U.K. charity law: Is it creating a true democracy of giving?

• Author: Michels, James Randolph
• Position: British reform of tax law

ABSTRACT

In November 1999, the British government announced important legislative reforms affecting the various methods of providing charitable contributions. The government expressed its desire to create a "democracy of giving" by expanding tax relief for charitable donations. These changes took effect in April 2000.

This note argues that the recent legislation reforms, while a step in the right direction, do not create a true "democracy of giving." In arriving at this conclusion, the note will outline the evolution of British tax law related to individual charitable donations. The note will also explore the problems experienced by the charitable sector that prompted legislative reform, and will provide an overview of recent reforms in this area. An overview of the recent reforms will be provided. Finally, the note suggests that adopting U.S.-style tax relief for charitable donations would better achieve the British government's goal of creating a true "democracy of giving."

1. INTRODUCTION

   Approximately 300,000 charities operate in the United Kingdom.(1) These charities employ over half a million people and create roughly 12 billion(2) [pounds sterling] in economic activity.(3) Approximately one-third of the income of these charities is generated by individual donations.(4) Tax relief is available for these donations under certain circumstances.(5)

   Despite the availability of tax relief for individual donations, the last two decades have shown a decline in the number of people giving to charity.(6) In response to this problem, the Government initiated a consultative process in order to draft new legislation related to charitable giving.(7) The Government announced several important legislative reforms in November 1999 intended to create a "democracy of giving."(8) These changes took effect in April 2000.(9)

   This note will examine the charitable sector in the United Kingdom from the viewpoint of an individual donor. In particular, the note will analyze the primary methods of making tax-efficient gifts. The Government's consultative process will also be discussed and the legislative reforms will be outlined. Finally, this note will argue that the proposed legislative reforms do not adequately address the scope of the problem facing the charitable sector. It will be suggested that the Government adopt a U.S.-style system of income tax relief for charitable deductions in order to create a true "democracy of giving."

2. U.K. TAX LAW RELATED TO CHARITABLE GIVING

   1. What is a Charity?

      Under English law, a charity is a trust, corporation, or unincorporated association established for purposes (or objects) that are "exclusively charitable."(10) The preamble to the Statute of Charitable Uses 1601 (commonly referred to as the Statute of Elizabeth) listed a number of objects considered to be charitable.(11) The current leading authority on charitable purposes, Income Tax Special Purposes Commissioners v. Pemsel, 1891 App. Cas. 531, defines charitable purposes as (1) the relief of poverty, (2) the advancement of religion, (3) the advancement of education, and (4) other purposes beneficial to the community not falling under the previous headings.(12)

      This definition does not permit what might be described as essentially "political" activities unless they are ancillary to the main objective of the charity.(13) This is not always easy to determine.(14) In McGovern v. A-G, the court concluded that a trust which included any of the following as its direct and principal purpose would not be charitable: (1) to procure changes in English law or the law of a foreign country; (2) to further the interests of a political party; or (3) to procure changes in government policy or administrative practice, whether in United Kingdom or abroad.(15)

      English charities are registered with, and supervised by, the Charity Commission.(16) The Charity Commission is the Government department whose aim is to give the public confidence in the integrity of charity.(17) In addition to the registration and monitoring of charities, the Commission also investigates alleged wrongdoing.(18) The Charity Commission is accountable for its decisions to the courts and for its efficiency to the Home Secretary.(19) The Home Secretary appoints the five commissioners.(20) There are over 180,000 charities registered in England and Wales.(21) In 1998, the total annual income of all registered charities was close to 20 billion [pounds sterling].(22) A significant portion of this income was derived from individual donations.(23)

   2. Evolution of the Tax Law Related to Individual Donations

      1. The U.K. Income Tax System

         Since the late 1970s, a series of tax acts in the United Kingdom(24) have significantly altered the income tax system.(25) During this period, the income tax rate structure has been dramatically transformed.(26) The most significant reform has been the substantial reduction of income tax rates.(27) The top rate on wage income fell from eighty-three percent in the late 1970s to forty percent by 1988.(28) An additional investment income surcharge of up to fifteen percent on very high investment income, leading to a maximum income tax rate of ninety-eight percent, was eliminated in 1984.(29) The basic rate faced by most taxpayers fell from thirty-three percent in tax year 1978-79 to twenty-four percent by 1996-97, and is now twenty-two percent.(30)

         The unit of taxation is the individual, although a system of joint filing for married couples was used prior to 1990.(31) More than twenty-six million individuals (out of an adult population in the United Kingdom of a little over forty million) are subject to the income tax.(32) Not all income is subject to tax.(33) The tax base includes wages, interest, dividends, some capital gains, pension benefits, unemployment benefits, royalties, property income, business income and other items.(34)

         The income tax operates through a system of allowances and tax brackets. Each individual's personal allowance (the equivalent of an exemption in the United States) is deducted from total income before tax in order to determine taxable income.(35) The personal allowance is 4,385 [pounds sterling] for taxpayers under sixty-five years old in tax year 2000-01 (which ends April 2001).(36) Taxpayers over sixty-five years old are entitled to higher personal allowances.(37) After subtracting any personal allowances, the marginal tax rate in 2000-01 is ten percent on the first 1,520 [pounds sterling] of taxable income, twenty-two percent (the basic rate bracket) on additional income up to 28,400 [pounds sterling], and forty percent on higher levels of income.(38) It is estimated that in 1999-00 about twelve percent of taxpayers faced the lower rate, seventy-nine percent faced the basic rate, and the remaining nine percent were taxed at the higher rate.(39) Allowances and tax brackets are indexed for inflation.(40)

         One of the most interesting aspects of the British income tax is that few citizens have to file tax returns.(41) Filing is usually unnecessary because withholding regulations generate (in principle) exactly the right amount of withheld taxes at source on wages and other income.(42) The main instrument of exact withholding is the "pay as you earn" (PAYE) system.(43) The PAYE system is a cumulative withholding scheme that applies to wage income.(44) Workers provide their employers certain basic information, including marital status and age, which is used to calculate withholding allowances.(45) Employers then withhold taxes as directed by these formulas.(46)

         The key to exact withholding is that the process is cumulative.(47) Total tax payable for a particular financial year depends upon total income in that year.(48) Thus, when calculating tax at each paycheck, the employer considers the income not simply for the period in question, but for the whole tax year to date.(49) Therefore, employees that stop working in the middle of the year still have the correct amount withheld.(50) When an employee changes jobs, information on his or her cumulative wages and taxes is provided to the new employer, and the calculations continue.(51) In contrast, in the United States, taxes on wages are withheld, but withholding is neither cumulative nor intended to be exact.(52)

         The comprehensive nature of the PAYE system has translated, in the past, to fewer than ten percent of taxpayers having to file tax returns in any given year.(53) Most taxpayers filing tax returns are high-income taxpayers with asset income (taxes which have been withheld at a lower rate), those with capital gains above the exempted amount, and those with self-employment income.(54) A new system was introduced in 1996-97 that represented a move towards greater self-assessment.(55) Nine million tax returns, covering roughly twenty percent of the adult population, were issued in that first year.(56) This system presents the individual taxpayer with two options: (1) self-assessment (the deadline for filing the return and paying the tax due is the following January 31st), or (2) electing to have the Inland Revenue compute the liability based on income and expense-related information provided by the taxpayer. (The return must be filed by September 30th of each year with the tax still being due by the following January 31st.)(57)

      2. History of Tax-Efficient Giving

         Fiscal policy has long been a concern of the charitable sector. The issue of income tax relief for donations to charity first emerged in the early 1920s due to an unforeseen result of a provision in the Revenue Act of 1922.(58) The provision was designed to close certain loopholes that involved the use of deeds of covenant, which are "promises to pay for a specified term of years a sum of money out of an individual's income."(59) According to long-established tax law principles, such transfers could be deducted from the income of the covenantor and added to that of the covenantee.(60) The covenantee would...