC’s latest guidance published on their website in November 2006 states:
‘ Once it has been determined that sponsorship payments are trading income in the charity's hands the next step is to consider whether the sponsorship arrangement falls into the primary purpose or non-primary purpose parts of the charity’s trade.
‘It is recognised that where a sponsor’s funding is tied to a particular event or project, it may not be practical to confine the charity’s response to a mere acknowledgement. However, any arrangement in which the charity's response is on such a scale that it appears to be a main purpose of the donation may be challenged. In such a case, HMRC will want to consider the possibility of non-primary purpose trading by the charity and whether there has been a breach of the donor’s benefits limits.’
Use of a trading subsidiary
In some cases a charity will use a wholly owned trading company as a vehicle to carry out income generation activities such as the receipt of commercial sponsorship which would be subject to tax if channelled through the subsidiary. Therefore, a commercial sponsor may be asked to make a payment to the trading subsidiary of the charity which will then Gift Aid its profits to the charity.
The VAT implications
Even greater care must also be taken in considering the VAT treatment of the provision of a charity’s name and logo or the provision of publicity to the sponsor in the way discussed above. The HMRC guidance on sponsorship explains, ‘where you receive sponsorship or some other form of support you will normally be making taxable supplies if, in return, you are obliged to provide the sponsor with a significant benefit’. They have provided some examples and have said that significant benefit might include any of the following:
- naming an event after the sponsor;
- displaying the sponsor's company logo or trading name;
- participating in the sponsor’s promotional or advertising activities;
- allowing the sponsor to use your name or logo;
- giving free or reduced price tickets;
- allowing access to special events such as premieres or gala evenings;
- providing entertainment or hospitality facilities; or
- giving the sponsor exclusive or priority booking rights.
They explain that ‘this list is not exhaustive and there are many other situations in which your sponsor may be receiving tangible benefits. What matters is that the agreement or understanding you have with your sponsor requires you to do something in return.’ They go on to say:
‘You may receive financial or other support in the form of donations or gifts. Provided they are freely given and secure nothing in return for the donor they are outside the scope of VAT. A taxable supply is not created where you provide an insignificant benefit such as a minor acknowledgement of the source of the support.’
The examples they provide include any of the following:
- giving a flag or sticker;
- naming the donor in a list of supporters in a programme or on a notice;
- naming a building or university chair after the donor; or
- putting the donor's name on the back of a seat in a theatre.
However, care must be taken when using the argument that the organisation has not ‘done anything’ to create a VAT supply. HMRC has explained that the granting of the right for a sponsor’s logo or name to appear in a charity’s publication or on their website is a supply of services for VAT purposes. It is the granting of the right that triggers the taxable event for VAT purposes rather than any activity (or lack of it) undertaken by the charity or the size and/or prominence of the logo. The same principles apply when a charity grants the right to a business sponsor to use the charity’s logo.
For the charity this area is fraught with the difficulties of interpretation and HMRC’s recent guidance appears to be taking a more robust view. It states:
‘Where a sponsor receives any benefits in return for a sponsorship payment, all of the payment for the sponsorship is consideration for a taxable business supply for VAT purposes.
‘However, it is recognised that there will be situations where the “benefit” amounts to no more than a mere acknowledgement of support, given gratuitously by the charity to the sponsor and is not directly linked to the payment made by the sponsor. Where this is the case the payments are considered to be a donation and therefore outside the scope of VAT.’
Events clearly organised and promoted primarily to raise money for the benefit of the charity are exempt from direct tax and VAT if certain conditions apply. Sponsorship income received from a sponsor will not be VAT-able or liable to direct tax if it is received to sponsor an exempt fundraising event.
Sometimes charging VAT can work to the charity’s advantage as it may increase the VAT the charity is able to recover on its own costs. In most cases the VAT charged to the commercial organisation will not be an additional cost as the organisation should be able to recover it. However some organisations such as banks may not be able to recover the VAT.
In other cases the charity may not want to register for VAT and the risk is that vatable sponsorships can push it over the VAT threshold.
Segregating the business sponsorship from the donation
Many charities have dealt with this problem by separating the donation from any payment for the benefit and minimising the element subject to tax. This is possible if the donation payment is entirely separate from the sponsorship payment. It must be clear that any benefits that the sponsor receives are not conditional on the making of the donation or gift.
This option must be used with care. The payments can only be apportioned when there is a clearly identifiable consideration for a supply for VAT purposes and a separate clearly identifiable donation. This means that is should be clear from the outset exactly what the intention is. Where there is a donation and separate payment for a benefit it is usually advisable for a written agreement that specifies the separate elements.
HMRC explains that if a donation is given in addition to the sponsorship payment this may be excluded from the taxable amount, provided that it is clear from any agreement that the donation is entirely separate from the sponsorship or the use of a logo and is freely given. If the donation is freely given, but on condition that a further benefit is provided, it is further consideration for a taxable supply for VAT purposes.
There can be one sponsorship agreement that identifies the element that is truly a donation and the element that relates to benefits, logo use etc. If HMRC believes that the agreement is not being adhered to it will base their tax treatment of the payments on the particular facts of the case.
In conclusion, this area is one where there are many opportunities and also pitfalls. It is therefore important to plan early and understand the substance and the legal form of the arrangements. To be on the safe side charities often include a clause in their sponsorship agreements stating that if VAT was deemed to be chargeable it will be in addition to the net amounts that the corporate may be paying.
Many of these arrangements are set up by fundraisers who do not have much knowledge of the tax rules and it is important that those that do, for example folks from the finance department, are involved at an early stage.
|
Key points
|
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.
kerry Jones, 08/10/2009
Excellent article keep up the good work.