Tainted Donation Rules

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Tainted donation rules - introduction

The tainted donation rules were introduced by the FA 2011.

In accordance with the drafting style introduced by the tax law rewrite, the provisions are set out twice, once for IT and once for CT. We set out the IT rules in full and give the CT references in footnotes.

Commencement date

Para 27(1) Sch 3 FA 2011 provides the commencement date:

Subject to sub-paragraph (2), the amendments made by this Schedule have effect in relation to relievable charity donations made on or after 1 April 2011.

Sub-para (2) is concerned with the substantial donor rules; see 6.2 (Prospective repeal of substantial donor rules).

Relievable charity donation

Section 809ZI(1) ITA provides a comonsense definition:

In this Chapter "relievable charity donation" means a gift or other disposal which-

(a) is made by a person to a charity, and

(b) is eligible for tax relief.

Eligible for tax relief

This expression is only used in the definition of relievable charity donation. Section 809ZI(2) ITA provides:

A gift or other disposal is eligible for tax relief if one or both of the following apply-

(a) (ignoring the tainted donation provisions) tax relief would be available in respect of it under a relevant relieving provision;

(b) the charity is entitled to claim a repayment of tax in respect of it.

Para (a) is a commonsense definition.

Para (b) is puzzling. It envisages a disposal under which tax relief is not available but the charity is entitled to claim repayment of tax. Perhaps the drafter had in mind the case of a basic rate taxpayer (or a taxpayer with no income at all) who makes a gift aid donation. It might be that since the taxpayer has no income taxable at the higher rate, relief on the gift is not "available."

The tainted donation provisions

This expression is only used in the definition of "eligible for tax relief". Section 809ZI(3) ITA provides a commonsense definition:

"The tainted donation provisions" are-

(a) this Chapter,

(b) section 257A of TCGA 1992 (tainted charity donations: disapplication of section 257), and

(c) Part 21C of CTA 2010 (tainted charity donations: removal of corporation tax reliefs).

Relevant relieving provisions

Section 809ZI(4) ITA provides:

The following are "relevant relieving provisions"-

(a) section 257 of TCGA 1992 (gifts of chargeable assets),

(b) section 63(2)(a), (aa) and (ab) of CAA 2001 (gifts of plant and machinery),

(c) Part 12 of ITEPA 2003 (payroll giving),

(d) section 108 of ITTOIA 2005 (gifts of trading stock),

(e) Chapters 2 and 3 of Part 8 of this Act (gift aid and gifts of shares),

(f) section 105 of CTA 2009 (gifts of trading stock), and

(g) Part 6 of CTA 2010 (charitable donations relief).

This is based on the definition of "relievable gifts" in s.550 ITA (with minor stylistic improvements in the drafting).

An interest-free loan is not a relievable charity donation. A gift for which a trader obtains a trading deduction is not a relievable charity donation.

A charity will know whether a Gift Aid gift made by an individual is relievable (since it reclaims basic rate tax) but it will not always know if other gifts are relievable. It may need to enquire.

Relief "available"

The definition of "relievable charity donation" requires that tax relief under a relevant relieving provision would be "available". What is the meaning of this?

If an individual makes a cash gift, but does not make a gift aid declaration, or cancels an existing one, no relief is available (even if it could have been available). Likewise if a donor makes a gift of a qualifying investment but does not make a claim for QIDR.

If an individual gives an asset on which no chargeable gain arises, because the base cost equals or exceeds market value, it is suggested CGT relief is not "available" (though it could have been, if a gain had arisen). Suppose Charity A transfers a chargeable asset to Charity B. Section 257 TCGA 1992 prevents a gain from accruing to Charity A. That appears strictly to be a relievable charity donation. But assuming the relief did not apply, the gain on the disposal would in principle qualify for charity CCT relief under s.256 TCGA .

"Tainted donation"

This is a key term. Section 809ZJ(1) ITA provides:

For the purposes of this Chapter, a relievable charity donation is a tainted donation if (and only if) Conditions A, B and C are met.

We refer to "tainted donation conditions A, B and C".

Tainted donation condition A (donation-arrangement)

Section 809ZJ(2) ITA provides:

Condition A is that-

(a) a linked person enters into arrangements (whether before or after the donation is made), and

(b) it is reasonable to assume from either or both of-

(i) the likely effects of the donation and the arrangements, and

(ii) the circumstances in which the donation is made and the circumstances in which the arrangements are entered into,

that the donation would not have been made and the arrangements would not have been entered into independently of one another.

It there any difference between the wording of (b) and the simple requirement that:

the donation would not have been made and the arrangements would not have been entered into independently of one another.

That is, could there be a case where (1) the donation would not in fact have been made independently of the arrangements, but (2) it is "reasonable to assume from:

(i) the likely effects of the donation and the arrangements, and

(ii) the circumstances in which the donation is made and the circumstances in which the arrangements are entered into,

that it would?

Or vice versa: could there be a case where (1) the donation would have been made independently of the arrangements, but (2) it is not "reasonable to assume from:

(i) the likely effects of the donation and the arrangements, and

(ii) the circumstances in which the donation is made and the circumstances in which the arrangements are entered into,

that it would?

It is considered that no such case is possible.

"Arrangements"

"Arrangements" is a word of wide import. Section 809ZR(1) ITA provides the now standard (though unnecessary) commonsense definition:

In this Chapter-

"arrangements" includes any scheme, arrangement or understanding of any kind, whether or not legally enforceable, involving a single transaction or two or more transactions;

Pre-2011 arrangements are caught. Para 28 Sch 3 FA 2011 provides:

In the amendments made by Parts 1 and 2 of this Schedule, references to arrangements include arrangements made, or made and implemented, before 1 April 2011.

EN FB 2011 provides:

The making of a donation is not in itself an arrangement and this legislation clearly refers to both concepts separately.

"Arrangements" is a common term in anti-avoidance legislation, and experience shows that identifying exactly what are the arrangements difficulty often arises. There was, for instance, considerable disagreement in the House of Lords as to what constituted the "arrangements" in Jones v Garnett 78 TC 597 though the facts were perfectly commonplace.

"Linked person"

Section 809ZJ(3) ITA provides a wide definition, as one might expect:

"Linked person" means-

(a) the person who made the donation ("the donor"), or

(b) a person connected with the donor at a relevant time.

"Relevant time" is widely defined. Section 809ZJ(4) ITA provides:

In subsection (3) "relevant time" means a time during the period which begins with the earliest, and ends with the latest, of the following times-

(a) the time when the arrangements are entered into as mentioned in subsection (2);

(b) the time when the relievable charity donation is made;

(c) the time when the arrangements are first materially implemented.

Tainted donation condition B (purpose of arrangement)

Section 809ZJ(5) ITA provides:

Condition B is that the main purpose, or one of the main purposes, of the linked person in entering into the arrangements is to obtain a financial advantage-

(a) directly or indirectly from the charity to which the donation is made or a connected charity,

(b) for one or more linked persons who are not charities (each of whom is referred to in this Chapter as "a potentially advantaged person").

Identifying the main purpose of an arrangement is a subjective test. It frequently a source of difficulty.

The rule is disproportionate in that the entire donation is tainted even if the financial advantage is only very small by comparison.

The scope of condition B is substantially increased by s.809ZK ITA and (slightly) curtailed by the exceptions in s.809Zl.

"Obtains a financial advantage from the charity"

Section 809ZK ITA provides:

(1) This section applies for the purposes of Condition B.

(2) Subsection (3) applies where the arrangements entered into by the linked person (as mentioned in Condition A) involve a transaction to which-

(a) that or any other linked person ("X"), and

(b) another person ("Y"), are parties.

(3) X obtains a financial advantage from the charity to which the donation is made or a connected charity if-

(a) the terms of the transaction are less beneficial to Y or more beneficial to X (or both) than those which might reasonably be expected in a transaction concluded between parties dealing at arm's length, or

(b) the transaction is not of a kind which a person dealing at arm's length and in place of Y might reasonably be expected to make.

(4) Nothing in this section is intended to limit the circumstances in which a linked person may be regarded as obtaining a financial advantage for the purposes of section 809ZJ.

This extends the expression "obtains a financial advantage from the charity" to include cases where a person does not obtain a financial advantage from the charity.

This will catch matched funding arrangements. Eg, suppose A and B agree to make a donation to charity on the basis that each will give if and only if the other makes the gift; or an company agrees to make a donation equal to the amount given by its employees. That would be caught, unintentionally, by the tainted donation rules. A gift made for a sponsored fun run is caught, if the gift is conditional on completing the run. In these cases it is not the purpose of the donor to obtain an advantage from a charity, but that does not matter as condition B is treated as satisfied. In practice no doubt HMRC will turn a blind eye.

Justine Greening, Economic Secretary to the Treasury, raises this example:

...many charities felt that they could not offer to host a gala dinner for a major donor, to thank them for their gift and to stimulate more donations from others attending the event, without the whole dinner becoming some kind of a gift. Of course, that is not the case because those kinds of events are not benefits to the donors at all; they are also part of the fundraising process.

If the charity invites the major donor to the dinner but does not ask him to pay, condition B is treated as satisfied. Once again, no doubt, no-one will take any notice of this in practice.

Section 809ZK(5) ITA provides some definitions:

In this section-

"Condition A" and "Condition B" have the same meaning as in section 809ZJ;

"linked person" has the meaning given by section 809ZJ(3);

These are needed since the definition of condition A, B, and linked person were not expressed to be for the purposes of the tainted donation rules generally. Lastly:

"transaction" includes (for example)-

(a) the sale or letting of property,

(b) the provision of services,

(c) the exchange of property,

(d) the provision of a loan or any other form of financial assistance, and

(e) investment in a business.

This is self-evidently unnecessary; some commentators might use unkinder words. But it does no harm.

Disregarded financial advantages

Section 809ZL(1) ITA provides four exceptions:

When determining whether a relievable charity donation is a tainted donation, a financial advantage within subsection (2), (3), (4) or (5) is to be ignored.

Application for charitable purposes

Section 809ZL(2) ITA provides:

A financial advantage is within this subsection if the person for whom it is obtained applies the advantage for charitable purposes only.

EN FB 2011 gives an example:

Example 3

A US resident donor lives and works in the UK (receiving UK-source income subject to UK tax) and decides he wants to make a £10,000 donation, tax effectively, to a charitable organisation in the US. The donor is linked to the US organisation to which the donation is to ultimately be made.

The donor arranges to make his donation to an agency charity recognised by HMRC and, on making the donation, applies Gift Aid so the agency receives £12,500 (£10,000 donation plus a £2,500 Gift Aid repayment) to distribute on the donor's behalf.

The donor instructs the agency charity to pass the funds to the US organisation that undertakes charitable activities, and the US organisation spends the charitable funds on charitable activities.

The HMRC analysis is as follows:

In this example the donation will not be caught by the new tainted donation legislation.

The donor enters into arrangements with the agency charity to confirm that his donation, once made, will be routed on to the US charitable organisation. The donation would not have been made to the agency charity in the absence of this arrangement so Condition A is clearly satisfied.

The main purpose for entering the arrangement is to increase the funds of the US charitable organisation (a financial advantage) and this organisation is linked to the donor. At first glance it would appear that Condition B is satisfied.

However, the legislation provides for certain financial advantages to be ignored. Where the body that receives the financial advantage (in this case the US charitable organisation) applies the financial advantage for charitable purposes only, the financial advantage is to be ignored. In this example, the donation is not therefore 'tainted'.

Small benefits within gift aid exemption

The next exemption concerns small benefits disregarded for gift aid purposes. Section 809ZL(3) ITA provides:

A financial advantage is within this subsection if (ignoring the tainted donation provisions) it is-

(a) a benefit associated with a gift which is a qualifying donation for the purposes of Chapter 2 of Part 8 (gift aid), or

(b) a benefit associated with a payment which is a qualifying payment for the purposes of Chapter 2 of Part 6 of CTA 2010 (charitable donations relief: payments to charity).

Section 809ZL(6) ITA provides commonsense supplemental definitions:

In this section-

"benefit associated with a gift" has the meaning given by section 417;

"benefit associated with a payment" has the meaning given by section 196 of CTA 2010;

"the tainted donation provisions" has the meaning given by section 809ZI(3).

At first sight it is difficult to see how this could apply, for the permitted benefits under the small benefit rule are so small that no-one could make the gift with the main purpose of obtaining them. However that is not usually true of rights of admission (which may be of a value equal or greater than the amount of the gift.)

Qualifying investment donation relief

The next exemption concerns QIDR. Section 809ZL(4) ITA provides:

A financial advantage is within this subsection if (ignoring the tainted donation provisions)-

(a) the relievable charity donation is a disposal in respect of which tax relief would be available under Chapter 3 of Part 8 of this Act (gifts of shares, securities and real property to charities etc) or Chapter 3 of Part 6 of CTA 2010 (charitable donations: certain disposals to charity), and

(b) the advantage is a benefit the value of which would be taken into account in determining the relievable amount in respect of the disposal for the purposes of the Chapter in question.

Gifts of trading stock to charities

The next exemption concerns the relief for gifts of trading stock. Section 809ZL(5) ITA provides:

A financial advantage is within this subsection if (ignoring the tainted donation provisions)-

(a) the relievable charity donation is a gift in respect of which tax relief would be available under section 108 of ITTOIA 2005 or section 105 of CTA 2009 (gifts of trading stock to charities etc), and

(b) the advantage is a benefit attributable to the making of the gift in respect of which an amount would be brought into account under section 109 of ITTOIA 2005 or section 108 of CTA 2009 (receipt of benefits by donor or connected person).

Tainted donation condition C (charity-owned companies)

Qualifying charity-owned company

Section 809ZJ(6) ITA provides:

Condition C is that the donor is not-

(a) a qualifying charity-owned company ...

Section 809ZJ(8) ITA provides the definition:

In this section-

"qualifying charity-owned company", in relation to a relievable charity donation, means a company which-

(a) is wholly owned by one or more charities, at least one of which is the charity to which the donation is made or a connected charity, and

(b) has not previously been under the control of, and does not carry on a trade or business previously carried on by, one or more of the following-

(i) a potentially advantaged person;

(ii) a person (other than a charity) who, at any time within the period of 4 years ending with the day on which paragraph (a) was first satisfied, was connected with a person who is a potentially advantaged person;

Section 809ZJ(9) ITA provides a referential definition of wholly-owned:

Section 200 of CTA 2010 (company wholly owned by a charity) applies for the purposes of subsection (8), and for those purposes references in that section to "charity" include a registered club within the meaning of section 658(6) of that Act.

Relevant housing provider

Section 809ZJ(6) ITA provides:

Condition C is that the donor is not ...

(b) a relevant housing provider linked with the charity to which the donation is made.

Section 809ZJ ITA provides the necessary definitions:

(7) For the purposes of subsection (6)(b) a relevant housing provider is linked with the charity if (and only if)-

(a) one is wholly owned, or subject to control, by the other, or

(b) both are wholly owned, or subject to control, by the same person.

(8) In this section-

..."relevant housing provider" means a body which is-

(a) a non-profit registered provider of social housing, or

(b) entered on a register maintained under section 1 of the Housing Act 1996, section 20 of the Housing (Scotland) Act 2010 (asp 17) or Article 14 of the Housing (Northern Ireland) Order 1992 (S.I. 1992/ 1725 (N.I. 15)).

Consequence of tainted donation

Section 809ZM ITA provides:

(1) This section applies where a tainted donation is made by a person.

(2) Where (ignoring this Chapter) income tax relief would be available in respect of the tainted donation, that relief is not available.

"Income tax relief"

Section 809ZM(4) provides a commonsense definition of "income tax relief":

In this section-

... "income tax relief" means relief under-

(a) section 63(2)(a), (aa) or (ab) of CAA 2001 (gifts of plant and machinery), so far as it applies in relation to income tax,

(b) Part 12 of ITEPA 2003 (payroll giving),

(c) section 108 of ITTOIA 2005 (gifts of trading stock),

(d) Chapter 2 of Part 8 of this Act (gift aid), or

(e) Chapter 3 of that Part (gifts of shares etc);

Associated donation

Section 809ZM(3) ITA provides:

Where-

(a) (ignoring this Chapter) income tax relief would be available in respect of an associated donation, and

(b) entitlement to that relief is not withdrawn by subsection (2), that relief is not available.

Section 809ZM(4) ITA provides:

In this section-

"associated donation", in relation to a tainted donation, means a relievable charity donation made-

(a) in accordance with the relevant arrangements, and

(b) by a person, other than-

(i) a qualifying charity-owned company in relation to that relievable charity donation, or

(ii) a relevant housing provider linked (within the meaning of section 809ZJ(7)) with the charity to which that donation is made;

"the relevant arrangements", in relation to a tainted donation, means the arrangements by reference to which Conditions A and B in section 809ZJ are met.

Section 809ZM(4) ITA provides referential definitions:

In this section-

"qualifying charity-owned company" has the meaning given by section 809ZJ(8) (except that paragraph (b) of that definition does not apply);

"relevant housing provider" has the meaning given by section 809ZJ(8);

Tainted gift aid donation

Section 809ZM(5) ITA provides:

Where entitlement to relief is withdrawn under this section in respect of a donation-

(a)subsections (6) and (7) apply if the relief is under Chapter 2 of Part 8 (gift aid)...

So we turn to s.809ZM(6) ITA which provides:

For the purposes of Step 2 in section 58(1), the donation is not a qualifying donation for the purposes of Chapter 2 of Part 8.

This prevents the gift from reducing the restriction on personal allowances. See 16.40.7 (Interaction with restriction on personal allowances). That may be strictly logical. As this rule is unlikely ever to apply, and if it did the amount involved is trivial, one might reasonably question whether this strikes the right balance between the need for simplicity as against fairness; but simplicity was not an important consideration to the author of the tainted donation rules.

Section 809ZM(7) ITA provides:

But-

(a) the donation remains a qualifying donation for the purposes of-

(i) Part 10 (special rules about charitable trusts etc),

(ii) section 899(5) (meaning of "qualifying annual payment"),

(iii) Chapter 2 of Part 11 of CTA 2010 (charitable companies: gifts and other payments),

(iv) section 664 of that Act (community amateur sports clubs: exemption for interest and gift aid income), and

(b) accordingly, section 414(2)(a) (donation treated as made after deduction of basic rate income tax) applies for the purposes of section 520(4) (income tax treated as deducted to be treated as income tax paid by charitable trust).

The effect is that a charity may reclaim basic rate tax on a gift aid donation which is a tainted donation - though in most cases the charity is likely to lose its tax relief and so not be entitled to reclaim the tax. Perhaps the reason is that it is envisaged that in some cases the charity may be unaware that the gift is a tainted donation. Similarly, a donor is liable if they pay insufficient tax.

We are unable to understand the point of the reference to s.899 and would be grateful to any reader who could offer an explanation.

Tainted payroll giving donation

Section 809ZM(5) ITA provides:

Where entitlement to relief is withdrawn under this section in respect of a donation ...

(b)subsection (8) applies if the relief is under Part 12 of ITEPA 2003 (payroll giving).

So we turn to s.809ZM(8) ITA which provides:

The donation remains a donation for the purposes of Part 12 of ITEPA 2003 for the purposes of-

(a) section 521A (gifts under payroll deduction scheme: income tax liability and exemption), and

(b) section 472A of CTA 2010 (gifts under payroll reduction scheme: corporation tax liability and exemption).

The effect is that although relief is denied, the donation is still income of the charity and (if the charity loses tax relief) it is taxable. It would have been sufficient to deny relief rather than imposing this (potential) double charge to tax.

Income tax charge where gift aid is withdrawn

Section 809ZN ITA provides:

(1) Income tax is charged under this section if-

(a) a person makes a tainted donation in a tax year,

(b) (ignoring this Chapter) relief would have been available under Chapter 2 of Part 8 in respect of the tainted donation or an associated donation ("the gift aid donation"), and

(c) the charity to which the gift aid donation is made is entitled to claim a repayment of tax in respect of that donation.

(2) The amount of the tax charged under this section is equal to the amount of the repayment of tax which the charity is entitled to claim in respect of the gift aid donation (whether or not such a claim is made).

(3) Each of the persons mentioned in subsection (4) is liable for any tax charged under this section, and the liability of those persons is joint and several.

(4) The persons are-

(a) the donor in respect of the gift aid donation,

(b) if different, the donor in respect of the tainted donation,

(c) each potentially advantaged person under the relevant arrangements relating to the tainted donation, and

(d) any charity to which the gift aid donation or (if different) the tainted donation is made, or any connected charity, which falls within subsection (5)...

(6) No liability to income tax arises under this section in respect of a repayment of tax, if (and to the extent that) the repayment is itself repaid to HMRC under any other provision of the Tax Acts.

EN FB 2011 provides:

Where the donation, if it were not a tainted donation, would have been a qualifying donation under the Gift Aid scheme, an income tax charge will arise on the repayment of tax due to the charity. The donor, a connected person or any other potentially advantaged person, in relation to the tainted donation, or the charity is liable to the tax charge. ...

There will be no liability to income tax where the repayment is repaid under some other provision, for example if the charity is charged to tax on non-charitable expenditure in relation to the donation.

Section 809ZN(7) ITA provides some referential definitions:

In this section-

"associated donation" has the same meaning as in section 809ZM;

"linked person" has the same meaning as in section 809ZJ;

"the relevant arrangements" has the same meaning as in section 809ZM.

These are needed since the definitions were not expressed to be for the purposes of the tainted donation rules generally.

Protection for charities

Section 809ZN(5) ITA provides:

A charity falls within this subsection if the charity-

(a) is or was party to the relevant arrangements relating to the tainted donation, and

(b) was aware, at the time it entered into those arrangements, that a linked person was entering (or had entered or was likely to enter) into the arrangements in circumstances falling within Condition B in section 809ZJ.

EN FB 2011 provides:

No charge will arise on the charity unless, exceptionally, the charity was party to, and fully aware of the arrangements.

The EN misrepresents the legislation here by paraphrasing the statutory term "aware" with fully aware. We do not see any reason to justify the statement that the cases where the charity is liable will be "exceptional".

"Entitled" and "liable"

Section 809ZR(2) ITA provides:

In this Chapter, in the case of a charitable trust, references to a charity being entitled to a repayment of, or liable to pay, tax are to be read as references to the trustees of the trust being so entitled or liable.

This provision is clearly unnecessary but it does no harm.

Payment from trust

Section 809ZI(1) ITA provides:

In this Chapter "relievable charity donation" means a gift or other disposal which-

(a) is made by a person to a charity, and

(b) is eligible for tax relief.

Section 809ZI(5) ITA provides:

For the purposes of this Chapter, an amount of income which

[1] arises under a UK settlement and

[2] to which a charity is entitled under the terms of the settlement

is to be regarded as an amount gifted to the charity by the trustees of the settlement.

Section 809ZO ITA provides:

(1) Income tax is charged under this section if-

(a) a person makes a tainted donation in a tax year,

(b) the tainted donation or an associated donation is a payment by the trustees of a settlement of income arising under the settlement ("the trust donation"), and

(c) the charity to which the trust donation is made is entitled to claim a repayment of tax in respect of that donation.

(2) The amount of the tax charged under this section is equal to the amount of the repayment of tax which the charity is entitled to claim in respect of the trust donation (whether or not such a claim is made).

(3) Each of the persons mentioned in subsection (4) is liable for any tax charged under this section, and the liability of those persons is joint and several.

(4) The persons are-

(a) the trustees of the settlement who made the trust donation,

(b) if different, the donor in respect of the tainted donation,

(c) if section 628 or 630 of ITTOIA 2005 (gifts from settlor interested trusts etc) applies in relation to the income out of which the trust donation is made, the settlor in relation to the settlement,

(d) each potentially advantaged person under the relevant arrangements relating to the tainted donation,

(e) any beneficiary of the settlement who is party to those arrangements, and

(f) any charity to which the trust donation or (if different) the tainted donation is made, or any connected charity, which falls within subsection (5).

(5) A charity falls within this subsection if-

(a) the charity is or was party to the relevant arrangements relating to the tainted donation, and

(b) the charity was aware, at the time it entered into those arrangements, that a linked person was entering (or had entered or was likely to enter) into the arrangements in circumstances falling within Condition B in section 809ZJ.

(6) No liability to income tax arises under this section in respect of a repayment of tax if that repayment is itself repaid to the Commissioners for Her Majesty's Revenue and Customs under any other provision of the Tax Acts.

(7) In this section-

"associated donation" has the same meaning as in section 809ZM;

"linked person" has the same meaning as in section 809ZJ;

"the relevant arrangements" has the same meaning as in section 809ZM;

"settlement" and "settlor" have the same meaning as in Chapter 5 of Part 5 of ITTOIA 2005 (see section 620 of that Act).

"Connected"

"Connected charity"

Section 809ZN ITA provides:

For the purposes of this Chapter, a "connected charity" in relation to another charity means a charity which is connected with that other charity in a matter relating to the structure, administration or control of either charity.

The definition derives from the substantial donor rules.

It is poor drafting to use the expression "connected" with a non-standard meaning, especially as the standard meaning is used later in the same code, but does not greatly matter.

The definition of "connected" in this context is hopelessly vague. Two charities are connected if they have identical trustees. Are they connected if they have just one trustee in common? Presumably not. Where does the dividing line come?

"Connected persons"

"Connected" in its usual tax sense is extremely wide, but the drafter has given it an even wider meaning here. Section 809ZQ ITA provides:

(1) Section 993 (meaning of "connected" persons) applies for the purposes of this Chapter-

(a) subject to section 809ZP, and

(b) as if, after subsection (7) there were inserted the provision in subsection (2).

(2) That provision is-

(8) A person who is a beneficiary of a settlement is connected with-

(a) a person in the capacity as trustee of the settlement, and

(b) the settlor in relation to the settlement.

"Beneficiary" is not defined.

(9) For the purposes of this section-

(a) a man and woman living together as husband and wife are treated as if they were husband and wife,

(b) two people of the same sex living together as if they were civil partners of each other are treated as if they were civil partners of each other, and

This is standard in modern anti-avoidance legislation.

(c) "close company" includes a company that would be a close company if it were resident in the United Kingdom."

This is otiose: non-resident companies are already covered by s.993(3)(d) ITA.

Application of tainted donation rules to CGT

Section 257A TCGA provides:

(1) Section 257 does not apply in relation to-

(a) a tainted donation made by a person, or

(b) any associated donation.

(2) For the purposes of this section-

(a) "tainted donation" means a tainted donation within the meaning of Chapter 8 of Part 13 of ITA 2007 (tainted charity donations: removal of income tax reliefs etc) or Part 21C of CTA 2010 (tainted charity donations: removal of corporation tax relief), and

(b) "associated donation" means an associated donation within the meaning of section 809ZM of ITA 2010 or section 939F of CTA 2010.

Application of tainted donation rules to CASCs

The tainted donation rules apply to CASCs as they do to charities. This is economically achieved by s.809ZR(1) ITA which provides:

In this Chapter-

"charity" includes a registered club within the meaning of section 658(6) of CTA 2010 (meaning of "community amateur sports club" and "registered club").

What is the reason for the tainted donation rules?

We do of course need provisions to prevent abuse of charities and charity tax reliefs. There are a number of such provisions, in particular:

(1) The application for charitable purposes rule (that relief is only available for income and gains applied for charitable purposes);

(2) The qualifying expenditure rules

(3) The benefit rules for gift aid and QIDR.

(4) Charity law (under which defaulting trustees are liable for breach of trust)

(5) Criminal law.

The question is whether these rules leave any gaps for which the tainted donation rules (or indeed their predecessors, the substantial donor rules) are needed.

EN FB 2011 sets out five examples including two where the tainted donation rules are said to apply. Here we might expect the reason for the new rules to be found.

Example 2

A donor donates £100,000 to a hospital (a charity) in recognition of the excellent treatment received by his son during his stay. The hospital subsequently writes to thank the donor for the unexpected donation.

The HMRC analysis is as follows:

In this example the donation will not be caught by the new tainted donation legislation. There was no arrangement in place for the hospital to provide any services in connection with the donation, so Condition A of the new legislation does not apply.

Even if his son (or any other person connected to the donor) were to receive further ongoing treatment at the hospital, a lack of an arrangement means that the donation will not be caught.

The making of a donation is not in itself an arrangement and this legislation clearly refers to both concepts separately. In this example, there is a donation, but there are no arrangements and the hospital may spend the donation as it sees fit. It is not under any obligation to provide the donor (or any member of his family) with specific medical treatment.

We would have thought that there would be an arrangement. However condition A is not satisfied so that makes no difference.

This is by way of introduction, and we now turn to the real point of the example. The example continues:

However, the position would be different if the donor had agreed with the hospital that in return for a Gift Aid donation of £100,000 the hospital would provide treatment that would ordinarily cost £125,000.

The original HMRC analysis in the EN to the draft clauses was as follows:

Because of the effect of grossing up the donation (under the Gift Aid scheme) of £100,000 the hospital would still receive £125,000.

This is obviously wrong. On that mistaken assumption, the original HMRC analysis explained how the tainted donation rules were intended to operate:

Condition A would apply because the donor would have entered into an arrangement to obtain an advantage from the hospital.

The advantage would arise from a transaction under which treatment was provided by the hospital on terms that would not be available to a party dealing at arm's length, so Condition B would apply.

EN FB 2011 acknowledges the error:

In this instance, the first principles of the Gift Aid legislation would apply and the Gift Aid benefit rules would determine that the £100,000 was not in fact a gift and therefore no tax relief would be available. There would not be any need to consider these new rules in this instance.

So why are the tainted donation rules needed?

However, if the donor entered into an artificial avoidance arrangement in order to distance himself from the Gift Aid donation (or the return of the benefit), the Gift Aid benefit rules may not operate in this way. The new tainted donation legislation could then apply.

Condition A would apply because the donor would have entered into an arrangement (now more complicated and contrived than the original scenario) in connection with their donation. Condition B would also apply because the main purpose of the donor in entering the arrangement is to obtain a financial advantage from the hospital (there being no other reason to enter into such a complicated arrangement). The clear financial advantage would arise from the fact that the donor has received services valued at £125,000 at a cost of £100,000. The donor is not a qualifying charity owned company or relevant housing provider so Condition C would apply. The donation would be tainted and the tax relief denied.

The EN does not offer any example of an "artificial avoidance arrangement" which "distances" the donor from the gift aid donation or the benefit. We are unable to think of any, and are left in some doubt whether HMRC could do so.

The second example is as follows:

Example 4

Mr A is a trustee of two charities, Charity B and Charity C. Charity B is responsible for running a college and Charity C provides financial support for the college.

Mr A also controls Company D which runs a leisure facility (swimming pool, gym, squash) which is used by the students of the college during school hours and fee paying members of the public outside school hours. Company D wants to expand the leisure facility to allow opening to the public in the day and to provide more up-market facilities i.e. this is a wholly commercial development.

To fund this, Company D offers interest free loan stock.

Mr A makes a Gift Aid donation of £100,000 to Charity B.

Company D issues interest free loan stock of £125,000. Charity B subscribes for £125,000 of the loan stock and requests it be issued in the name of Charity C.

The HMRC analysis is as follows:

In this example the donation will be caught by the new tainted donation legislation. There is an arrangement in place that, in connection with the donation, the charity will provide an interest free loan (by buying loan stock) to a company connected with the donor and the donation would not have been made and the arrangements would not have been entered into independently of one another. Therefore, Condition A of the new legislation will be satisfied.

The main purpose of entering into the arrangement is for the donor to obtain a financial advantage (in this instance, an interest free loan for his company) and therefore Condition B is satisfied.

The donor is not a charity owned company or relevant housing authority so Condition C is satisfied and the donation is therefore a tainted charity donation and the relief is denied.

This arrangement is very obviously caught by the charitable expenditure rules. The £125k is not applied for charitable purposes only. Accordingly it is non-charitable expenditure under s.543(1)(f) ITA, and the charitable expenditure rules apply.

There is also a benefit to the company as a result of the gift. The subscription of the interest free debenture is as clear a case of a benefit as one could wish for. The company (being controlled by Mr A) is a connected person. Accordingly gift aid does not apply to the gift by Mr A.

Further, the payment by charity C is a self-evident breach of trust. HMRC should report that to the charity commission who should:

(1) take proceedings on behalf of the charity to recover the loss caused by the breach of trust, and

(2) in the absence of mitigating circumstances, which I think unlikely, remove the trustees of the charities.

Conclusion

It is an article of faith within HMRC that tainted donation or substantial donor rules are needed. However HMRC have been unable to provide any example of where they are actually needed.

If any gap in existing legislation could be identified (which we would not rule out, though so far has not been done) the next step should be to see if existing legislation can conveniently be amended to cover it. The starting point should not be to devise a new and complex anti avoidance code which is added to existing anti-avoidance code.

In failing to approach the matter this way, the legislation is in breach of Hampton Principles.

We take the view that there is no need for the rules whatsoever; though it is difficult to prove a negative, it is at least clear beyond argument that no case for the rules has ever been made out.

HMRC may informally take the view that it is convenient to have tainted donation rules and since they do no harm, and may help them in cases of abuse, it is not really necessary to demonstrate need. That would be absolutely wrong. A full explanation of the law - which must wait for the next edition - will require a very long chapter, maybe 100 or more pages. The burden for the charity sector in dealing with this will be considerable. This is exactly the sort of red tape that the government are trying to avoid.

The consultation process

Official government policy on consultation is that:

6.1 All responses ... should be analysed carefully, using the expertise, experiences and views of respondents to develop a more effective and eficient policy. The focus should be on the evidence given by consultees to back up their arguments. Analysing consultation responses is primarily a qualitative rather than a quantitative exercise...

6.4 Following a consultation exercise, the Government should provide a summary of who responded to the consultation exercise and a summary of the views expressed to each question. A summary of any other significant comments should also be provided. This feedback should normally set out what decisions have been taken in light of what was learnt from the consultation exercise. This information should normally be published before or alongside any further action, e.g. laying legislation before Parliament.

It is fair to say that the Finance Act provisions are in some ways better than the draft clauses as a result of the consultation. However no summary of responses was published on the responses to the consultation for the tainted donation rules. The rules could probably not have been enacted if it had been.

It is no answer to say, as does EN FB 2011, that "the vast majority of donors do not need to consider these new rules." That is undoubtedly true. However since most of the population of the UK give to charity, the remaining tiny minority is a very large number; moreover donors and their advisors need to keep the rules in mind in order to know whether or not they need to consider them.

The lessons of the debacle of the substantial donor rules have not been fully learned - though on this occasion there has been a consultation even if not meeting the code of practice on consultation - so it should not be surprising to find a repeat of some of the same mistakes.

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