Taxing matters
The misconception that charities are 'exempt' from taxation has obscured the tax costs charities do incur, according to the Charity Tax Map
KEY POINTS
- 18 different taxes affect the sector
- This research examined a representative sample of 31 charities
- Their total tax bill was £147.3m
- The largest tax burden on charities is unrecovered VAT
- Total compliance costs were £2.9m
Any organisation employing staff has to pay employer's national insurance and will have to pay VAT on most goods and services it purchases. The basic rule of recovering VAT on inputs (business purchases) and charging VAT on outputs (supplies) gets complicated because charities’ main objective is not to make a profit in the course of business and engage in commercial activities.
As Pesh Framjee pointed out in the Caritas Guide to Finance (December 2010), “Charities are affected by income/corporation tax, VAT, employee taxes, and capital gains tax (CGT) and a vigilant penalties regime means that charities cannot afford to be ignorant of potential tax liabilities.”
Quite apart from the liabilities themselves, one of the biggest problems is the cost of compliance. The issue of whether charities should have further concessions from HMRC is rather separate from unnecessary costs imposed by an inefficient collection system. While charitable status confers some basic benefits, it is the complication of working out where the tax reliefs are and the various different compliance regimes that eats into valuable operational resource.
Charity Tax Map
So, the recent research from the Charity Tax Group (CTG), outlining the precise impact of the current tax regime on charities, has gone a long way to engage the government and HMRC in looking again at what can be done to help the sector. Dave Hartnett, the permanent secretary for tax and head of HMRC, sees part of the solution to driving down compliance costs as moving as fast as possible over to electronic media and welcomes the research “because it promotes transparency.” He was speaking at the launch of the Charity Tax Map on 3 February 2011. The rest of this article summarises the main results of the research which was conducted by the CTG under the supervision of Cathy Pharoah from the Centre for Charitable Giving and Philanthropy at Cass Business School.1
The details of all the relevant taxes and their reliefs by activity can be found in a summary of the Charity Tax Map on page 13 of the full report (see note 1).
Aims and methods of the research
As part of the mapping exercise, 31 charities responded to a detailed questionnaire which asked in depth about the general financial and compliance impact of dealing with the taxes that affect them. The research supplemented data from the responses of 87 charities to a survey about their irrecoverable VAT. The aims of the general mapping study were to:
- establish the extent of different taxes affecting charities;
- estimate the total amount of tax paid;
- estimate the costs of compliance;
- identify and analyse patterns and key trends in charities’ tax burdens; and
- identify any important messages and conclusions about charities’ tax liability.
While some accounting conventions led to a few problems with matching up tax paid with both income and expenditure in a given year, the researchers did not believe these minor distortions invalidated the picture presented by the overall findings.
The costs of internal compliance were quantified using a notional figure of £35 per hour for suitably qualified financial staff and the data on time devoted to it provided by charities, to give indicative and comparative estimates. External compliance costs (such as fees paid to tax advisers) were taken into account when the charity had provided this information.
Findings
Number of taxes paid
Charities in the sample paid 18 different types of tax, revealing the need for a high level of tax expertise in the charity sector as a whole, and there was a lot of variation across the charities surveyed in the number and range of taxes that affected them. The average number of different taxes paid by the sample was six, and the range went from three to nine. The average number of types of tax that charities had to comply with was five (the range was one to 14). The reason for this discrepancy was that:
- a charity may spend money to ensure compliance with a particular tax, although the result may be that it pays no tax in this category; and
- data on compliance time and costs is incomplete − while some charities have access to data showing the amount of tax paid, they do not necessarily have corresponding data detailing how long the process of compliance took or their compliance costs against each individual tax.
Amount paid
A total of £147.3m was paid in taxes across the 31 charities. Across the sample, it was found that the total amount of tax paid by charities was broadly in line with total expenditure – the larger the charity, the larger its tax bill. However, some charities had a much higher burden of tax per pound of expenditure than others. This was partly because some are subject to more than one tax and the different types of charity will have different exposures. An organisation employing a lot of staff will inevitably pay a greater amount of employer’s NICs. For example, Action for Blind People’s tax burden was 57.4 per cent employer’s NICs and 39.6 per cent irrecoverable VAT. Scope came in at 75 per cent employer’s NICs and 6.6 per cent irrecoverable VAT. However those involved in a lot of trading transactions come up against VAT as the main problem. For example, Build Africa’s tax burden was 63.5 per cent VAT and 34.4 per cent employer’s NICs, and Amnesty International UK was 39.6 per cent VAT and 23.5 per cent employer’s NICs.2
Distribution of total tax paid
The survey examined the distribution of the total tax paid across different types of tax. The table set out in Figure 1 demonstrates that:
- Employers National Insurance Contributions (NICs) is the largest single category of tax paid and affected all charities in the sample. Just over half the total tax cost (54 per cent) relates to NICs.
- Irrecoverable VAT, also affecting all charities in the sample, represents just over one-third (37.5 per cent) of the total tax cost for the 31 charities in the detailed survey.
- Using figures from the larger survey of irrecoverable VAT which was carried out and which obtained 87 charity respondents, we can estimate through extrapolation that it costs charities approximately £1bn per annum.3
- Business rates accounted for 5.8 per cent of the total.
- The remainder of the tax burden is split between a wide range of other taxes which have a differential impact on different charities.
- Corporation tax, income tax, stamp duty land tax and capital gains tax can all lead to significant compliance costs being incurred by a charity in order to minimise a tax bill or to take advantage of an exemption/relief.
- Air passenger duty and insurance premium tax incur virtually no compliance costs because both taxes are collected by the supplier.
Compliance costs
The total cost to the respondents of tax compliance was £2.9m, of which 57 per cent represented the cost of compliance related to irrecoverable VAT. These costs cover internal costs of finance staff (at a notional £35 per hour) and external costs on advice. They include not only the cost of meeting internal requirements in a comprehensive and timely fashion but also the cost of taking full advantage of the tax reliefs available. For example, a lot of the costs associated with business rates will relate to applications for discretionary relief – and the more successful the charity is in making the applications, the lower its business rates will be.
Turning to Figure 2, it can be seen that the vast majority of tax is paid out in the form of irrecoverable VAT and employer’s NICs. Although, proportionately, employer’s NICs raise more tax, the compliance costs for irrecoverable VAT are higher. Worryingly, while the other taxes may raise little in revenue for HMRC, for individual charities there may still be a substantial compliance cost in order to qualify for the relevant exemption or relief.
Gift Aid recovery
The total benefit in terms of tax reclaimed through Gift Aid by the 31 charities who took part in the survey was £60.5m, 6 per cent of the total Gift Aid reclaimed by the sector. 4 The associated compliance costs to recover that amount of Gift Aid were estimated at £1.4m, equal to 2.4 per cent of the total Gift Aid received (see Figure 3). The compliance costs per pound of Gift Aid income across the sample varied widely from one penny per pound to 70 pence per pound of Gift Aid income.
The take-up rate of donors using Gift Aid was in the range of 50 per cent to 75 per cent, averaging out at 65 per cent. In addition, the research suggests that compliance costs for Gift Aid may create a barrier to using the scheme if the charity has a low level of eligible donations. More detail on the Gift Aid system and its limitations is helpfully set out in ResPublica’s Digital Giving research report which highlights that charities are missing out on as much as £750m in Gift Aid recovery because of the current ‘antiquated system’.5 Peter Fanning’s final report to the Treasury on the Gift Aid consultation is also important background.6
Summary of main findings and comments
The research has demonstrated how difficult it is for charities to compile complete data on their tax burden and associated compliance costs.
The main findings do point to the high proportion of the total compliance costs being related to irrecoverable VAT. Also the significant variation between charities in their tax and compliance costs, in this sample, bore little relationship to variations in the scale oftheir activities.
“It is likely that the biggest factor underlying variation in the tax burden is the nature of the charity’s objectives and activities”, reflects Cathy Pharoah. “It seems unfair that certain types of charity and of good causes are penalised because of the nature of their mission, especially as all the objectives of registered charities are equally charitable in the eyes of the law.
The result is that there is less resource for some groups of charity beneficiaries and types of services, a situation undesirable for donors,recipients or organisations”, she said.
CFDG’s chief executive Caron Bradshaw sees the report as evidence that simplification of the tax system is long overdue. “Crucially, this report shows that it is not only the tax that charities do pay, but also taxes they don’t pay,but have to comply with, which are highly burdensome to the charity – with no benefit to the Exchequer.
This shines a spotlight on the extent to which the tax system weighs down on charities’ functions; if the government wishes to support and enable the sector, simplifying the tax environment in which they are required to work would be a significant contribution to this.”
The CTG is delighted with the level of interest in the Charity Tax Map, which was downloaded nearly 1,500 times in just four weeks. Helen Donoghue, director of the CTG, said: “There has been a long-standing assumption that charities are not particularly affected by the tax system and that the only tax that they pay is VAT. As the Charity Tax Map demonstrates, that is simply not the case. Charities certainly do pay taxes other than VAT and for some of them the compliance costs are very high.
“’Mapping’ the interaction between the tax system and charities is just the first step in getting to grips with the scale of the problem. We plan to repeat the exercise with a much wider sample of charities and to conduct further detailed research on the tax positions of individual charities – it is the only way of demonstrating to the government precisely where the problems are most acute and where action is urgently needed”, she said.
1. A PDF of the full report, Charity Tax Map, published February 2011 by the Charity Tax Group and supported by the Nuffield Foundation can be downloaded from: www.ctrg.org.uk/files/tax_map/ CTG_charity_tax_map_03-02-11.pdf
2. See pages 121 to 134 of the full report for all 12 case studies.
3. Irrecoverable VAT and its impact on charities – June 2010, Charity Tax Group, available from: www.ctrg.org.uk/files/?id=221
4. For a total reclaim picture see the HMRC figures at www.hmrc.gov.uk/ stats/charities/table10-4.pdf
5. www.respublica.org.uk/sites/ default/files/Digital%20Giving.pdf
6. http://www.hm-treasury.gov.uk/d/ gift_aid_forum_final_report.doc
Author: Clarissa Dann
Clarissa Dann was the editor of Caritas as well as an HR and management online service,he People Bulletin until July 2011.
She is now the editor of the specialist trade finance magazine, Trade and Forfaiting Review which can be viewed at www.tfreview.com but does write on charity finance and investment from time to time.
Clarissa has a background in legal and professional publishing, as well as business journalism and holds an MBA from
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