Crossing borders

The tectonic plates of cross-border giving shifted significantly following the ruling of the European Court of Justice in the Persche case (C-318/07) at the beginning of 2009 (see solicitorsjournal.com 27 January 2009). However, it has taken 15 months for the regulatory waves caused by this ruling to wash up onto the shores of the UK in the form of schedule 6 of the Finance Act 2010. These measures will be hugely significant for donors and not-for-profit organisations throughout the European Union and will significantly influence how organisations, which operate internationally throughout Europe, arrange their operational affairs.

Foreign charities discriminated

The reform of UK tax reliefs was triggered ostensibly by the European Commission infringement procedure against the UK and other member states in 2006, formally requesting the UK to end discrimination of foreign-based charities. This was because the UK allowed tax relief for gifts to charities, but only if they were established in the UK. Charities established in other member states were excluded from the relief and the European Commission considered that this behaviour was discriminatory and contrary to the EC treaty on the basis that it.

According to the commission, this constituted an obstacle to the free movement of capital and conflicted with the free movement of persons, because individuals moving to the UK might wish to make gifts to charities established in the member state countries where they came from.

The commission also considered it was contrary to the freedom of establishment, because foreign charities were forced to set up branches in the UK in order to benefit from the favourable tax treatment.

This infringement action was launched in the wake of a series of ECJ rulings which culminated with the Persche case, where the court said German donor Hein Persche was entitled to receive the same tax reliefs on donation to a Portuguese charity as he would have received for a donation made within Germany. This was decided on the basis that the Portuguese recipient would have qualified as a German charity if it had been established within national borders.

Fiscal walls tumbling down

The opportunities for not-for-profit organisations active throughout the EU are significant and should give rise to a number of improvements for their cross-border work in the following ways:

• It should avoid the administrative burdens and costs of an organisation having to establish a legal foothold in different jurisdictions, thereby releasing funds which would have paid for such costs to be distributed or used for programme activities.
• It will avoid the governance problems associated with maintaining a common and effective operational strategy as between different legal entities in different jurisdictions.
• Most significantly EU charities should now qualify for tax privileges and receive tax deductible donations in relation to funds received from outside the domestic jurisdiction.
• EU countries will no longer be able to refuse tax deductibility to donors in relation to their gifts made to foreign-based foundations.

UK compliance

On 24 March 2010, the chancellor of the exchequer announced the extension of UK tax-exempt incentives to cross-border giving as part of his 2010 Budget report; it provided that UK charitable tax reliefs would be extended to certain organisations equivalent to UK charities and UK community amateur sport clubs (CASCs) in the EU and EEA countries, Norway and Iceland. The new rules would affect tax reliefs available to all charities, CASCs and their donors, which are administered by HMRC. These would include:

• income tax;
• gift aid;
• capital gains tax;
• corporation tax;
• VAT reliefs and exemptions;
• inheritance tax; and
• the various stamp duty taxes.

While it appeared that the UK would be adopting a relatively enlightened approach, the legislation is anything but benign, introducing a new definition of 'charity' for tax purposes with HMRC supplanting the Charity Commission as arbiter. This new law will apply to new and existing charities alike.

New definition of charity

The new definition of 'charity' requires that the body concerned should satisfy four conditions; it should:

• be established for charitable purposes only;
• meet the jurisdiction condition;
• meet the registration condition; and
• meet the management condition.

The first three conditions are, for the most part, uncontroversial and consistent with English charity law. It is the fourth part of the test which raises significant difficulties and which may give rise to enormous uncertainty for charities.

Aside from introducing another definition of 'charity' which enters a crowded marketplace with several definitions already in play in each of the national charity jurisdictions within the UK and the EU, the management condition runs absolutely contrary to the English law model.

The management condition

The difficulty with the management condition is that, rather than focusing on what the organisation in question is '“ or is not '“ doing, it instead depends upon HMRC's view of certain individuals.

While managers are defined as the 'persons having the general control and management of the administration of the body or trust', mirroring the definition of 'charity trustees' in the Charities Act 1993, with the implication being that the meaning of the two phrases will be the same, it seems clear that HMRC intends to interpret the expression 'managers' a great deal more widely. HMRC guidance provides that the term 'manager' includes, in addition to charity trustees, 'any cheque signatories' or 'financial controller'. HMRC's application form adds to the confusion by referring to 'a responsible person' rather than 'managers', which it defines to include 'other persons in controlling positions in your organisation such as the chairman, treasurer, company secretary, financial controller' and 'any individual authorised to sign cheques on behalf of the organisation'.

Apart from the practical difficulties and administrative cost (both for charities and for HMRC) arising from such a wide meaning, which encompasses anyone to whom delegated authority along lines is given, there appears to be no basis for HMRC to interpret the wording so widely. This could have significant implications for charities with a whole tier of senior staff treated as falling within the definition of 'manager'.

What do HMRC mean by 'fit and proper'?

While the legislation requires managers to be 'fit and proper persons' this term is not defined in the legislation. HMRC offers some guidance on the meaning, but makes it clear that it is not definitive. It refers to 'HMRC knowledge' of someone's involvement in a tax against or abusive tax repayment systems and 'information or evidence' pointing to a 'heightened risk' of involvement in other fiscal financial impropriety. This seems to be a somewhat flighty and fickle basis on which to deny an organisation its eligibility for tax reliefs.

For reasons unknown, HMRC has chosen not to rely on the common sense presumption that charities already registered with the Charity Commission (or indeed OSCR or the new Charity Commission in Northern Ireland) would already meet the definition of 'charity'. Instead, the decision as to who is 'fit and proper' will be left entirely to HMRC's discretion with no mechanism for appeal set out in the legislation. It appears that HMRC intends directly to intervene into the operations of an organisation and the guidance provides that 'if a charity does not amend its organisation response to a challenge from HMRC, then HMRC may refuse the charity's claims to reliefs'. The clear implication being that a charity may lose its tax reliefs if it does not remove a charity trustee or dismiss an employee at HMRC's command. Not only does the latter have employment law implications for charities which may be asked to choose between the tax relief or an employment claim, it also cuts across the Charity Commission's role as regulator of the sector. In the absence of clear legislation or a proper appeal process, the concern is that it will be left to HMRC to fill in the blanks in the guidance '“ which is not subject to parliamentary scrutiny.

Practical difficulties

To deal with the new law, HMRC has introduced a new seven-page form '“ much of which mirrors information already provided in the Charity Commission registration form '“ adding yet another layer of regulation to an already very regulated sector. The form enquires about the charity's public benefit, which appears to be an unnecessary duplication for any organisation registered with the Charity Commission and one queries whether HMRC actually has the expertise to judge the answers to that question in any event.

HMRC has stated that existing charities already registered with HMRC will not be affected by the new law until such time as HMRC's point of contact with the charity changes. However, this is not what their website provides, which states that 'if the charity trustees or managers change'¦ HMRC should be notified as soon as possible', using the notification form. No exception is made for charities already registered with HMRC. This may result in large organisations providing huge amounts of information to HMRC every time a bank mandate is changed or a cheque signatory added. So grave are the penalties, it would not be prudent for charities to take a robust, or indeed practical, view that HMRC do not really mean what they say.

Illogical and ill thought out

Overall, the legislation is ill thought out and has been introduced without sufficient consultation, thereby resulting in a second tier of cumbersome regulation for UK charities '“ already the subject of rigorous regulatory supervision.

HMRC has adopted a conceptually flawed position to assess a charitable organisation on the basis of whether its personnel are 'fit and proper'. There seems to be no logic in determining the tax status of an organisation according to HMRC's view of some of the individuals who are involved in that organisation, rather than according to whether or not that organisation complies with the legislative requirements to qualify for the relevant relief.

The charity sector in the UK is a pioneering, well-regulated, thriving sector, which makes an enormous contribution to the British economy. The Persche case provides this country with a real opportunity to become the jurisdiction of choice of any international organisation seeking to have a presence in the European Union. However, with legislation as ill thought out and hostile as this, there is a real danger that this will result in an opportunity missed.