Sweet FA

Changes contained in the Finance Act 2010 (FA) may lead to a revolution in the way the third sector operates in the future if the tax advantages which it, and donations made to it, have enjoyed are to continue to be available.

Following increasing pressure on the government as a result of the European Court of Justice decisions in Centro di Musicologia Walter Stauffer v Finanzamt München für Körperschaften (C-386/04) and Persche (C-318/07), the Act extended the tax reliefs granted to domestic charities to non-UK, EU, Norwegian and Icelandic organisations carrying out activities which English law would recognise as exclusively charitable '“ a 'European charity'.

HMRC has confirmed that a European charity, if registered with HMRC, will be eligible for all the reliefs given to domestic charities, including relief from income tax, Gift Aid, capital gains tax, corporation tax, VAT reliefs and exemptions, inheritance tax and the various stamp taxes. Therefore, any donor to such a charity should now enjoy the same inheritance tax exemption and income tax or capital gains tax benefits in respect of donations to charities as have previously been available for gifts to UK charities.

The price of the departure from the strict territoriality rules which were previously at the heart of the UK's approach to the taxation of charities and charitable giving was the introduction of two new, interrelated, hurdles which apply to all charities, UK or

European. First, to benefit from UK tax reliefs a charity will now be required to be registered with HMRC and recognised by HMRC as a charity for UK tax law purposes. Second, one of the prerequisites for such registration is that the organisation must satisfy the 'management condition'.

To satisfy this test the managers of the charity must be 'fit and proper persons', which fundamentally means that HMRC must be satisfied that their involvement will not give rise to a risk that the charity will abuse the beneficial tax treatment to which it and gifts to it would be entitled.

Signing up

Tax reliefs for all charities will now only be available if they are registered with HMRC. To be registered, an organisation must demonstrate that it meets the new definition of a 'charity' in UK tax law, is based in the EU, Norway or Iceland, is registered with any regulators in the organisation's home country which the law of that country may require, and fulfils the management condition.

Because, no doubt, of the anti-discrimination principles which led to the changes being made in the first place, these requirements apply equally to UK domestic charities and European charities. HMRC guidance states that, as previously, the mere fact that a domestic charity is registered with the Charity Commission or OSCR (or the Charity Commission for Northern Ireland) will not be conclusive of charitable status. The difference, however, is that such registration will no longer be prima facie evidence of charitable status for tax purposes.

An application for charitable status for tax purposes is now to be made by filing a new HMRC form: ChA1. This must be submitted to HMRC with a copy of the charity's governing document, any registration documents issues by the appropriate charities regulator, any available accounts, bank account statements and evidence of the charity's public benefit activities. The information requested includes:

• the funding history of the charity;
• the manner in which it proposes to raise new funds;
• the charity's area of operation;
• a description of the public benefit the charity provides;
• the identity of the charity's Gift Aid or tax repayment nominees; and
• the trustees, directors and managers of the charity.

An application cannot be made until the charity is registered with any domestic regulator, such as the Charity Commission or OSCR, with which it is legally required to be registered. Though some comfort for domestic charities can be found in the fact that this information is largely the same as that required for registration with the domestic regulators, there will be a duplication of effort as a result of the addition of another, separate application process for all existing and new charities.

In due course, it is intended that a full list of organisations to which HMRC has agreed to extend tax relief will be published on its website.

As the extension of the tax treatment of UK charities and donations to them followed changes to EU law, it is worth considering how other EU countries have changed their law. Of particular note is the Netherlands, which was one of the first to change its tax code to comply with the changes to EU law. Currently, Dutch donors receive a tax benefit when donating to foreign charitable organisations if it has been certified as a qualified charitable institution by the Dutch Finance Ministry and is registered with the relevant regulator in the country in which the charitable organisation is established.

However, on 19 March 2010, the European Commission delivered a formal request and reasoned opinion to the Dutch government requiring it to amend its tax code relating to donations to foreign charitable organisations on the ground that the Dutch registration requirement was too restrictive and should be changed.

The similarity of the Dutch registration requirement to that being implemented in the UK raises questions as to whether the EU will consider the UK regime similarly restrictive and require further alterations.

Fit and proper

The management condition requires that all 'charity managers' be 'fit and proper' persons. The definition of 'managers' contained in FA 2010 is 'in relation to a body of persons or trust'¦ the persons having the general control and management of the administration of the body or trust', which follows the definition of 'charity trustees' in section 97(3) Charities Act 1993. So, while 'managers' obviously catches a charity's trustees and directors, HMRC's guidance indicates it also extends to cover any person who has control, or can 'exert direction or influence', over the running of the charity or the application of its funds. It is clear from HMRC's initial guidance that it believes that, although the wording of the two Acts is identical, the concepts of 'managers' and 'charity trustees' do not have identical scope.

As an example of the people with control over the running of a small charity or of the application of its funds, HMRC's guidance on the point adds to the list above 'authorised cheque signatories'. Though this example is restricted to 'small charities' (a term itself without any clear limits) it is difficult to see any obvious boundaries on the class of persons who control or 'exert direction or influence' over the application of a charity's assets. Did Parliament really intend that a charity's advantageous tax treatment may be suspended because of the background of one of their employees in its accounts department? One must hope HMRC will exercise a degree of common sense on a case-by-case basis to identify those persons actually making decisions about the charity's strategic direction and spending decisions.

Irrespective of the question of who is, or is not, one of its managers, if a charity's regulator determines that an individual should not be a trustee or director of a charity, HMRC considers that that person cannot be a fit and proper person to act as a manager. However, the opposite is not true, though comfort may be found in the guidance where HMRC concedes that, as a matter of practice, it will normally assume that charities have given proper consideration to the selection of their managers until information that suggests otherwise comes to HMRC's attention. When information is brought to its attention, HMRC indicates that it will challenge the charity to prove that the person is fit and proper.

Charities are expected to be in a position to be able to demonstrate that they have taken reasonable steps to satisfy themselves of this; for example, by verifying the identity of trustees, checking their criminal records and obtaining a declaration from prospective trustees. The guidance suggests charities should be aware of 'evidence pointing to a heightened risk of involvement in'¦ fiscal or financial impropriety'. This may sound vague, but the crux of the issue must rest in what would amount to fiscal or financial impropriety. HMRC's guidance is silent, though it is safe to assume that the category of activity must be a broad one.

The result of this uncertainty of who may not be fit or proper and the potential consequences of being caught out '“ or losing advantageous tax reliefs '“ is that charities could now have imposed upon them a 'know-your-staff' burden greater than that in many areas of private industry.

Payback

HMRC's most recent guidance indicates that the level of any investigation into the fitness of a manager will vary from case to case to determine whether that person has any history of fraudulent behaviour, tax abuse or financial impropriety. The aim of these investigations will be to determine whether or not the individual in question is considered likely to exploit the charity tax reliefs for non-charitable purposes. HMRC indicates, however, that the consequences of a finding that a manager is not a fit and proper person will not always be a denial of tax reliefs. Rather, HMRC will have the discretion to allow tax reliefs throughout the entire period such a person was in office if it does not consider that failure to meet the management condition has not prejudiced the charitable purpose of the charity and it is just and reasonable to do so. HMRC also has a wide discretion to work with charities to 'remedy' the situation and may require the charity to dismiss the individual in question as a condition for continued relief.

While not obviously related to the extension of UK tax reliefs to European charities, there have also been amendments to the provisions of section 547b of the Income Tax Act 2007 and section 500b of the Corporation Tax Act 2010 which render payments to a body situated outside the United Kingdom non-charitable expenditure. Until FA 2010, this would automatically be the case if the charity did not take 'such steps as are reasonable in the circumstances' to ensure that the payment will be applied for charitable purposes. Now, the words 'the commissioners for Her Majesty's Revenue and Customs consider' have been inserted after the words 'such steps as', removing the decision of whether or not reasonable steps were taken from the courts and giving it, instead, to HMRC.

Whether such a requirement will itself be seen as a breach of the EU treaty, as restricting the flow of capital within the EU (the reason that tax reliefs have had to be widened in the first place) remains to be seen.

It was inevitable that the UK would have to amend its tax code to extend the tax treatment available to UK charities and donations to them to charities based in other EU states and donations made to them. The Stauffer and Persche cases each provide that an EU member state may take appropriate steps to satisfy itself that a foreign charity is subject to an equivalent degree of supervision as that which it requires for its own indigenous charities. However, the tests which the UK has introduced in FA 2010, coupled with the amendment to the provisions regarding the transfer of funds to non-UK bodies, are reminiscent, in several ways, of theintroduction of the Substantial Donor Rules in 2006.

Following criticism of the Substantial Donor Rules, HMRC set up a working party to review the changes required to remedy their shortcomings. Ironically, however, the implementation of these amendments was delayed by the introduction of the FA 2010 changes. Given the additional compliance obligations which the FA 2010 changes impose on charities, the fact that so much power has been transferred to HMRC, that the new provisions may themselves fall foul of European law and that they were, in any case, not subjected to the usual degree of parliamentary scrutiny in the scramble to get FA 2010 through Parliament before the election, it is hoped that they will now be subject to prompt and thorough review.