Well, the long-awaited HMRC and Treasury “clarification note" on the proposed new tax cap measure has finally come out, and it isn’t good news for the voluntary sector. There are still a lot of questions to be answered, but what is clear is that HMRC’s interpretation of the rule is about as bad as it could be for charities.
In a few previous posts I tried to outline how I thought the new measure would work, based on what I thought were some reasonable assumptions. I did make a couple of caveats about possible alternative interpretations, although I ruled these out on the grounds that they seemed absurd and unworkable…
Unfortunately it is precisely these caveats that have proved to be true.
The main problem is that HMRC and Treasury have taken it as definitional that “tax relief” refers to a “reduction in the amount of income you pay tax on” rather than “the amount of tax you save”. This definition works OK for tax breaks where you offset against gross income, but is confusing when applied to a system like Gift Aid, which relies on reclaiming tax already paid. In this case, it is more natural to think of the “tax relief” as the value of the marginal tax that you can reclaim personally (and perhaps also the basic rate tax, although this has to go to the charity).
HMRC and Treasury have managed to square this apparent circle by allowing that: "as some reliefs (such as Gift Aid) reduce tax liability in a different way the self assessment return will calculate the amount of relief to make it equivalent to those reliefs that offset income."
But this just seems like they are trying to retro-fit a consistent interpretation onto a system of charitable tax reliefs that contains some obvious inconsistencies, and have chosen the most swingeing interpretation in order to do so. It also sounds like it is going to make an already quite complicated system even more difficult to fathom.
It should be noted, as well, that HMRC and Treasury intend to include the amount of basic rate tax reclaimed by the charity in the calculation of when the cap kicks in:
The cap will not impact on the tax reclaimed by charities under the Gift Aid scheme. However, the grossed up donation (that is the donation made by the donor plus the tax reclaimed by charities) will be taken into account when assessing whether an individual donor has reached the cap. If the cap has been reached the donor will receive no tax relief on the grossed up donation above the cap and, as now, the donor will need to have paid enough tax to cover the tax repaid to the charity.
So for Gift Aid, this means that it is not the value of reclaimed tax that is subject to the “£50K or 0.25% of income rule”, but the grossed up value of the gift (i.e. the gift plus the basic rate of tax reclaimed by the charity). I am still not quite sure what is meant by the donor “receiving no tax relief on the grossed up donation above the cap”. My best guess is that it is intended to account for the fact that the personal higher-rate relief available through Gift Aid is calculated on the grossed up amount of the gift. So this means that the maximum that someone earning £200K would be able to give truly “tax-effectively” would be £40K (As this gets grossed up to £50K).
This is quite confusing, as the example given in the clarification note states that:
"An individual with an income of £4 million will still be able to give £1 million to charity - or offset £1 million of income against their business losses – and
still get full tax relief for that £1 million.”
What this doesn’t make clear is that this individual would presumably be worse off than they are now? Whilst currently they would be entitled to marginal rate relief on the gross value of their gift (i.e. £1.25m, giving relief of £312.5K), under the new rules, the amount on which they could claim relief would be limited to £1m, so the relief would be reduced to £250K. This is really not clear.
“My lustrous hair and I are so confused…”
Attempting to apply these rules might seem like a mug’s game. However, I have broad shoulders, so I have attempted to modify the examples I gave in my previous post to reflect the clarification (or at least my understanding of it) and spell out the impact of the new cap. Here goes…
Example one: Ms Rockefeller is a keen patron of the arts who earns £800K, and pays 45% tax. She has accumulated some assets, and decides to respond to a capital appeal by her local museum by giving £1m.
Under current Gift Aid Rules: Her gift is grossed up to £1.25m, and she can get personal relief on the marginal tax she has paid on this sum, i.e. £312.5K. This means that it effectively costs her £687.5K to give a gift of £1.25 charity.
i.e. charity gets £1.25m, effective cost to donor: £687.5K
Under current share giving rules: She is able to offset her £1m gift against her income, thus reducing her income tax liability to zero. This results in a reduction of £478K in the amount of tax she pays, so it effectively costs her £522K to give £1m.
i.e. charity gets £1m, effective cost to donor: £522K
Gift Aid under the proposed cap: Her gift is still grossed up to £1.25m, but now the amount on which she is able to claim marginal tax relief is limited to 0.25 of income i.e. £200K (as this is greater than £50K). So she can claim £50K of relief. It now effectively costs her £950K to give £1.25m to charity
i.e. charity gets £1.25m, effective cost to donor: £950K
Share giving under the proposed cap: She can now only offset £200K against her income tax liability (as this is 0.25% of income, and is greater than £50K), thus reducing tax liability to £600K. This results in a reduction of £100K in tax paid, so it effectively costs her £900K to give £1m
i.e. charity gets £1m, effective cost to donor: £900K
Example 2: Mr Carnegie is a manager earning £140K per year, and paying 40% tax. He has a fairly generous share windfall and decides to give £300K to charity. (Assume these shares have risen in value £500K, so in the Gift Aid example where he sells them, he pays roughly £98K in capital gains tax, as this ensures he has paid sufficient tax to be able to make a Gift Aid declaration)
Under current Gift Aid Rules: His gift is grossed up to £375K, and he can get personal relief on the marginal tax he has paid on this sum, i.e. £75K. This means that it effectively costs him £225K to give a gift of £375K charity.
i.e. charity gets £375K, effective cost to donor: £225K
Under current share giving rules: He is able to offset his £300K gift against his income, thus reducing her income tax liability to zero. This results in a reduction of £49K in the amount of tax he pays, so it effectively costs him £251K to give £300m.
i.e. charity gets £300K, effective cost to donor: £251K
Gift Aid under the proposed cap: His gift is still grossed up to £375m, but now the amount on which he is able to claim marginal tax relief is limited to £50K (as this is greater than 25% of income). So he can claim £10K of relief. It now effectively costs him £290K to give £300 to charity
i.e. charity gets £375K, effective cost to donor: £290K
Share giving under the proposed cap: He can now only offset £50K against his income tax liability (as this is greater than 0.25% of income), thus reducing tax liability to £90K. This results in a reduction of £23K in tax paid, so it effectively costs him £277K to give £1m
i.e. charity gets £300K, effective cost to donor: £277K
There seems to be no acknowledgment in the note of the fact that Gift Aid fundamentally differs from reliefs based on direct deductions in that a portion of the available tax relief has to go to the charity, so does not benefit the donor personally, whereas in direct deduction reliefs the full tax benefit goes to the individual.
This is linked to the fact that there is an ongoing failure to recognise the clear qualitative difference between someone being able to reduce their tax liability because they are making payments on a loan or offsetting business losses (from which they receive a clear benefit) and someone being able to reduce their liability because they have given away a significant proportion of their income to a children’s hospice. This doesn’t seem a particularly difficult distinction to grasp to my mind.
There also seems to be a naivete about the way that major donors think about their giving, betrayed by the suggestion that:
"Individuals who want to give more than 25%, or £50,000, of their income
to charity will still be able to do so from their taxed income.”
This shows a failure to grasp that donors who are aware of tax-effective methods of giving often think in gross terms, rather than deciding on the value of a gift and then working out the tax relief later. It also ignores the fact that major donor fundraisers will now be put in the impossible situation of not being able to say with any certainty what a gift will actually cost to a donor, unless they have full knowledge of the donor’s income and other tax affairs.
Oh, one other thing: the note suggests that the cap on charitable tax reliefs is OK “because they have one in the US”. And this seems to be a line that is set to be repeated ad nauseam over the coming months. Well, yes- they do have a cap in the US. But for a start it is set at 50% of AGI rather than 25%. Also, the entire US system is based on direct deduction rather than reclaim. And it covers gifts of property as well as cash (works of art, clothes etc.) And they have a greater range tax-effective giving methods available in the US, such as living legacies. And lower rates of income tax. But other than that, it’s a great example…
It certainly seems like any government ambitions to match the much-vaunted “US philanthropic culture” should now be shelved, if they are introducing a tax relief cap that is twice as strict as that in the US, without making any other changes to bring us into line with their charitable deduction system.
Finally, the note states that:
Whilst the Government has decided that unlimited income tax reliefs, including
charitable reliefs, should be capped, it is committed to exploring with the philanthropy and charity sectors ways to ensure that this change does not significantly impact on charities which depend on large donations.
Obviously we need to continue to engage with this as far as possible, but it is really quite hard to see, given this interpretation of the rule, how the impact on charities of all sorts can be anything other than “significant”. The Give it Back George campaign is going to be even more important now.