I know what you are thinking. Charities do not pay tax and therefore do not need to tax plan. Am I right? If I am right, then, sadly, you are dead wrong. Charities actually pay tax on taxable income just like anybody else! They also pay Value Added Tax and, unlike everybody else, generally will not qualify for a refund of input VAT, because (i) they cannot satisfy the VAT registration threshold, and if they do, (ii) they still may only be entitled to a partial recovery at best.
“The issue for charities is that donations may not be enough to fund its charitable work.”
The main (if not only) advantage of charitable status, quite frankly, is the entitlement to receive covenanted donations from supporters, covenanted donations being tax deductible donations. The thing is, though, donations/gifts are not “income” and, therefore, are not taxable in the first place. So this “tax” benefit is not really for the charity, it is really a benefit for the donor. The charity derives an indirect benefit, because “but for” the donor’s tax break (in tax lingo: covenanted donation i.e. the ability to “expense” a gift) it may not have received the funding in the first place.
The issue for charities is that donations may not be enough to fund its charitable work. After all, like everybody else, charities have bills to pay (e.g. rent and salaries) in addition to funding the charitable work (e.g. clothes and food to cover and feed the poor).
When donations fall short, the charity must find other ways to raise funds, more often than not including operating a “commercial enterprise”. Surely, you say, such “commercial” activities must be tax exempt, because the “profits” will be reinvested into the charity’s coffers to help feed and clothe the poor. Sadly, once again, you are wrong.
The Board of Inland Revenue (“the Board”) in Trinidad and Tobago has begun to challenge such charitable “enterprises” (the “real” oxymoron in the Board’s view), and it has legitimate grounds. Specifically, section 6(1)(g) of Trinidad and Tobago’s Corporation Tax Act, Chap 75:02 (the “CTA”) provides that the profits of any ecclesiastical, charitable or educational institution of a public character, approved by the President by writing under his hand, insofar as such profits are not derived from a trade or business carried on by such institution, shall be exempted from corporation tax. The underlined text reveals that even charitable entities will be subjected to tax on receipts from a trade.
When donations fall short, the charity must find other ways to raise funds, more often than not including operating a “commercial enterprise”
Section 2 of the Income Tax Act of Trinidad and Tobago, Chap. 75:01 (the “ITA”) provides that “trade” includes a business, and every trade, manufacture, adventure or concern in the nature of a trade or business. This definition is unhelpful and requires us to look at the development of case law to determine what business income in this context is.
In the United Kingdom case of Brighton College v Marriott (H M Inspector of Taxes) (1924), 10 TC 213 the House of Lords endorsed the principle that:
“Whether in any particular case activities which may properly and exclusively be described as charitable have become trading or commercial must always be a question of fact, one important consideration being whether these activities are being conducted with commercial considerations in view and on commercial principles”. [Emphasis Added]
It was also observed that:
“A charitable institution which carries on a trade at a profit is chargeable with Income Tax in respect of its profits or gains in that trade, notwithstanding that they are and can only be applied to the purposes of the charity.” [Emphasis Added]
So, if charities are taxable on trading income, and are also subject to VAT, then operating a charity is not tax efficient is it? Well it really wasn’t meant to be. “Tax” is for profit generating entities. Charities, on the other hand, are meant to be focused on noble activities, such as feeding the poor, not on generating profit. Perhaps a charitable organization is just meant to be eternally grateful that its sponsors get tax benefits when they provide financial support towards the charity’s work.
Let’s be real. Charities need to be self-reliant in fund raising, because 3rd party donations may not be (and generally never are) sufficient. Profit is a good source of funds (if it were not, Bill Gates and others wouldn’t be trying so hard to generate them). There is an apt saying, which is worthy of mention at this point: you need to spend money to make money (in tax lingo: you have to incur input VAT – VAT incurred on the consumption of goods and services – if you are going to provide a commercial supply). This is where tax planning for charities comes in: charities need to maximize after tax profits and minimize their input VAT bill, if they are to effectively and efficiently raise funds to clothe and feed the poor.
Although the CTA and ITA do not provide tax incentives to charities per se, they do provide tax incentives to sponsors/donors of charitable causes. It is in this context that effective tax planning strategies can be employed to provide real “tax” benefits to charities, resulting in an overall reduction in their corporation tax and VAT bills.