As its not compulsory, for some charities it could appear that filing a tax return is simply not worth the time. However, this doesn’t prevent HMRC from performing random checks on charities to ensure exemptions are being claimed correctly.

Registered charities are able to access exemptions from direct tax (either income tax or corporation tax, depending on the legal form of the charity) on various sources of income. However, there is no blanket exemption from tax afforded to charities simply by virtue of their charitable status. If a charity is in receipt of income that does not fall within any of the available exemptions then the profit element of the income – i.e. following the allocation of attributable costs – will be subject to tax.

In this insight we outline the basics of a charity tax return and what qualifies as exempt income. As we mentioned, even though there is no compulsory need for charities to complete tax returns, if a charity is issued a notice to complete a tax return, they must complete it or if they have been exempted for a period but still have a taxable source of income, they must still complete a return. 

So what qualifies as exempt charitable income?

Broadly speaking, the main exempt forms of income in the hands of a charity are:

• Donations and legacies;

• Trading income, where this derives from activities in furtherance of or ancillary to the charity’s objectives, or activities carried out by the charity’s beneficiaries; and

• Certain investment and property income.

Trading income derived from activities not directly linked to the charity’s objectives, such as rental of facilities or sponsorship arrangements, may not necessarily be exempt from income or corporation tax; the question of whether or not trading income is taxable in the hands of a charity can be complex, and will depend on the specifics. However, there is an additional exemption available in respect of ‘small-scale’ taxable trades, which exists to allow charities to generate small amounts of non-charitable trading income (such as from sales of merchandise) without incurring a tax liability, and applies where the total of all non-charitable trading income generated in the tax year is less than 25% of the charity’s total income for the year, subject to a cap of £80,000*.

What happens if the £80,000 charitable tax exemption limit is breached?

Where this limit is breached, all non-charitable trading and/or miscellaneous income – not only the amount in excess of the limit – is taxable and must be reported by you under a self-assessment tax return, even where the taxable source of income does not give rise to a taxable profit after attributing expenses.

All exemptions are also subject to a further condition that the funds are applied to the charity’s purposes as set out in its governing document. If this is not the case, then the charity has incurred ‘non-charitable expenditure’ and will lose exemption on an amount of otherwise exempt income equal to the amount of the non-charitable expenditure; effectively, the charity is taxed on the amount of its non-charitable expenditure.

How we can help with your charity tax return

Even where there is no taxable source of income to report, HMRC typically request that charities file a tax return approximately every 3-5 years, to ensure that the charitable exemptions are being claimed appropriately. With that said, we have seen a marked increase in recent years in the number of charities being asked by HMRC to file returns annually (usually larger charities and those that make substantial Gift Aid claims).

If HMRC write to your charity to request that a tax return is filed for a given accounting period, you must file a return, even where there is no taxable income to declare.

The tax returns we complete for our clients include detailed disclosures of pertinent matters to pre-empt questions from HMRC, even where the outcome is ‘nil’ tax. In addition to the increase in the number of charities selected for annual filing, we have also seen an increase recently in the number of HMRC enquiries into charities – particularly into areas such as grants to overseas organisations (which can constitute non-charitable expenditure where certain conditions are not met), investments in non-listed funds and either funding of or transactions with trading subsidiaries and commercial partners (which in some circumstances can constitute non-qualifying charitable investments – a form of non-charitable expenditure – or non-charitable trading income).

If you are concerned that your charity may have a taxable source of income to report, or your charity has received a notice to file a tax return and you require assistance with this, then please contact our team today.