A charity must be “established for exclusively charitable purposes” – but what does that actually mean? And what differentiates charities from other socially motivated organisations?
Charity Commission registration does not make a charity a charity. It confirms charitable status and having a charity number to prove it can be useful – like when applying for funding. Not all charities can register. Some are exempt and are not directly regulated by the Charity Commission, but have a different principal regulator, e.g. the Department for Education for academy trusts and DCMS for exempt museums. There is also an income threshold, below which charities cannot register, which applies to some forms of charities.
Charities come in all different shapes and sizes. They may be just starting out or be ‘kitchen table’ or small local charities operated purely by volunteers, with low turnover and very specific scope. At the other end of the spectrum there are household names, e.g. Save the Children International and Alzheimer’s Society, with turnover of 10s of millions and a huge multinational reach. They comprise a number of different legal structures.
- Legal structures
Trusts were the original legal structure for charities. Charitable trusts are set up with a simple declaration that certain funds or property be held and used only for specific charitable purposes, operated by trustees under the terms of the trust deed (or the will, which set it up) and trust law.
Unincorporated associations were traditionally used as a legal structure for membership organisations – where the members decided the rules and delegated powers to a smaller executive committee (also referred to as charity trustees). Trustees of unincorporated forms have to act (hold assets, enter contracts etc.) in their own individual capacities, albeit on behalf of their trust or association.
Nowadays, corporate structures are typically used instead. The charity then has its own legal personality and can hold assets and property, enter into contracts and sue and be sued in its own name. Incorporation provides limited liability, so that trustees are not personally liable for liabilities of the charity that cannot be covered by its assets, provided that they have acted properly. The main types of corporate charities are charitable companies limited by guarantee, charitable incorporated organisations (CIOs) and charitable community benefit societies (Bencoms).
- Charitable status requirements
An organisation’s charitable status is not defined by its legal structure or registration with the Commission. Instead, the requirement is that they have exclusively charitable objectives and activities, operate for the public benefit and are within the jurisdiction of the courts of England and Wales.
Distinct from other social enterprises, charities have more stringent rules around public and private benefit. This is integral to charitable status.
Let’s look at how this plays out in practice and distinguishes charities from social enterprises more generally:
- Exclusively charitable purpose
Non-charitable objects are a “no no” and cannot be included in the charity’s purpose. A charity’s purpose must be to relieve a need or prevent a need arising, and any private benefit must be incidental to this. Examples of non-charitable objects include commercial objects (see below with regard to commercial trading), community benefit that does not relieve or prevent a real need and private benefits for members or members’ clubs.
Fundraising activity is commonly misconceived to be charitable in itself. Charities can carry out a small amount of commercial trading (up to a certain limit - see below), but this cannot be the purpose of the charity. If fundraising activities are generating significant income, this can be operated through an ordinary commercial company (a trading subsidiary), which then passes up profits to the parent charity tax free (under the gift aid regime). One example of this, which we come across in everyday life, is charity shops. These are operated by trading companies – typically selling donated goods – which then donate the profits to the relevant charity.
- Public benefit
A charity’s objectives and activities must benefit the public. This is assessed when a charity applies for registration and can be challenged if the ongoing operation of the charity is called into question. The Commission has published guidance on what constitutes public benefit within each charitable theme (religion, education, health etc.).
In short, to fulfil the “public benefit” requirement, an organisation’s purpose must be beneficial, any detriment or harm of the purpose must not outweigh the benefit and the benefit must be to the public in general or at least a sufficient section of the public.
- Restrictions on private benefit
Any private benefit must be incidental to the charity’s public benefit only and this is accomplished in a number of ways:
- Charities must redress a need;
- Asset lock: As with all social enterprises (of which charities are a subset), capital is locked into the organisation through restrictive constitutional provisions and the broader regulatory framework. The distinction is that this is absolute for charities and any distribution, on dissolution, merger or otherwise, must be for charitable purposes only; and
- Trustee/director positions are voluntary, though payment may be approved by the Charity Commission in exceptional circumstances.
A charity can trade, provided that its strategy, assets and energies are focused on promoting its objects. It can trade in furtherance of its objects (“primary purpose trading”), but its ability to carry out trading outside its objects is limited and any non-primary purpose trading may become subject to corporation tax. Ancillary trading must support the primary purpose. For instance, an entry fee to a museum is primary purpose trading and clearly comes within the charitable trading bracket. Visiting a museum café during a visit would be assessed as ancillary trading, since it enables museum goers to access food and drink whilst visiting the museum.
Non-primary purpose trading is subject to corporation tax, unless it fits within the “small scale exemption” (25% of turnover, with a maximum limit of £80,000). This is trading outside the charity’s purposes, whether charitable or not. Significant non-primary purpose trading should be carried out through a trading subsidiary, to ring-fence the risk from its charitable funds and to avoid the charity from becoming liable to corporation tax. The profits of the subsidiary can be gift aided to the charity.
Charities are treated the most favourably of all social enterprises, from a tax perspective. They are exempt from corporation or income tax for primary purpose trading (and non-primary purpose within the small scale exemption mentioned above), tax on rental income and capital gains, provided that the funds are used for charitable purposes. Charities are also exempt from stamp duty land tax and receive mandatory business rates relief of 80%, with the remaining 20% being at the discretion of the relevant local authority.
VAT is far more complex – there is no general VAT exemption for charities. VAT exemption or partial exemption is based on the activities itself and recovery can only be claimed where the charity makes VAT taxable supplies and is VAT registered. Gifts to charities in wills are either taken off the value of the estate before inheritance tax is calculated or reduce the overall inheritance tax rate, if at least 10% of the estate is left to charity. And last, but very much not least - charities can recover gift aid tax relief on donations.
Public awareness and familiarity with ‘non-charitable’ social enterprises is increasing and arguably some of the following points do not apply to the same degree that they perhaps once did.
Charities have the value of:
- Charitable status, which can be helpful in attracting funding and volunteers. It is a classification that the public understands, although social enterprises are becoming better recognised with the emergence of a number of kite marks and increased popularisation of forms such as CICs and Bencoms.
- Corporation, rental income, capital gains and SDLT tax exemption and 80% mandatory business rates relief.
- Gift aid tax relief on donations.
- Increased public trust and confidence - afforded by stricter restrictions on public and private benefit, a tight legal and regulatory regime and enhanced financial reporting standards, and
- Permanence – charitable assets must always be used for the charitable purpose for which they are intended.
Compared with other social enterprises and commercial companies:
- The stringency of regulation and laws can be administratively burdensome.
- Restrictions and requirements of charity law (e.g. in relation to disposing of land or financial/investment) can pose hurdles that restrict enterprise.
- The concept of voluntary trusteeship can make it more difficult to recruit and gain an appropriate level of commitment from board members.
- The fiduciary duties and responsibilities of charity trustees (equivalent of directors) have the potential to be more onerous.
- Charity boards tend to be more risk averse, impeding innovation and efficiencies in business.
- Diversity and inclusion on trustee boards can be lacking, not reflecting the communities they serve and despite the charity sector being values driven*.
- The view of charities as a vehicle for helping those in poverty and otherwise impoverished can, in itself, portray a negative image and instil pity, which may undermine the organisation’s purpose or patronise its beneficiaries.
*Research conducted by the agency Inclusive Boards in 2018 found that charities have less diverse boards than FTSE 100 firms, with only 6.6% from black, Asian or minority ethnic background. Nearly 80% of senior leadership teams had no one from and ethnic minority background and women of colour were the least likely group to be on a board or senior leadership team. In 2017, the Charity Commission urged charities to do more to promote diversity since commissioning its own report with the Office of Civil Society (delivered by a consortium led by Cass Business School and The Cranfield Trust), which found that men outnumber women by 2 to 1, with 92% of trustees being white, older and above average income and education.