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Sweet Charity

Welcome to my first column as I take over from my old friend Brian Lawless. Brian will certainly be a hard act to follow but I would like to start with a topic frequently raised by financial advisers – suitable investments for charities.

Most charities are constituted as trusts. The last few years have certainly been interesting ones for trustees, with substantial alterations to the tax regime affecting trustee investments and the Trustee Act 2000, which also applies to trustees of charities.

In considering their strategy, trustees need to be mindful of the tax treatment of any proposed investments. In the right circumstances, packaged products such as single premium bonds and mutual fund investments can have advantages over direct equity investment. The question is, are such products suitable investments for a charity?

A major tax advantage for charities is the exemption from income tax and capital gains tax in respect of income and capital gains arising from investments made for charitable purposes (qualifying expenditure).

A list of investments that constitute qualifying expenditure for charities is set out in Schedule 20 of the Income and Corporation Taxes Act (ICTA) 1988 but this does not include life assurance or capital redemption policies. The Inland Revenue has recently confirmed in Annex VI on the Charities section of its website that it will no longer accept claims by charities for such investments to be treated as qualifying investments.

The effect of this is that if a charity has relevant income of more than £10,000 in a year and invests in life assurance or capital redemption policies (either UK or offshore), the exemption from income tax and capital gains tax on income and gains that exceed £10,000 in that year will be restricted.

Consider the position if a charity has income and gains of £80,000 (after expenses) and invests £50,000 of its funds into a single premium bond. Only £30,000 (i.e. the first £10,000 plus £20,000) would be exempt from tax.

Furthermore, if a charity invests in a UK bond, the tax suffered on income and gains by the life fund would be unreclaimable, as indeed would any withholding tax suffered within an offshore bond fund.

Finally, although there is a general exemption from income tax on investment income, that exemption does not extend to income taxed under Schedule D Case VI – the very way that chargeable gains under life assurance and capital redemption policies are taxed. Thus, on encashment of a bond, assuming the charity is constituted as a trust, a tax liability could arise which could have been avoided by the use of more suitable investments.

This tax liability will be at the basic rate (22 per cent for 2002/03). For a UK bond, there will be no further tax to pay. For an offshore bond, tax at 22 per cent will be payable on the gain. Investment into a single premium bond, either UK or offshore, will be a highly inappropriate investment for a charity to make.

Let us now consider other alternatives. Mutual fund investments such as unit trusts and Oeics are permissible investments for charities under Schedule 20 ICTA 1988.

However, trustees should bear in mind that since April 6 1999, charities, along with other non-taxpaying shareholders, have not been able to reclaim the notional 10 per cent tax credits on UK dividend income. To cushion the impact of this change, charities have been able to claim compensatory payments from the Inland Revenue over a five-year period by way of payments equal to the following percentage of their UK dividend income:

1999/2000 21 per cent

2000/2001 17 per cent

2001/2002 13 per cent

2002/2003 8 per cent

2003/2004 4 per cent.

In view of the reducing level of compensatory payments, charities may wish to consider investment in unit trusts or Oeics where the emphasis is on growth and which pay no income so that they could realise units/shares to provide the “income” they require.

As described earlier, charities are exempt from any charge to capital gains tax as long as the amounts received are applied for charitable purposes. In particular, a “fund of funds” unit trust may be attractive in order to gain access to a large spread of funds without the need for, and the costs of, constant buying and selling by the trustees.

Charitable trustees, like all other trustees, will be looking for advice and guidance. The bond route seems unsuitable but capital growth orientated unit trusts or Oeics might well be an attractive option.

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