The clause introduces schedule 3 to allow the new anti-avoidance measures to prevent the abuse of tax reliefs on charitable donations for income tax, corporation tax and capital gains tax. I think we all agree that the whole point of charitable donations should be to benefit a charity, so it is right to continue to crack down on misuse for tax avoidance purposes. Our amendment is designed to ensure that the Treasury reviews the impact of the new rules to determine the most appropriate and effective means of doing so.
The Finance Act 2006 introduced the substantial donor rules, which applied where a donor made a charitable donation of at least £25,000 over 12 months or at least £100,000 over six years. The substantial donor rules limited tax relief where the donor entered into a subsequent transaction with the charity from which the donor benefited. It is necessary to tackle such tax avoidance measures, of course, but charities raised concerns about the application of the 2006 rules in practice. Some reported that innocent donations were being wrongly caught and that the rules had the potential to deter much-needed and genuine substantial donors.
Given the increased burden on the charitable sector from the big society agenda and the cut in local authority grants, charities are basically being asked to do more for less money. Now is the time when charities can least afford to lose potential donations. Charities also reported that the substantial donor rules added to their administrative burden, as they were required to hold records on both substantial donors and their connected parties. As the charities were responsible for ensuring compliance, it was they who were held responsible for any penalties.
Following consultation with charities, it was clear that there was scope for improvement, and that was why the 2009 pre-Budget report announced the intention to replace the substantial donor rules with new rules to deny tax relief on donations to charities when the donor was party to an arrangement the purpose, or one of the main purposes, of which was to extract value from the charity. That is the context of schedule 3, which accordingly introduces a purpose test and sets out the three criteria that must be met for a donation to be classed as tainted and consequently as ineligible for tax relief.
The Treasury’s consultation on the draft legislation stated:
“The new legislation is intended to catch only donors (or persons connected to them) who, in respect of a donation to charity, have entered into arrangements with the purpose of receiving an advantage from the charity.”
The intention of schedule 3 is, accordingly, to ensure that anti-avoidance legislation targets only people who have made a donation for personal gain, does not wrongly catch out or discourage genuine philanthropic donors and does not penalise the charitable organisation unless they have knowingly entered into the avoidance arrangement. Can the Minister tell us how many, or what proportion of, charitable donations over the past five years have been deemed to breach the existing substantial donor rules, and whether the Government have an estimate of the proportion of them that were wrongly judged to have broken the rules?
I am also interested to know whether the Government have any indication of the number of potential substantial donors who were deterred by the regulations, because it is important to have as much information as possible about the apparent weaknesses of the previous system to ensure that the provisions in schedule 3 are the appropriate solution.
A common concern raised during the 2008 consultation was that the substantial donor rules were complex and insufficiently targeted, and it is not clear—as I shall come on to discuss—whether schedule 3 addresses that concern. The Government published draft legislation in December on the tainted charitable donations provisions and the consultation on it was welcomed. The responses were informative but, although many of them welcomed the review of the substantial donor rules, the draft proposals did not receive a glowing endorsement. For example, Russell-Cooke solicitors noted that:
“on a close analysis, these new rules may also catch genuine donations (for example, a sale at an undervalue), and many are now querying whether or not the tainted charity donations rules will improve the current position.”
James Kessler, QC, the author of “Taxation of Charities”, described the proposals as
“lengthy, complicated and wide ranging”,
and concluded that
“the tainted donation rules are unfit for purpose, and…would seriously damage charities and charity fundraising.”
Worryingly, he also highlighted a number of inaccuracies in the explanatory notes, including the wrongful assertion that a donation to a hospital in return for treatment would qualify for gift aid. Under the Income Tax Act 2007 that is clearly not the case, as there is an obvious benefit attached to the donation. I am glad to say that that inaccuracy has been corrected in the final version of the notes, but it raises questions about the level of consideration given to the existing legislation and to the draft proposals.
The intention is clearly to ensure that innocent donors and charities are not penalised, but James Kessler unfortunately came to the conclusion that the tainted donor regulations
“are not better for the charitable sector than the substantial donor rules. They are in fact worse.”
Similarly, the Law Society warned that the suggested replacement of the substantial donor rules is complex, and the uncertainties that are likely to result seem contrary to the Government’s stated aim to promote greater predictability, stability, simplicity, scrutiny and transparency in the UK tax system. That body has also expressed its concern that the legislation may not be easy to follow and apply in practice.
Some modifications have been made to the draft legislation—the Minister might want to comment in more detail about the changes that were made in response to the consultation—but things that the Law Society, and others, have reservations about, including the lack of a minimum level for donations that could be considered tainted, and the potential for charities to be held jointly and severally liable, remains in schedule 3. Although many people criticised the previous rules for being insufficiently targeted, it seems that they are now concerned about the potential impact of broadening the scope of the anti-avoidance measures to include all donations, not just, as within the substantial donor rules, donations of more than £25,000 or £100,000 in the given period. Have the Government given any consideration to whether that might discourage donors? Also, will charities have to be cautious with all donations to ensure that none of them may be considered tainted?
A prime objective in replacing the substantial donor rules seems to be to ensure that charities do not pay the penalty for a donor’s mistake or abuse of the system. However, it seems that that objective will not necessarily be achieved. Proposed new section 809ZN, which is in schedule 3 of the Bill, makes it clear that a charity will be held liable only if it was “party to” the arrangements, but whether a charity was or was not aware of such arrangements could be open to misinterpretation. Will the Minister give more information about where the burden of proof will fall and what criteria will be used to judge a charity’s liability? Are the Government satisfied that there are sufficient safeguards to ensure that charities are not wrongly accused?
Regarding the three Conditions set out in proposed new section 809ZJ in schedule 3, the Institute of Chartered Accountants expressed concerns that Conditions A and B could bring within the new provisions many arrangements that are not the intended target of this new legislation. It is important to ensure that the regulations do not target genuine philanthropic donors, and Condition A accordingly requires some proof of intent. Although the explanatory notes to the Bill provide a number of examples in which Condition A may or may not apply, the term “reasonable to assume” that Condition A relies on to a large extent seems rather vague and open to subjective interpretation. Will the Minister provide more information about who will be the arbiter of that issue and the criteria they will use?
In contrast to the substantial donor rules, the tainted donation rules include only people living together as husband and wife or civil partners, trustees and connected companies, rather than most immediate family members. Although that may represent a simplification, the new rules introduce the problem of associated donations, whereby all tax reliefs are disallowed on donations connected to the tainted donation even if they are not tainted directly. Accordingly, doubts have been raised about whether that achieves the Government’s aim of focusing on the purpose of an arrangement.
On publishing the draft legislation, the Treasury estimated that the tainted charity donation provisions would cost £10 million per annum, due to the projected rise in tax relief claims. Will the Minister say how that estimate was arrived at, how many donors the provisions are expected to affect and by how much charitable donations are expected to increase?
It is also unclear how the rules on tainted donations will be applied and how tainted donations will be monitored if the starting point is to be tax return audits. With no limit on donations, it seems that every donation on which relief is claimed could be examined, so how will HMRC decide which claims should be investigated and how will HMRC apply the purpose test?
If new rules are to reduce the administrative burden on charities, they need to be simple to understand and administer, but they have been described as user-unfriendly and the Treasury itself concedes that they could mean that donors incur more costs in seeking accountancy advice on the validity of their donation arrangement. Therefore, we want to ensure that schedule 3 is not unnecessarily complex and represents a significant improvement on the substantial donor rules in terms of ease of administration for HMRC, the administrative burden placed on charities, the incentive for potential donors and, of course, the reliability of the test.
The reservations that I have outlined indicate that there are doubts about how the tainted donation rules can be applied in practice and about the impact that they will have on charities. It is also clear that the consultation on the substantial donor rules proved very informative in highlighting the weaknesses and unintended consequences of that regime. Therefore, I encourage the Minister to consider our amendment, so that the impact, effectiveness and scope for potential improvement to the provisions are kept under review.
Clause 27, along with schedule 3, introduces new anti-avoidance rules to replace the anti-avoidance rules on substantial donors to charities. As we have heard, the path that we have taken to the clauses that we are discussing started back in 2008, when the first formal consultation on the existing anti-avoidance legislation was undertaken. In Budget 2009, there was an announcement that further informal consultation would take place with charities, their representative bodies, large donors to charities and charity tax professionals to develop a replacement for the existing rules. That informal consultation took place during the summer of 2009.
In the 2009 pre-Budget report, there was an announcement that the existing rules would be replaced with new rules based on a purpose test. As part of clause 27 and schedule 3, we set out that purpose test. On coming to office, the Government confirmed in the June Budget our commitment to replacing the existing rules.
It is probably worth setting out why it is important to take donor abuse seriously. Charities and their donors receive a generous package of tax reliefs designed to encourage and support charitable giving, in fact in total the reliefs are worth more than £3 billion each year. Unfortunately, as the Committee can imagine, that generosity attracts not only people who wish to support charitable activities but those who seek to gain a financial advantage for themselves by avoiding tax, so we need anti-avoidance legislation to ensure that we can counter that abuse.
A significant area of abuse of charitable tax reliefs is donors’ abusing their control of a charity. Large donors are often in a position of influence and may look for ways to extract the funds that they have donated to the charity after they have received tax relief on them. It is worth pointing out that the vast majority of such donor-controlled charities act with complete propriety, but a small minority are involved in abusive behaviour, which puts at risk the good name of all charities in the UK. The new rules will counter that behaviour. They will also mean that the taxpayer’s money that we, as a country, want to use to support charities will go more holistically towards doing so, and we will not see an element of it being, in effect, siphoned off to people who should not have been eligible for tax relief in the first place.
It is widely accepted that the rules were poorly targeted. The burden was on the charity, both administratively and financially, and it, not the offending donor, was liable for any tax loss if an offending donor was caught. Furthermore, the rules caught unintended transactions and discouraged large, genuinely philanthropic donations to charity. Quite simply, the substantial donor rules were not fit for purpose, and work on reforming them rightly began under the previous Government.
HMRC’s consultation has been broad and inclusive, and everyone agrees that, although it is essential to counter real abuse of tax reliefs, we cannot leave legislation in place that deters genuine donors from supporting charities. The change is supported. Nicola Evans, of the law firm Bircham Dyson Bell, said that it
“removes many of the problems that previously existed around perfectly legitimate arrangements”.
“evolution of the improved rules...is a good example of how anti-avoidance legislation can be improved through consultation”.
The hon. Member for Bristol East mentioned James Kessler, and he is a part of the HMRC working group looking at the rules, but most people in the working group have welcomed the changes. Those who oppose them generally do not approve of any anti-avoidance rules at all. Therefore, the opinions that she quoted are, first, not the views of the majority and, secondly, certainly not the views of the Government, because we want to ensure that the £3 billion of taxpayers’ money for tax relief on charitable giving has integrity. The new rules are the culmination of an extensive consultation, which ensures that unintended transactions are not caught.
At the centre of the new rules is a new purpose test that must be satisfied before they are triggered. First, has the donor, or someone connected with them, entered into arrangements with the intention of receiving some sort of financial advantage from the charity over and above any tax relief properly due on the donation? Secondly, would the donation and the arrangements have been made independently of each other? If the donor would not have made the donation without the prospect of a financial advantage, the donation will be deemed to be a “tainted donation”, and the tax relief that would have been due on it will be denied.
The vast majority of donations to charity are not caught by the legislation, because the vast majority of donors do not donate to gain a financial advantage. When abuse occurs, it will be the dodgy donors, rather than charities, who will have to pay the additional tax. The one exception is when a charity knowingly becomes involved in an arrangement that results in a tainted donation, but it is not possible to obtain the tax from the donor. That, however, would be a last resort and it is only in place to prevent such deliberately contrived arrangements that would seek to undermine the rules.
The new legislation will also largely repeal, in two years’ time, the current rules in relation to substantial donors to charities. In the meantime, there will be a transitional period, during which people who have made donations before 6 April 2011 may still be caught by the substantial donor rules. The only limited scope for a substantial donor to be caught after the two-year transition period is when they enter into a contract before April 2013, but payment under that contract is deferred until after that date. This is anti-avoidance legislation and not catching that situation would allow people to circumvent the old and the new rules.
The new rules will cost an extra £10 million to the Exchequer, but that is an extra £10 million in tax relief, because donations that have been disallowed or discouraged under the old rules will no longer be caught. Effectively, that means that more will be given to charity. The hon. Member for Bristol East has asked what impact the clause will have. It is anticipated that it will mean an extra £10 million in tax relief to charities.
As I have said, the consultation undertaken over a number of years, under both this Government and the previous one, has helped to develop the underlying principles for the new rules. The group of interested parties that we set up to work alongside HMRC helped significantly in the development of those principles, and their comments on the draft clauses have resulted in several significant changes, ensuring that the rules target real abuse of charity tax relief.
On amendment 96, the impact of all the measures has been published in their respective tax information and impact notes. The note for this measure was published alongside the draft legislation on 9 December. I shall explain it further for the benefit of the Committee and hope to resolve any remaining queries. Charities will be helped by the new rules, because they move the compliance burden away from charities and on to donors. As I have said, the cost of £10 million to the Exchequer represents additional tax relief on donations, so those charities that will benefit will do so, all together, by £10 million each year.
We have not made an estimate of the additional cost for individual donors, but it is likely to be very small. Obviously, most donors simply make a donation and then enter into an arrangement with the charity. Those donors will be unaffected by the new rules and will incur no costs. The majority of donors who enter into arrangements with a charity will not be caught by the new rules, because their purpose will not be to obtain a financial advantage. They will not, therefore, need to consider this legislation. As for those individuals who seek to gain a financial advantage, HMRC does not generally estimate the administrative burden of trying to avoid tax. Presumably, the harder and higher, the better.
My final point on the amendment is that the door has not closed on this legislation. The impact of the new rules will be reviewed by a sub-group of the HMRC charity tax forum, which has proved helpful in working with me as a Treasury Minister and with HMRC over recent months to help us develop not just this legislation but the whole philanthropy package that we introduced in the Budget. I am sure that we will discuss that package later. The first meeting of the HMRC charity tax forum to review the new rules is anticipated by the end of the year. If it becomes apparent that innocent donors are being caught by the new rules—although we do not anticipate that—we will, of course, look at what changes we might need to introduce in a future Finance Bill. I hope that I have reassured the hon. Lady that we keep a watching brief on the issue. We want to make sure that, although they are complex, the rules operate as intended.
In conclusion, the new tainted charitable donation rules represent a huge improvement on the substantial donor rules. The new rules have been broadly greeted by a number of charity representatives, who are keen for them to be included in the Bill. The new rules remove the administrative burdens imposed on charities by the substantial donor rules. The vast majority of donors will be unaffected. A donor will always know if they have entered into arrangements with the purpose of getting a financial advantage in return for a donation. It will be the donor, not the charity, that is liable for any tax charge. The new rules will protect the Exchequer from the abuse of the UK’s generous charity tax reliefs, leaving charities to concentrate on building their relationships with donors and making their contribution to the country and our big society. This is but one measure that has led the Charities Aid Foundation to say that the Chancellor
“delivered for charities and those who want to support them.”
I therefore reject the hon. Lady’s amendment, but I hope that she will concede that we have some safeguards in place. We believe that these rules will work much more effectively.
It certainly was my intention to press this amendment to a vote, but in view of the assurances that the Economic Secretary has given on the measures that will be taken with the working group to keep the provisions under review, I beg to ask leave to withdraw the amendment.