Facing up to fraud

HM Revenue & Customs' latest bid to tackle fraud in the charitable sector has sparked a backlash - but, as David Ainsworth reports, charity fraud of various kinds is a real problem

Earlier this year, HM Revenue & Customs was given sweeping new powers to crack down on fraud in the third sector.

The main one, known as the 'fit and proper persons' test, gives HMRC officials the power to refuse tax relief to any charity in the European Union if they feel its trustees and management are not suitable.

This test is the subject of a bitter battle between HMRC and a coalition made up of charity lawyers, accountants, sector umbrella bodies and peers, who say that it gives HMRC far too much power over UK charities.

This is not the first time HMRC has asked for and obtained powers to combat fraud in the sector. In 2006, a law was passed forbidding charities to pay money, even in the form of a salary, to any major donor or anyone connected with them - forcing charities, in effect, to track for up to 17 years all the relatives, business partners and companies connected to anyone giving them more than £25,000 per year.

So what is HMRC worried about? According to Bill Lewis, a tax consultant at the charity lawyers Bates Wells & Braithwaite, HMRC is largely concerned about people who make gifts to charities, allowing both themselves and the charity to claim tax relief, usually by using Gift Aid, and then get the money back.

In particular, he says, the new law has been introduced because of a decision in the April 2010 Budget to allow charities in the EU to claim tax relief on donations from UK taxpayers. "The fear is that fraudsters will establish fake charities in under-regulated eastern European jurisdictions," Lewis says. "They can then donate to those charities, collect personal tax relief and Gift Aid on that donation, and transfer the money back to their own bank accounts."

HMRC has said the fraud risk to the exchequer is about £500m a year. More controversially, it also says fraud is sufficiently widespread in the UK for the same rules to be applied to domestic charities, citing the fact that a number of Gift Aid frauds have been reported in the media.

These include the case this year of the theatre manager Andrew Fishwick, who fraudulently claimed £200,000 in Gift Aid by submitting evidence of non-existent donations to the arts charity Word of Mouth. And only last month, two managers at the accountancy firm Vantis appeared in court accused of using charity tax relief as the main tool in a complicated £219m tax-avoidance scheme in which shares were paid to charity, with donors claiming tax relief based on their full value, before buying them back at knock-down prices. The pair have insisted that they are innocent.

However, many feel the wide-ranging powers HMRC has been given are not justified by these frauds. "The powers in the Finance Act confer devastating and uncontrollable powers on HMRC," says charity tax lawyer James Kessler. "In effect, it has the power to say to any senior charity employee 'your charity will have to sack you or lose tax relief'. Certainly, HMRC needs some powers to fight fraud. But it shouldn't have the power to strip organisations of tax relief merely because it doesn't like them."

One problem, says Lewis, is that all charities find themselves increasingly tied up in red tape because of HMRC's nervousness about the tax breaks they have been given. "The UK has some generous tax breaks and they bring with them some potential for fraud," he says. "But HMRC has a tendency to see one or two examples of fraud and overreact. Its response has often been to establish new laws to give it more power, even though considerable powers are already available to it - powers they have often not even tried to fully test in the courts."

How much fraud is there in the sector? Ros Wright, chairman of the Fraud Advisory Panel, says that tax fraud is an issue, but bogus charities and fraud within charities are bigger concerns.

Charities suffer internal fraud in the same way as the private sector, she says, chiefly when employees put their hands in the till. "Last year, we surveyed 1,100 charities and we found that reported fraud was much lower than in the private sector," she says. "But we believe the situation was under-reported because many charities do not wish to admit they have been defrauded. When we carried out a round-table discussion with 27 charities, all said they had been victims of fraud from within."

Wright says there is a culture of trust and a lack of internal checks, particularly of volunteers, that might make charities easy targets for fraud. But she does not believe the scale of fraud in the voluntary sector is different from that in the private sector.

Charities are targets for fraud because of their mindset, says Sterl Greenhalgh, head of the anti-corruption unit at accountants Grant Thornton. "Charities are seen as vulnerable to fraud - and often are - because they exist to help people and distrust doesn't come easily," he says. "Many small organisations in the sector don't have the money for training. The important thing is to have an anti-fraud mindset. Think about how you would commit fraud, then look at how to prevent it."

It is harder for charities to stop frauds committed in their names, says Andrew Studd, a partner at law firm Russell-Cooke. "These come with reputational risks attached, but it's difficult for charities to even know they exist," he says. "One of our clients, a large charity, found out that someone had been collecting clothes in its name. The charity discovered this was happening only because a friend mentioned it to one of its employees. The fraudsters who do this look increasingly like the real thing."

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