The Business Lounge has identified an unlikely group of winners from recent tax changes: charities and more specifically, their donors. With many of us entrepreneurs now seeing philanthropy as an integral part of our business activities, read on to make sure you maximise any benefits.

The following relates to cash donations by individuals to registered charities; a form of “gift aid” does exist for donations direct from companies, but how tax relief is obtained is different and is not covered here to avoid further complications.

Gift Aid – the basics for individuals

The phrase “gift aid” refers to a set of tax rules which allows a charity to recover tax that a donor has already suffered on the money used to make a donation. You will be familiar with charities asking whether you wish to “gift aid” your donation. If you answer yes, then they will direct you to make a declaration which will include your confirmation that you have paid sufficient tax that year for the charity to reclaim, and some details such as your name and address etc.

Prior to April 2008, the charity would recover 22% (the basic rate tax), and if you as the donor were a higher rate tax payer, you could recover the other 18% (giving a total of 40% tax). If that’s clear as mud, take a deep breath and let’s look at an example.

Example – pre-April 2008

Say I gave £100 cash to a charity, and made a gift aid declaration. This amount would then treated as the net donation, after tax of 22%, i.e. the gross donation would be £100 x 100/78 = £128. The charity would then reclaim the extra £28 from the taxman. If I were a higher rate tax payer (i.e. I had actually suffered 40% tax on the money I used to make the donation), I could then make a claim on my tax return to recover the further 18% tax myself i.e. £128 x 18% = £23. So my donation of £100, really only cost me £77, but would benefit the charity by £128.

Put like that, you can see the benefit both to the charity and the donor of making the gift aid declaration and crucially, of the donor remembering to make the claim on their tax return.

Recent changes – position for the charity

As we’ve discussed in some detail in The Business Lounge, there have been two recent changes to income tax rate – abolishing the 10% tax rate, and decreasing the basic rate of tax from 22% to 20%.

Luckily, we are not going to talk about the 10% yet again, but as you can see from the example above, if the basic rate were reduced with no change to the gift aid rules, then the charity would suffer to the tune of £3 in the example above. This is because, for the same cash gift, the gross donation would be £100 x 100/80 = £125, instead of £128, and so the charity would only be able to reclaim £25 of tax.

In response to the outcry from the charitable sector, the Chancellor announced in his 2008 Budget that for donations made between 5 April 2008 and 5 April 2011, the Government would make up this shortfall to charities by topping up the “lost” 2% in the form of a supplement. Therefore in our example above, the charity would still benefit by £128.

Recent changes – position for the donor

Despite this supplement, it appears that the higher-rate donor may still recover the extra tax, being 40% less the 20% claimed by the charity, i.e. 20% of the gross donation. This ignores the supplement. Working through the same numbers then, the donor recovers £125 x 20% = £25. So the net cost to the donor becomes £75, while the charity still benefits by £128.

You note that we have said this “appears” to be the case. While the supplement for charities has been mentioned in the press, there has been little analysis of the donor’s position. However, the examples given above are consistent with HM Revenue & Customs own information. The introduction of the supplement, and indeed of the change in the basic rate of tax, have yet to be finalised in legislation. This won’t happen until the Finance Bill receives Royal Assent in the summer, and given the controversy over the 10% rate etc, we would not be surprised by any further changes.

Practical issues

This then, is an example of how an attempt to limit the damage of the proposed tax rate change to a particular group (charities), actually gives rise to an overall benefit to the tax payer.

However, this could largely be a theoretical benefit if donors aren’t careful. As we know from our own experience, a gift aid declaration is not made in all cases where it could be, and even if it is, how many higher rate taxpayers then remember to make the appropriate claim on their tax returns? Donors do tend to give round sum figures, and, especially for one-off payments, do they ever take into account the actual net cost to them after tax relief, and bump up their donations accordingly?

We suggest that unless as a donor you are careful in recording your donations, and making your claims, this benefit could largely be wasted.

There is also a form you can fill in when completing your tax return, which allows you to donate any repayment due to the charity of your choice. While everyone welcomes a tax repayment, if this is not going to be much you may consider donating in this way too. As you might not know what amount is due back when completing your form, you can specify a maximum amount you wish to donate.

A note of caution
This article does not deal with all the criteria necessary for a donation to qualify for gift aid (including to whom the donation is made, what qualifies as a “donation” – generally, if you receive anything in return then gift aid is jeopardised – when a payment is made etc), so we recommend that you check with the charity to which you are donating and with your accountant, whether a claim is possible.

As with all our information in The Business Lounge, this is not comprehensive tax advice, and may not apply to your specific circumstances; to discuss how these issues affect you, contact your accountant.