It's up to charities to make sure their supporters take advantage of available tax relief, says tax lawyer David Rhodes.
When considering whether to make a charitable gift, most people are likely to consider only "how much?" and "to whom?" Some gifts are spontaneous, such as loose change in a collection box; some may be planned but non-recurring, such as a gift to a disaster appeal or a legacy in a will. Other gifts take the form of regular structured giving, perhaps a weekly contribution to the church fund or a monthly direct debit to a charitable cause. Whichever method of giving is chosen, the intention is usually to simply benefit the cause selected.
Although the intention of the giver is the same in each case, each type of gift may be treated in a different way when it comes to tax. By giving a bit more thought to the various ways in which a gift can be made and choosing the most efficient method, the value of the gift can be increased significantly.
There is no denying that taxation is a difficult subject, and the complexity of the annual tax return forms can put people off claiming the tax reliefs that are available. There is a natural fear of getting it wrong, or of provoking HM Revenue & Customs into asking questions.
However, successive governments have legislated to encourage charitable giving by providing specific tax reliefs for individuals who wish to do so. These are not tax loopholes whose exploitation denies the exchequer important revenue - they are deliberately targeted reliefs, intended to be used.
Charities can help by making sure they understand the options themselves and encouraging donors to think about them. Here we provide a summary of the key tax reliefs and an indication of some of the issues donors should consider.
The article is arranged to reflect the main types of gift a donor can make and the taxes that have an impact on the value of that donation.
In short, gifts may be made during an individual's lifetime, or through their will, and can take different forms - cash, shares and land, to name the main three. The form of gift can have important implications for the value the charity receives when the effects of taxation are taken into account.
Three key taxes affect a gift: income tax, capital gains tax and inheritance tax. Tax reliefs can reduce the impact of each of these taxes either by allowing the charity to reclaim tax already paid by the taxpayer or by allowing the taxpayer to pay less tax. Either way means significantly reducing the real cost of charitable gifts for the donor and increasing the net value of the gift to the charity.
Gifts of Cash Income tax relief
When an individual makes gifts of cash to a registered charity, the Gift Aid scheme can apply.
The effect is that the charity can recover basic rate tax on the grossed-up value of the gift. For example, £78 in a basic rate taxpayer's pocket is the equivalent of £100 pre-tax income. If the taxpayer makes a £78 gift to charity under the Gift Aid scheme, the charity can recover the £22 income tax paid in addition to the £78 received direct from the taxpayer - so £78 is worth £100 to the charity.
Where a higher-rate taxpayer makes the gift, it takes only £60 in their pocket to be the equivalent of £100 pre-tax income. A charitable gift of £78 by a higher-rate taxpayer would still allow the charity to recover only £22 in income tax, but the taxpayer can recover the missing £18, making the net cost of a £100 charitable donation only £60. Nevertheless, many taxpayers fail to recover their own portions of the available tax relief.
In order to qualify for the Gift Aid scheme, a gift must comply with certain conditions, mainly that the gift is in the form of cash, the donor benefits no more than minimally from the gift, that no condition as to repayment is attached to the gift, that the donor makes a formal declaration in the prescribed manner and that the donor has paid enough income tax to cover the tax relief.
The taxpayer's declaration is essential if the charity is to comply with the requirements placed upon it. It asks for details of the person making the gift, the name of the charity and a description of the gift itself.
At the very least, charities must now keep auditable records of Gift Aid declarations so that they can show donors were made aware of the effects of making a Gift Aid donation.
Some individuals make charitable gifts from their income by payroll deduction, which is another method of tax-efficient charitable giving regulated by law. This method provides income tax relief because the gift is deducted from gross pay before tax - so Gift Aid is not applicable in these cases.
GIFTS OF CASH INHERITANCE TAX RELIEF
To benefit from inheritance tax relief for charitable giving, a donor doesn't have to specify which charity will benefit from the gift: it will apply even where there is a general gift for charitable purposes. This can be a useful distinction where a charitable gift is to be made but the precise charities to benefit have not yet been identified. Provided the gift is exclusively for charitable purposes and does not form part of any wider scheme to try to avoid inheritance tax, it will immediately fall outside the donor's estate for inheritance tax purposes - so, if the donor died the very next day, the donation made to charity would not be subject to inheritance tax at all.
However, because there is no inheritance tax to pay on charitable gifts made on death, there is no inheritance tax advantage in making the gift early. Indeed, there can be advantages to delaying the capital gift on death if there is an overall inheritance tax liability on the estate.
For example, if a taxpayer with an estate valued in excess of the tax-free limit (£275,000 for 2005/06, £285,000 for £2006/07) wants to share their estate between their children and charities, but can only spare a certain amount of cash immediately, it may well be more advantageous from an inheritance tax perspective to make the lifetime gift to the children, reserving the charitable gift to take effect on death. This allows any capital gains to disappear on death (see below) while avoiding any inheritance tax liability charge because of the charity exemption.
If the gifts made to children in the taxpayer's lifetime are survived by seven years, they fall outside the taxpayer's estate completely, lowering the overall inheritance tax burden. If the lifetime gift had been made to the charity instead, a higher proportion of the estate passing on death would pass to the children and would be subject to inheritance tax.
GIFTS OF CASH CAPITAL GAINS TAX
This tax can never arise on a gift of cash.
GIFTS OF SHARES AND LAND INCOME TAX
Income tax relief is available on gifts of shares, whether listed on the main stock exchange or on the Alternative Investment Market. It is also available on the gift of unit trust holdings and shares in open-ended investment companies.
The income tax treatment of such gifts differs from gifts of cash. The Gift Aid scheme, allowing the charity to recover income tax already paid by the donor, does not apply. Instead, the donor simply deducts the market value of the investments given from their taxable income in the year in which the gift is made. Their income is therefore lower than it would otherwise have been, resulting in a lower income tax bill.
Where donors pay their income tax through deduction at source rather than through the method of self-assessment, they will already have paid income tax and will need to reclaim any overpayment that has occurred in order to obtain the tax benefit.
Gifts of land are treated in the same way, except that, if the income tax relief is to apply, the land must be situated in the UK and the charity must give a certificate to the donor confirming key information about the land received.
GIFTS OF SHARES AND LAND INHERITANCE TAX
The treatment of gifts of shares or land for inheritance tax purposes follows the treatment of cash. The gift reduces the value of the donor's estate and less inheritance tax should be payable than if the charitable gift was not made. But there is no material tax difference between making a lifetime gift and making a gift by will, except as noted below.
GIFTS OF SHARES AND LAND CAPITAL GAINS TAX
When individuals give assets away they will normally be deemed to have disposed of them, and a capital gains tax charge may arise if the value of the asset has increased since the taxpayer acquired it. Gifts of assets to charities are deemed to be on a 'no loss-no gain' basis - the taxpayer does not incur a gain by making the gift. Instead, the charity acquires the asset at the same base cost the taxpayer had. Fortunately, because charities do not pay capital gains tax on gains made on disposal of their assets, any asset they receive that has a capital gain attached to it can be sold by the charity without tax becoming due. Therefore, giving land or shares pregnant with capital gains directly to the charity, rather than selling the asset and making a gift of the cash proceeds, will enable the charity to realise the full value of the gift without deduction of any tax.
For example, a donor may wish to give £50,000 in cash to a charitable cause. If this money is generated by selling some investments that have grown in value, capital gains tax may be payable by the donor. But if the donor had given the shares themselves to the charity, it could have sold them without risking any liability to capital gains tax. In the second case, the charity has the benefit of the entire value of the shares. In the former, either the gift would have to be reduced to set aside the tax or the taxpayer would be forced to use further funds to meet the tax liability. Either the charity or the taxpayer is worse off.
GIFTS ON DEATH
Gifts of Shares or Land Income Tax
There are no income tax effects of a gift to a charity in a person's will.
GIFTS OF SHARES OR LAND INHERITANCE TAX
Gifts to charitable causes made by will are exempt from inheritance tax, and none should arise on the gift as a result. Take care when the estate contains gifts to non-charitable beneficiaries as well as charitable gifts, especially if the residue is shared between charitable and non-charitable beneficiaries.
The residue of an estate is that part left over after all other legacies and expenses have been paid. Dividing the residue between charitable and non-charitable beneficiaries can result in more inheritance tax being paid than would otherwise be the case through what is known as 'grossing-up'.
If the will says the residue is split equally between a charity and, say, a child, this suggests that each should get the same amount. However, because the child's share bears all the payable inheritance tax, the child will actually receive less than the charity. In order to receive the same amount after payment of these taxes, the child's entitlement has to be increased to the amount that, after deduction of inheritance tax, is the same as the charity. Because the child's share has notionally gone up, inheritance tax is payable on a larger amount, resulting in more inheritance tax becoming payable. Careful will drafting can deal with this, but there are other pitfalls, so advice should always be sought where the estate might have inheritance tax liability.
GIFTS OF SHARES OR LAND CAPITAL GAINS TAX
When a person dies, all the gains that might have built up in the assets they own are 'washed out'. Because inheritance tax is chargeable on their entire estate (even if none is actually payable), the capital gains are eliminated without charge and the base values brought up to the values at the date of death. It might be thought that this is universally good news - and it generally is.
Great care should be taken, however, if those assets continue to increase in value while the estate is being administered and a charitable beneficiary is ultimately entitled to them. The reason for this is that if the executors sell the asset, they may incur a capital gains tax liability. If the executors transfer the asset to the charity, or even declare that they hold the asset on behalf of the charity before it is sold, no capital gains tax will become payable.
David Rhodes is an associate solicitor with Hull-based law firm Andrew M Jackson. He specialises in inheritance tax and capital gains tax planning for clients, as well as advising on succession planning within businesses and the use of wills and trusts in tax planning strategies. Email email@example.com.
PLANNING TIPS FOR DONORS
- Consider making lifetime gifts to non-charitable beneficiaries and charitable gifts by will to give the best chance of minimising overall inheritance tax
- Keep a clear note of charitable donations to enable higher-rate taxpayers to recover further tax from the HMRC
- If you have assets that have a capital gain, consider giving the asset itself to the charity rather than a gift of cash
- Consider setting up a personal charitable trust if you want to make a substantial gift but have not yet decided on its ultimate destination.