As a charity, you won’t need to pay tax on most kinds of income or gains – so long as the money is used for charitable purposes. However, the blanket assertion that charities are completely exempt from paying taxes is not accurate. While charities usually have smaller tax bills than other types of organisations, they’re not completely exempt and may be liable for corporation or income tax in specific situations.
It’s important to understand how much tax you need to pay and what the exemptions are so you can run your organisation efficiently and stay in HMRC’s good books. Here’s what you need to know.
What are charities exempt from?
Once you’re registered as a charity, you will be exempt from paying corporation tax and eligible for a number of tax exemptions and discounts on income such as donations, trading profits, and investment income.
If tax is deducted from income from donations, you’ll be able to claim that tax back using the online charities service.
Corporation tax
Generally speaking, charities are exempt from corporation tax. You won’t need to complete a corporation tax return unless:
- your charity has any taxable income or gains not covered by reliefs or exemptions
- HMRC has specifically asked you to file a corporation tax return.
Certain expenditures, not directly related to advancing the charity’s objectives, are considered non-charitable expenditure and may lead to the loss of tax exemption for the charity.
For example, you may need to pay corporation tax on non-charitable profits, as this may not be exempt.
You’ll also need to file a return if HMRC requests one – even if there is no liability. Otherwise, your charity will incur penalties.
Charitable purposes
As mentioned, in most cases charities don’t need to pay tax on income used for “charitable purposes” – but what exactly does this mean? Charities must ensure that their charitable expenditure is accurately reported to avoid potential tax liabilities.
According to the Charities Act, charitable purposes are actions that help the public and further the organisation’s charitable objectives. These objectives can include:
- relieving poverty
- education
- health
- the arts
- human rights
- animal welfare.
Capital spending from investment income or gains from certain property deals can also be considered when assessing tax exemptions for charities.
Operational expenses such as paying rent and employee wages also further charitable objectives, and so are also exempt.
However, your charity may be taxed on any non-charitable income or activity deemed not directly linked with building the charity or fundraising – unless it falls under the small trade exemption limit.
Small trade exemption limit
The small trade exemption limit is the maximum amount of money a charity can spend on non-charitable purposes before it needs to pay tax on it.
Your charity’s limit depends on its overall annual income, but the maximum ranges from £5,000 for small organisations to £50,000 for larger charities.
This means that if you manage your charity finances well, you may not need to pay any tax on your annual income.
When do charities pay tax?
Your charity will need to pay tax on any dividends received from UK companies before April 2016 and on any profits gained from developing land or property. Additionally, charities may become liable for paying corporation or income tax due to non-charitable expenditure, specific capital spending, investment income, or gains from certain property deals.
Purchases are also taxed, but special VAT rules do apply. Charities pay a discounted 5% VAT rate or flat rate on certain goods and services such as construction services, medicine and aids for disabled people.
When it comes to non-domestic buildings, charities need to pay business rates, but do get a generous 80% discount on their bills.
If your charity sells goods and services to customers, you’ll need to pay close attention to all trading activities to ensure you’re making the most of your money.
Because of this, many charities choose to use a subsidiary trading company to trade on their behalf. This is particularly useful if your charity makes a profit higher than the small trading tax exemption limit, or if you want to protect its assets from trading losses.
Making a difference
While charities have access to more generous reliefs and exemptions than other organisations, managing the tax obligations can be complicated. All the admin required to keep on top of everything can eat into valuable time you could be spending on furthering your charity’s mission.
With years of experience providing specialist accounting and taxation services for charities, we’ll help you meet your obligations and claim all the tax reliefs and discounts you’re eligible for. We can manage your accounts as well as help you plan ahead to maximise your savings.
Get in touch with us to find out how to make the most out of your organisation’s money.
Dick Haffenden
