Charity begins at the Treasury

Last year's Budget wasn't kind to the voluntary sector. Adrian Randall outlines some cost-effective ways the Chancellor could help - and even win some votes - and even win some votes

Charities are always hopeful that this year's Budget will at last be a budget for charities. Their idea of a perfect Budget is one that exempts all charities from any kind of tax. So what are charities' chances of the Budget of their dreams in 1996? It has to be said that they are not great, with so many other pressures on the Chancellor, particularly from MPs of his own party anxious to get themselves re-elected.

But with a little thought and at limited cost, the Chancellor could help charities, and now that prosperity seems to be finally returning to the UK there is no obvious reason why giving to charity cannot be made more tax effective for both the charity and the donor.

We need to look closely at the American way of giving, and ask why US citizens give more generously to charities than people in the UK. The simple answer is tax breaks.

The introduction of self-assessment in 1996/97 opens the way to the Chancellor to make giving to charity easier for the individual, perhaps by reducing the five-year period that a covenant must last in order to allow the charity to reclaim the income tax that the donor had originally paid.

If the Treasury overrules a concession in that direction, amendments that were raised in discussing the 1996 Finance Bill should this time meet with approval. The first amendment that charities seek is a change to Section 338, Income & Corporation Taxes Act 1988, in order to provide a period of grace of one year for trading subsidiaries of charities to covenant their income to the charity, thus allowing exact covenants rather than estimates.

The second amendment sought at that time was to exempt the first pounds 25,000 of trading profit from tax, thereby avoiding the necessity of setting up trading companies that have to covenant back their income to the charity.

Both these amendments were lost earlier this year, and it was clear from the reporting that the then Paymaster-General, David Heathcoat-Amory, failed to understand the points that were being made. He is on record as having wondered whether many charities would want to defer covenanting for up to 12 months. He obviously completely missed the point. Perhaps the change following his resignation in July will be for the better for charities.

Charities also hope that income from deeds of covenant and Gift Aid is not further reduced, as it was in last year's Budget with the reduction in the basic rate of tax from 25 per cent to 24 per cent. Reducing the rate of tax that donors pay actually reduces the value of the tax rebate that the charities can claim. The reduction in charities' income that resulted was just over 5 per cent, and a further penny off the standard rate of tax this year would have a similar effect on charities.

The two suggested changes relating to charity trading would not create any cost burden for the Government and could even reduce its expenditure as a result of saving some Inland Revenue time spent checking repayment claims, as most charities recover all the tax anyway. However, most importantly, it would enable charities to devote more resources to achieving their primary objectives.

The principal change that charities want is the lifting or at least the reduction of the increasing cost of irrecoverable VAT to charities, which is said to be costing them pounds 350m a year. Charities suffer a VAT burden because they are unable to recover much of the VAT they incur when they purchase goods and services. Charities are involved in fund-raising and similar activities which are outside the scope of VAT, and the tax on the costs involved cannot be reclaimed. Therefore, VAT continues to be a nightmare for them.

Irrecoverable VAT affects the capacity of larger charities to deliver the services for which they are set up. It has had a considerable impact on the level of voluntary welfare provided. It is not just larger charities that are affected; the problem has spread across the whole of the sector.

There is an even greater threat on the horizon, which is the threat from the European Union of VAT harmonisation. This will see the removal of all zero rates. If nothing is done to help charities to recover VAT, increasing the extent of VAT payments could mean a trebling of the irrecoverable VAT bill for charities, and the pounds 350m could well become a figure in excess of pounds 1bn.

Harmonisation has been postponed once already, in 1992, and almost certainly it will be postponed again, but it still creates a spectre that haunts the charity sector. A lot of work needs to be carried out to ensure that if zero rating is lost, then those purchases to which it applies for charities are covered either by the introduction of reduced rate bands or a compensation scheme.

Meanwhile, the Charities' Tax Reform Group has launched an initiative to make a special effort to press for a VAT compensation scheme to return money equivalent to the irrecoverable VAT that charities already pay on their non-business activities. Charities are therefore urging that this year the Chancellor introduce such a scheme.

Let us hope that on Tuesday 26 November we won't see charities suffering more and gaining nothing, as happened last year. A few minor tweaks in the way in which government operates could see considerable improvement for charities to make tax-effective giving to charities easier and more efficient, the removal of the administrative burdens on trading by charities, and the reduction of their VAT costs. All this would cost the Government little and put much more in the hands of charities. It might even gain quite a few votes

The author is a partner of the chartered accountants Moores Rowland.