Gift Aid: Is It ‘Broke’ and Should You ‘Fix It’?

The United Kingdom, in common with many countries, enables its taxpayers to make income tax-effective gifts to charities. However, whilst many countries do this by allowing the donor to deduct the amount given from his or her income subject to tax, the UK adopts a more complex approach for gifts of cash.

To many, the workings of the system are over-complicated and some have concluded (wrongly) that it does not provide full tax relief to donors in the same way that other systems (such as that of the United States) do. However, there is no doubt that it could be simplified and that many higher rate taxpayer donors do not bother to claim the entirety of the tax relief due to them. The problem in finding an acceptable form of simplification, however, lies in reconciling the interests of charities and their donors which, it is submitted, requires an understanding of how (and why) the Gift Aid scheme currently works as it does.

The Origins of the Gift Aid Scheme

Before 1990, a UK taxpayer could only obtain income tax relief for a gift of cash to charity if it was made under a deed of covenant capable of lasting for four years or more. In 1990, the Chancellor introduced the Gift Aid scheme which enabled one-off charitable cash donations to attract tax relief. Initially, for a gift to be relievable it had to be of GBP600 or more but this minimum was reduced over the years until it was removed altogether on 6 April 2000.

Originally, deeds of covenant were not simply used to make donations to charity: any deed that was capable of lasting for at least six years reduced the payer’s taxable income by the amount of the annual payment and increased the recipient’s taxable income by an equivalent amount. Because deeds of covenant transferred taxable income from payer to payee, payers had to deduct income tax at basic rate when making the payment; if the recipient was eligible, it could recover the tax deducted from what was then the Inland Revenue. Covenants were frequently used as a means of enabling parents to fund students, and divorcing spouses to pay maintenance, tax-efficiently. By 1990, however, the ability to redirect income under non-charitable deeds of covenant had been removed and the period for which a charitable covenant had to be capable of lasting had been reduced to a minimum of 4 years.

How the Gift Aid Scheme Works

The Gift Aid scheme adopted elements of the covenant regime; thus, when a donor makes a gift under the Gift Aid scheme, the gift is treated as a payment from which basic rate tax (currently 20 per cent) has been deducted. A cash gift of GBP80 made under the Gift Aid scheme is therefore characterised as a gift of GBP100 from which the donor has withheld GBP20. If the donor has provided the recipient charity with a Gift Aid declaration and none of the requirements of the Gift Aid scheme have been breached, the charity can recover the tax element from HM Revenue and Customs.

If the donor is a basic rate tax-payer, there is nothing further to be done. The GBP100 which the charity has received (GBP80 from the donor and GBP20 from HMRC) reflects the GBP100 originally earned by the donor in order to make the gift. Had the donor not made the gift, after paying basic rate tax on the GBP100 earned he or she would have had the GBP80 which was the subject of the gift; HMRC would have received GBP20 in tax and this is the sum refunded to the charity. This can be illustrated by reference to the table below:

In each case, the net effect is exactly the same as it is in those jurisdictions which allow the donor to deduct the total amount which the charity receives from his or her taxable income. However, the practical differences are twofold: first, in the UK, where a donor wishes to make a gift to charity which will be worth GBP100 in its hands, he or she must pay over GBP80 and supply a Gift Aid declaration; and, secondly, where the donor is a higher rate taxpayer, part of his or her relief comes from the reduction in the amount paid over (from GBP100 to GBP80) with only the balance coming from HMRC.

Suggested Reforms of the Scheme

Charities have been lobbying for the balance of the tax relief received by higher rate taxpayers to be redirected to the charity because, it seems, many donors do not bother to reclaim their higher rate relief. If the donor writes a cheque for GBP80, which enables the charity to recover GBP20 from HMRC, but makes no effort to reclaim his or her higher rate tax relief, that relief is ‘wasted’.

The net cost of the cash gift to the higher rate taxpayer donor would have been GBP60 had he or she reclaimed the higher rate relief; instead it is GBP80, the full amount of the cash transferred. Whilst a basic rate tax payer needs to earn GBP100 to have GBP80 cash left to make a gift, a higher rate tax payer would need to earn GBP133.33 to have the same amount of cash left after tax. Of this, GBP100 will have gone to the charity in total (assuming a Gift Aid declaration was made) and GBP33.33 will have gone to HMRC.

It has been suggested that in order to avoid possible tax ‘wastage’, where a higher rate donor gives under the Gift Aid scheme, the entirety of the tax relief should be recovered by the charity. Using the example above, if a higher rate taxpayer made a cash gift of GBP80 to charity, it would not simply recover the GBP20 available on a basic rate taxpayer’s gift but the whole GBP53.33 paid to HMRC on the GBP133.33 earned by the higher rate tax payer in order to make the GBP80 cash gift.

The consequence of this would be that the cost of such a gift to a higher rate taxpayer who would previously have reclaimed the higher rate relief has been increased in after-tax terms from GBP60 to the full GBP80 actually paid. The amount of income which he or she had to earn (before tax) to make that gift has similarly increased from GBP100 to GBP133.33. In reality, however, a higher rate taxpayer who understood how the Gift Aid scheme worked and only wished to suffer a net cost of GBP60 (or who only wished the charity to receive a total of GBP100) would reduce the sum he or she paid to GBP60 so that the after tax position of donor and charity would remain as at present. Those donors who currently do not bother to reclaim their higher rate relief would remain in the same after-tax position, although the recipient charity would be considerably better off.

The practical difficulties with this proposal centre upon the fact that the charity will have to know the donor’s tax position in detail in order to make a proper recovery. At the most basic level, a donor would have to be prepared to indicate to the charity whether he or she was a higher rate taxpayer (and, from April 2010, whether or not in the 50 per cent bracket): there may be some reluctance on the part of donors to do this. Even if this obstacle could be overcome, however, and despite the figures used in the examples above, the marginal tax rate at which relief is given is not necessarily 40 per cent (or 50 per cent). In some cases, a charitable donation will take a donor from being a higher rate taxpayer to being a basic rate taxpayer. For example, if a donor with taxable income of GBP47,400 (after all other allowances and reliefs) makes a (net of tax) gift of GBP16,000 (which is treated as GBP20,000 from which basic rate tax has been deducted) this will reduce his or her taxable income to GBP27,400. GBP10,000 of the gift will then be relievable at the 40 per cent rate and GBP10,000 at only the 20 per cent rate. As things presently stand, the donor would receive higher rate relief of only GBP2,000 and the total tax relief will then be GBP6,000. Whilst HMRC will calculate this when the donor makes his or her tax return under the present rules, how will the charity proceed?

In order to get around this issue, a ‘composite’ rate at which charities would recover tax from HMRC has been proposed. The intention would be that such a rate would be ‘tax neutral’, reflecting the average tax rate applicable to donors giving under the Gift Aid scheme. Instead of recovering GBP20 when given GBP80, it has been proposed that charities might recover slightly more than GBP23.

Whilst this would have the effect of increasing the value of the GBP80 cash gift to the charity to just over GBP103, it must be remembered that the higher rate taxpayer donor would now have had to earn not GBP100, but GBP133.33, in order to have the GBP80 to pay over to the charity. If he or she only has GBP100 surplus income, the net-of-tax gift may have to be reduced to GBP60, in which case the charity will receive a total of just over GBP78 instead of the GBP100 it receives at present. A reduction would follow for any ‘composite’ repayment lower than the full GBP40, which would be inevitable if it were to apply on a tax-neutral basis to all Gift Aid donations.

Conclusions

While the UK Gift Aid scheme currently offers the same overall tax relief to those taxpayers who understand how it works and who remember to claim relief in their tax returns as is provided by countries such as the USA, it is more complex.

It has been suggested that only 35 per cent of higher rate taxpayer donors bother to reclaim their higher rate relief, although some 80 per cent by value of the higher rate relief available is reclaimed. This suggests that those higher rate taxpayers who make smaller donations are less likely to bother to reclaim their relief than those whose donations are more substantial. Given that the latter are more likely to be properly advised and the compliance costs involved in making the reclaim will be more proportionate, this may not be surprising.

The charities which would benefit overall from the proposed reform are likely to be those which predominantly receive many small gifts as opposed to a few larger gifts. Charities which predominantly receive a smaller number of large gifts from well advised higher rate taxpayers are more likely to lose out.

In order to reduce the likelihood of major donors who currently reclaim their higher rate tax relief reducing their after tax giving were the ‘composite rate’ to be introduced, some have suggested that a higher rate taxpayer who makes a donation in excess of GBP10,000 might be permitted to opt out of the ‘composite rate’ scheme and continue to receive higher rate relief. If this were to be adopted, the ‘composite rate’ would presumably have to be set at a lower level, if it were to continue to be ‘tax neutral’ overall. In addition, it would introduce additional complexities, with two schemes in operation which would potentially treat a donor who made two gifts of GBP7,500 differently to one who made one gift of GBP15,000.

It is submitted, therefore, that the reforms which have been suggested all carry either significant complexities or risks. There are, of course, two further alternatives: either introduce a system like that in the USA, where the donor receives tax relief in his or her tax return for the full amount actually given (but which would require the donor to reclaim the tax and remove the current basic rate repayment to the charity); or leave things as they are, on the basis that although the scheme is presently imperfect, the proposal which may appear attractive to some charities could prove unattractive to major donors and ultimately lead to an overall loss in funds to the charitable sector. This may explain why it has been reported that the proposed reforms have been ‘kicked into the long grass’.

Clive Cutbill
In addition to providing advice to a number of household name charities and charities with City livery connections on governance and operational issues, Clive Cutbill leads the philanthropy practice at Withers Worldwide, advising both charities and donors in relation to tax-efficient giving and funding. His practice extends beyond the domestic to the cross-border context and encompasses advice on venture philanthropy, social investment and the structuring of transactions involving charities and others so as to deliver maximum social benefit. Clive acted in two leading High Court cases concerning trustees' powers and duties: Hillsdown Holdings plc v. Pensions Ombudsman (1996); and Public Trustee and Anor v. Cooper and Ors (1999) and has been acknowledged as a major contributor to the debate concerning the powers of trustees to adopt a socially responsible approach to the investment of their funds. He is the firm's nominated officer for money laundering reporting purposes and, as chair of the STEP Anti-money Laundering Task Force, has been involved in discussions with HM Treasury, MEPs, the European Commission and the Financial Action Task Force of the OECD regarding the fight against money laundering and terrorist financing. In the latter role, he was a recipient of an outstanding achievement award at the STEP 2007 Private Client Awards for his role in securing key amendments to the Money Laundering Regulations 2007 at draft stage. His combination of knowledge and experience in the fields of trust and charity law, on the one hand, and money laundering and terrorist financing issues, on the other, has been described as ‘unique'.