When it comes to running a charity, one of the essential tasks is generating income to support its charitable activities. While it is commonly assumed that charities do not pay taxes on their income, the reality is more nuanced. Depending on the nature of the income-generating activities, charities might indeed face tax liabilities unless specific exemptions apply.

In CHARITIES DO NOT PAY TAX - OR DO THEY? Mark Heaton explores the different types of trading activities that charities might engage in, focusing particularly on areas where tax exemptions can be leveraged, namely primary purpose trading, ancillary trading, fundraising events, donated goods, and small-scale trading.

Primary Purpose Trading

Definition and Scope

Primary purpose trading is an activity directly related to the charity's main objectives. This type of trading is typically exempt from tax because it is intrinsically tied to the charitable activities the organisation was established to perform. For example, if an educational charity offers training sessions and charges fees for these sessions, the income derived is considered primary purpose trading.

Examples

• Educational Charity: Delivering training for a fee.
• Arts Charity: Selling tickets for theatrical performances.
• Rehabilitation Charity: Operating a restaurant staffed by beneficiaries (e.g., individuals with disabilities).

Tax Implications

Profits from primary purpose trading are exempt from tax. This type of exemption acknowledges that the trading activity is integral to achieving the charity’s aims.

Ancillary Trading

Definition and Scope

Ancillary trading involves activities that are secondary but supportive to the charity's primary purpose. While these activities are not the main objective, they are closely connected and necessary for the charity's core operations.

Examples

• Arts Charity: Running a bar or a café that operates in conjunction with theatre performances.
• Educational Charity: Selling course materials and books during educational sessions.

Tax Implications

Profits from ancillary trading are also tax-exempt, given that these activities support the main charitable objectives without diverging from them. The key is that the ancillary activities are timed and coincident with the primary purpose operations.

Fundraising Events

Definition and Scope

Fundraising events are activities specifically organised to generate income for the charity. These events are designed with the express purpose of financial support, rather than fulfilling the charitable objectives directly.

Examples

• Charity Galas: Ticket sales for charity dinners or galas.
• Sponsored Walks: Entry fees for athletic or endurance events.
• Auctions: Charitable auctions for donated items.

Tax Implications

Income from fundraising events typically enjoys tax exemptions, under specific conditions. For example, the events should not pose significant financial risk to the charity, and they must be planned and executed within the scope of the charity's legal and constitutional boundaries.

Donated Goods

Definition and Scope

Donated goods refer to items given to the charity, which are then sold to generate income. This category covers various goods, from clothing to books and household items.

Examples

• Charity Shops: Selling second-hand clothing, books, and furniture.
• Seasonal Sales: Sales of donated Christmas cards or other seasonal items.

Tax Implications

Sales of donated goods are generally tax-exempt since the items are provided to the charity at no cost and the entire proceeds contribute towards the charity’s work. The exemption recognises that these sales do not constitute a trade in the conventional sense but are in line with the charitable aim of recycling and reusing resources.

Small-Scale Trading

Definition and Scope

Small-scale trading refers to marginal, occasional trading activities that help generate income without becoming a focal business operation of the charity.

Examples

• Community Events: Small-scale sales at community fetes or local markets.
• Seasonal Stalls: Pop-up shops or stalls during holidays or local festivals.

Tax Implications

For small-scale trading to be exempt from tax, the revenue generated must not exceed a stipulated amount set by tax authorities. This exemption helps smaller charities engage in limited trading without the burden of tax implications, acknowledging that the scale of operations does not warrant the same scrutiny as larger, more consistent trading efforts.

Governance and Risk Management

Understanding which activities fall into these exempt categories is crucial for proper governance and financial management. As Mark Heaton, an expert in charity and not-for-profit accounting, emphasises, failing to grasp the distinctions can result in unintended tax liabilities. Charities need to carefully plan and execute their income-generating activities within the framework of charity law and tax legislation. Doing so avoids jeopardising their charitable resources and ensures compliance with legal standards.

Additionally, charities must remember that while direct tax exemptions can be enjoyed in these scenarios, VAT considerations can introduce complexity. Therefore, it is often beneficial for charities to consult experts in charitable tax law and engage in thorough planning before embarking on significant trading activities.

The assumption that charities are exempt from all forms of tax is a misconception. Charities must navigate a landscape where different types of trading activities can have different tax implications. Primary purpose trading, ancillary trading, fundraising events, sales of donated goods, and small-scale trading typically receive favourable tax treatment, provided they are structured and executed within the confines of both charitable and tax laws. By understanding and appropriately leveraging these exemptions, charities can maximise their income to further their charitable goals while maintaining compliance and minimising potential financial risks.

For the full session, please click here. In this course Mark Heaton covers the following topics;

• Types of trading
• Tax effects
• Trading subsidiary
• Governance
• Small trades exemption and other aspects

The contents of this article are meant as a guide only and are not a substitute for professional advice. The author/s accept no responsibility for any action taken, or refrained from, as a result of the material contained in this document. Specific advice should be obtained before acting or refraining from acting, in connection with the matters dealt with in this article.