UK: Income Tax Cap – Update And Frequently Asked Questions

Those following the state of UK giving could be forgiven for having allowed themselves to feel cautiously optimistic during the past two years. Although the pain of public sector austerity was only starting to bite, it was nevertheless clear from a series of statements, consultations, policies and legislation, that the Government was serious about promoting charitable giving and philanthropy in the UK. The December 2010 Ten Point Philanthropy Strategy and the 2011 Green and White Papers were followed by Budget 2011 which announced a tax relief on gifts of pre-eminent works to the nation and the reduced rate of inheritance tax for estates leaving a bequest of at least 10% of the net taxable estate to charity.

Then on 21 March 2012, the 2012 Budget contained the unwelcome announcement that an income tax relief cap would be introduced across non-charitable and charitable reliefs alike. This proposal was announced without prior consultation with the sector and has caused a substantial backlash from charities and philanthropists. Overall this proposal has left the sector wondering at the Government's mixed messages on UK giving and hoping for reversal, or at least a reasonable concession, so as to avoid compounding the financial crisis with a crisis in major giving.

The following frequently asked questions provide an update on where we have got to with the proposed income tax cap and where we may be headed.

1. What has happened?

Budget 2012 announced that a cap will apply to all income tax reliefs that are not currently capped.

2. When will this be introduced?

The announcement indicated that the cap would apply with effect from 6 April 2013.

3. How much is the cap?

At the time of writing, the proposal is that income tax relief will be capped at the greater of £50,000 or 25% of a donor's income.

The cap is an aggregate one and applies across all uncapped reliefs, both charitable and non-charitable. An individual could therefore exhaust the limit with a single charitable gift, or several, or may use the whole of the relief cap up with non-charitable reliefs. Although an aggregate cap may appear simple, it conflates reliefs which allow an ultimate net benefit to the taxpayer with charitable giving, which always results in a net loss to the donor taxpayer and a substantial boon to the charitable recipient.

4. How is the limit calculated?

It is clear following informal and formal clarifications by HMRC that the cap is calculated with reference to the amount of the 'relief' that is claimed. For Gift Aid, this is the amount of the 'grossed up' gift, that is, the gift plus the basic rate tax paid on it, which may be reclaimed by the recipient charity.

In the immediate aftermath of the Budget announcement, it seemed possible that the 'relief' referred instead to the amount of tax paid which could be reclaimed by the charity and by higher or additional rate donors. This would have made the cap considerably higher, lessening its damaging impact on charitable giving.

5. What reliefs does the limit apply to?

The cap applies to reliefs which are at present uncapped. Pensions contributions, Enterprise investment or venture capital reliefs are all already limited reliefs so will not come within this cap. It will, however cover Gift Aid, payroll giving, gifts of shares and securities, and land. The relief in respect of gifts of art and pre-eminent objects to the nation is already capped annually, so this relief should not be included in the proposed regime.

6. What happens if a donor makes a gift that exceeds the limit?

It has been indicated that the charitable recipient of the gift will still be entitled to claim an amount equal to the basic rate tax on the gross gift provided it has a Gift Aid declaration from the donor. If the cap has been exceeded, the tax that has been reclaimed by the charity would be chargeable to the donor.

7. Does the cap apply to gifts to all types of charities?

Yes. A gift to any UK charity for tax purposes could potentially be caught by this cap.
It is important to note that at present, there is no distinction in the UK between a charity which is established and funded by an individual or family as a grant-making 'foundation' and a charity which fundraises from the public and operates its own projects.

8. Can a donor still give the whole of his or her earned income away?

Currently, all of a donor's pre-tax income (including the tax payable on it) can be transferred to charities of the donor's choice. This will no longer be possible under the proposed cap, unless a donor's income is £50,000 (or is reduced to £50,000 after the application of other, already capped, reliefs).

The Government now considers that high earners should be taxed on income received, even if they give it away to charity, consequently diverting money from charity to the Government.

9. Why is this being introduced? 

It is now clear that at the heart of the proposal is a new policy position centring on the notion that individuals should pay a minimum percentage of their income in tax. Accordingly none of that minimum tax charge should be reclaimable by charities or reducible by donors; it should remain with the Treasury for expenditure by the Government. This is a manifestly political issue and a policy position which, if put to the public in a straightforward fashion, could be the subject of a reasonable debate.

It has unfortunately been presented in a less than straightforward fashion, however and appears to have been formulated quickly and without due regard to the practical realities and impact. The underlying purpose has been obscured with confused and misleading references to 'foreign charities' and baffling references to charitable giving as a tax 'loophole'.  

10. What does this have to do with gifts to foreign charities?

There have been suggestions from 'Treasury sources' that the introduction of the cap was motivated by the extension of charitable reliefs to eligible organisations in the EU, Norway and Iceland following the Hein Persche line of cases at the European Court of Justice. These cases established a principle of non-discrimination between EU member states such that a member state cannot discriminate on the grounds of territoriality when determining which public benefit organisations may come within the scope of that member state's charitable tax relief regimes.

Following the introduction of Finance Act 2010, eligible organisations in the EU, Norway and Iceland may receive donations from UK taxpayers which are relieved under Gift Aid and other charitable tax reliefs.

Public comments from the highest level of Government have additionally referred to high-income UK tax payers making gifts to organisations which they set up abroad and then fraudulently misusing those funds for non-charitable purposes. However, the Treasury has indicated that fears of foreign abuse are not the motivation for the proposed cap.

Leaving aside the fact that HMRC may refuse to relieve any donation to an organisation that is not charitable in English law (in its purposes and activities), there is no logic in tackling fraud or abuse of the tax system with a cap. As has been pointed out elsewhere - if it is fraudulent or abusive to make a gift to a foreign charity, then it is no less fraudulent to do so with merely 24% of one's income.

There are already provisions in the tax system to deal with those who give in order to misuse funds or obtain private benefit. The Tainted Charity Donation Rules were painstakingly crafted after it was acknowledged that the Substantial Donor Rules which preceded them were not fit for purpose. Depending on its ultimate post-consultation form, the General Anti-Avoidance Rule (GAAR), which was also announced in Budget 2012, could be an appropriate tool to tackle abuse.

11. The USA has a relief cap, right? 

Yes and this has been referred to by HMRC and Treasury in justifying the proposed cap.

The Treasury has said that imposing a limit on uncapped relief is similar to the position in the United State, where philanthropy nevertheless thrives. It seems somewhat disingenuous of the Treasury to compare the UK flat cap at 25% of taxable income to the US restrictions on charitable deductions.

First, the US limit on deducting contributions to public charities is set at 50% of adjusted gross income rather than 25% of taxable income as is proposed for the UK (the limit is 30% of adjusted gross income for contributions to private foundations).

Second, the US permits a carry-forward of an individual's unused charitable contribution where it exceeds the deductible ceiling for the year of the contribution. The carry-forward permits an individual who makes a contribution in excess of 50% of his adjusted gross income in one year to be carry forward the excess portion up to the 50% limit each year for the following five years.

Third, the US charity fundraiser has a greater armoury of weapons at his or her disposal, including split interest charitable trusts (or 'lifetime legacies') which allow a major gift can be structured so that the income is retained by the donor and the remainder given to charity.

Finally, the US limit relates only to charitable donations so cannot be 'used up' with non-charitable reliefs.

12. Will the Government abandon this proposal now that charities have lobbied against it?

It has now been indicated that the Government is interested looking for 'an acceptable solution' to the impasse playing out publicly between the Governments on the one hand and the charities sector and philanthropists on the other.

It has been suggested that either a rise in the cap to 50% of income or an ability to carry forward (or possibly both) might be proposed in order to give limited concessions. It has also been suggested in some corners that the proposal will be abandoned entirely.

Mentions in the press that lifetime legacies – or tax-efficient charitable remainder trusts – may be introduced as part of a solution have been denied by the Treasury.

13. What happens next?

Informal consultation is already taking place between Treasury, HMRC and sector groups.
A formal consultation document is expected this summer and draft legislation would then be expected in late 2012.

14. How can we get involved and have our say?

A great deal of lobbying is going on and readers may also be interested in the 'Give it Back George' lobbying campaign (http://giveitbackgeorge.org/), which has been backed by the Charities Aid Foundation, the Charity Tax Group, National Council of Volunteer Organisations and many others.

Charities and donors wishing to have their voices heard on this should participate in the consultation this summer and where possible provide concrete examples of how their income or giving may be affected.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.