A s widely reported, the UK government has bowed to European Commission pressure and in the Finance Act 2010 extended UK charity tax reliefs to charities in the European Union, Iceland and Norway (hereafter ‘EU charities’).

As the legislation comes into force, donors to EU charities and EU charities themselves will be able to claim the full range of UK tax reliefs and exemptions available to UK charities, provided the relevant charity has registered with HMRC.

Reaction to the changes has largely focused on the new registration requirements and, in particular, the new ‘fit and proper’ test for managers.¹ This is because the new rules introduce further regulation for charities seeking to maintain their charity tax reliefs in the face of an increasingly watchful HMRC. That said, the opening up of UK charity tax reliefs to EU charities will create opportunities for individuals and charities dealing with cross-border gifts and will, it is hoped, increase charitable giving overall.

The extension of UK charity tax reliefs to EU charities was perhaps inevitable. The European Court of Justice cases of Centro di Musicologia Walter Stauffer v Finanzant München für Körperschaften (C-386/04) and Hein Persche v Finanzant Lüdenscheid (C-318/07) confirmed that the common practice among Member States of applying charity tax reliefs only to domestic charities and to donors to domestic charities was discriminatory and in breach of the fundamental EU principles of freedom of establishment and the free movement of capital.²

It follows that since the UK signed the Treaty of Rome in 1973, charities established in other Member States and UK taxpayers donating to those charities could (in theory) lay claim to UK tax reliefs; it was just that the charity or donor would have to go to the European Court of Justice to prove it. Now that UK domestic law has changed, it opens the way for claims to be made without a trip to Luxembourg. To date, the new law is in force only in relation to claims for gift aid relief and HMRC has indicated that it will consider such claims on donations made since 27 January 2009 (the date of the Persche judgment). However, arguably claims could be made in respect of donations before this date, given that the gift aid rules were introduced in 1990. In Belgium, for example, where favourable tax rates were extended to EU charities in 2004, the tax authorities have agreed to apply reduced rates for earlier periods.³ As the new law comes into force for the full range of UK charity tax reliefs, this type of claim might be considered by EU charities and donors where substantial tax was paid in discriminatory circumstances.

The new legislation specifies that in order for any charity to benefit from UK charity tax reliefs it must first register with HMRC. HMRC has always had control over whether a charity receives reliefs, but being registered with the Charity Commission was usually sufficient to demonstrate eligibility. Now, UK charities have two registers to keep up to date and two sets of rules to abide by.

One of the new rules introduced by HMRC is that to claim reliefs a charity must have ‘fit and proper’ managers. ‘Fit and proper’ is not defined in the legislation and its application is wider than tests found in the Charities Act 1993, as HMRC’s guidance states that the rule is to apply not only to a charity’s trustees, but also to any officials ‘having general control and management over the running of the charity or the application of its assets’. HMRC has said that it expects the new rules to have little impact on existing UK charities, but there is a genuine concern that the lack of definition and extended scope gives HMRC flexibility to make its own determinations on a case-by-case basis.

Before the Finance Act 2010, charities making payments to bodies situated outside the UK lost tax relief if they failed to take ‘such steps as are reasonable in the circumstances’ to ensure that the payment would be applied for charitable purposes, as defined under English law (the reasonable steps rule). The relevant provisions (s500(b) Corporation Tax Act 2010 and s547(b) Income Tax Act 2007) have now been amended so that the steps taken must be those that HMRC consider are reasonable – this is a subtle but important change hinting at a greater degree of HMRC regulation than has hitherto been the case.

Until now, donors wishing to give to EU charities and to claim UK tax reliefs were obliged to make the gift to a UK registered charity. Larger EU charities sometimes established ‘sister’ organisations in the UK to receive donations from UK taxpayers. Donations to other EU charities had to be paid via donor-advised funds – UK grant-making charities that take into account the wishes of the donor in deciding how the funds will be spent.

Donors can now make their donation direct to an EU charity, provided the charity registers with HMRC. Once the procedure has been streamlined, registration need not be arduous and EU charities will not need to register with the Charity Commission, which means that HMRC will be their only regulator in the UK.

The EU organisation applying for registration must be one that would be regarded as a charity under English law had it been established in the UK. This could cause difficulties for existing EU public benefit organisations where the constitution or activities it undertakes might prevent registration.

Larger public benefit organisations that do not satisfy the English definition of charitable, but that want to solicit donations in the UK, can either alter their constitutions in order to register with HMRC or establish a sister charity. Establishing a sister charity will be expensive and there will be ongoing administrative costs in running two organisations in two different jurisdictions, but it will enable the organisation to solicit donations from UK taxpayers without having to change its own constitution or activities (though the sister charity would still need to be sure that the reasonable steps rule is followed when making any payment to the parent organisation). Where the organisation can be regarded as an EU charity, registration with HMRC may be the simpler option, as though there will be regulation by HMRC, the administrative burden will be less than administering an entirely separate organisation.

New EU charities could be set up taking into account the requirements of English law as well as the requirement of the country of establishment (and indeed any other country that may be relevant for charity or tax reasons). The experience of dual registration of charities in England and Scotland and elsewhere will assist in this.⁴ Of course, when jurisdiction shopping, it is not just the tax position that a philanthropist will take into account but also the regulatory environment, any restrictions on operation, cultural considerations and practical matters, such as the nature of its investments.

An EU charity would not be able to promote itself as a UK charity, but there would be nothing to prevent it from identifying itself as a charity of a particular jurisdiction and stating that it benefits from UK charity tax reliefs, including gift aid. EU charities that want to invest or operate in the UK may be in a more favourable position than English charities as they will not be subject to English charity law (for example, they can buy and sell land without complying with the restrictions imposed by s36 Charities Act 1993) or to Charity Commission regulation and accounting standards.

However, the reasonable steps rule applies equally to EU charities as it does to UK charities. EU charities wishing to benefit from UK tax reliefs on their income and capital gains will need to be alert to the rule when transferring funds to bodies in the same jurisdiction, as the activities of the recipient body might not be regarded as charitable under English law.

Double tax treaties are primarily designed to relieve double charges to tax, not to remedy the application of double reliefs. It is generally understood that a UK resident non-domiciled individual can donate untaxed offshore funds to the offshore account of a UK registered charity, which brings the funds onshore (thus ensuring there is no remittance), and then claim gift aid relief on the gift in respect of his UK taxable income. The same could now apply where funds in another EU jurisdiction are applied direct to an EU charity, allowing the donor and the EU charity to claim tax back from HMRC without any UK tax having been paid on the funds donated and without the funds ever touching the UK (provided of course that the donor has paid sufficient UK tax to cover the reclaim). If the EU jurisdiction also grants tax relief on that donation, would the double tax treaty prevent double relief?

For international philanthropists, this type of tax inconsistency may provide altruistic incentives to increase the value of charitable donations.

The UK offers one of the most extensive systems of tax reliefs to charities. The UK government estimates that by 2018-19 (when full take up is expected) the Exchequer cost of extending charity tax reliefs to EU charities could be GBP150 to GBP200 million.⁵ It is likely that EU charities will seek to benefit from the generosity of the UK system by soliciting donations from UK taxpayers. However, other EU Member States do not have such generous tax reliefs and the culture of giving is arguably less pronounced than in the UK. There is therefore a fear that the flow of tax will be largely one way with little expectation that UK charities will receive much financial benefit from tax reliefs to which they are entitled from other Member States. The question is then whether the disparity between the generosity of UK tax reliefs and those of the Continent, combined with a possible sharp outflow of UK tax to benefit charities in other jurisdictions might lead to a scaling back of reliefs in the UK?

Further, a charity outside the EU could seek to claim UK charity tax reliefs on donations to that charity on the basis that the principle of free movement of capital extends to third countries.⁶ There is nothing in the new legislation that allows for such a possibility, but it might only take a challenge from one large charity in receipt of a substantial gift from a UK taxpayer, for this particular aspect to be given further scrutiny.

Beyond the immediate outcry over HMRC’s enhanced regulatory powers, there is much to be determined and thought through for international charities and donors. However, it must be hoped that donations to all well regulated charities, whether in the UK or not, will increase.