Whose relief is it anyway?

Nigel Williams, 20 April 2012

The Chancellor has got into difficulties in trying to limit levels of tax relief for those with the highest income. The principle of paying a fair share of tax is popular, but so is the principle of making philanthropic donations. Is there a way out? This illustration uses the 20 per cent and 50 per cent rates from 2011-12. After the 2012 budget, the new 45 per cent rate will make the arithmetic harder to follow, but the principles remain.

Gift Aid

Tax relief on charitable donations uses a scheme called Gift Aid. The HMRC self-assessment guidance explains how Gift Aid donations are treated.

Claiming back higher rate tax
If you pay higher rate tax, you can claim the difference between the higher rate of tax 40 and/or 50 per cent and the basic rate of tax 20 per cent on the total ‘gross’ value of your donation to the charity or CASC.
For example, if you donate £100, the total value of your donation to the charity is £125 – so you can claim back:
• £25 – if you pay tax at 40 per cent (£125 × 20%)
• £37.50 – if you pay tax at 50 per cent (£125 × 20%) plus (£125 × 10%)

So the donation is £100, the tax relief, given to the charity, is £25 and the tax relief to the donor is £37.50. The reasons for these precise amounts are not obvious. Compare a basic-rate donor with a top-rate one.

One might expect the gross donation to be twice the net. In fact, the gross donation is £125, and the charity gets it all. The odd part is that the net donation, the discretionary amount that the donor chooses to devote to the charity, is actually £62.50, not £100. The donor effectively gets full relief on a smaller donation. Whether higher- and top-rate donors know that they are expected to scale up their donations by as much as eight pounds to five is uncertain.
On this basis, there is no difference between the basic-rate taxpayer and the top-rate tax-payer. Both allocate money to the charity out of their gross, untaxed income. The charity gets it all. The top-rate payer gets more relief, but only after having more tax demanded in the first place. The top-rate payer also has to wait to get reimbursed for some of the contribution, but this is a minor consideration.

Differences

But differences there are. In terms of disposable income, the basic-rate taxpayer has to find £100 for the charity to benefit by £125. The top-rate taxpayer has only to find £62.50. Where a donation brings tangible benefits to the donor, those benefits that still qualify for relief are not taxed, but are purchased out of gross income.

Benefits to the Donor

The Royal Academy of Arts recognizes some of this in its Patrons scheme. ‘Silver’ Patronage costs a minimum of £1,500 per year. Patrons are offered a programme of events and exhibitions in return but the Academy declares the benefits to be worth £600 commercially and therefore not eligible for Gift Aid. But if a donor especially wants the extra benefits of ‘Gold’ membership, the £4,000 Gift Aided donation requires a lower rate taxpayer to forgo the full £4,000 of post-tax income and pay £600 of National Insurance, the top-rate counterpart does without £2,500 and pays NICs of £100.

National Insurance

Since there is no equivalent of tax relief for National Insurance contributions, the basic-rate payer normally has to find more money than the higher-rate payer. Tax reliefs are generally at the marginal rate. At top-rate tax levels, the marginal rate of National Insurance is only 2 per cent. NI calculations are seldom simple, but the difference is fully ten per cent of the gross income.

Improvements

Is there a way out of the Chancellor’s tangle? The biggest actual discrepancy surrounds National Insurance Contributions. Raising the rate of NICs for earners in the upper tax bracket would allow the Chancellor to keep the rates of charitable relief intact while asking the richest to pay more to the Exchequer.
A more visible change that would make paradoxically less difference to donors and charities would be to alter to the definitions of net and gross. Instead of reducing the donor’s contribution by a reimbursement in the tax return, the top-rate donation as paid to the charity could be treated as the net donation.

The charity claims 25 per cent relief on top, as now. Then at the time of the tax return, HMRC could pay further relief to the charity, so that the net donation plus the two reliefs amounted to the gross earnings. In 2011/12, a payment of £100 is reduced to a net £62.50 to match a gross donation of £125. Under this suggested change, a payment of £100, taken as the net, is grossed up to £200. (At the new 45 per cent top rate, it would be £182 gross, but the illustration is complicated enough already.) It takes away the apparent injustice that HMRC return money to top-rate tax payers, which has already confused at least one commentator. As now, it is not the donors that enjoy the tax relief, but the charities.