A head of steam has recently built up suggesting that changes are needed to the gift aid scheme. One suggestion is to abolish higher rate relief and replace it with an all-encompassing composite rate relief, where the charity would claim gift aid at a rate which would be a bit more than can currently be claimed on gift aided donations, but not as much as the total relief on gifts from higher rate payers.
One of the reasons for arguing for this method is that apparently gift aid is complicated and difficult to explain to donors. I beg to differ, so let me explain:
A basic rate taxpayer
Imagine someone earns £10. Basic rate tax is levied at 20 per cent, so they pay £2 tax on their £10, leaving them with £8 of take-home pay. (We can forget National Insurance for these purposes.) If they give that £8 to the charity, the charity can reclaim the £2 of tax that was paid. Thus (and this bit requires you to be able to divide by 8) for every £1 given to charity, the charity can reclaim 25p.
A higher tate taxpayer
Once again, imagine someone earns £10. Higher rate tax is levied at 40 per cent, so they pay £4 tax, leaving them with £6 of take-home pay. Since they don't have to tell the charity whether or not they are higher rate taxpayers they give the charity £8, just like a basic rate taxpayer. The charity reclaims £2, thus receiving £10 in total. The higher rate taxpayer is now £2 out of pocket so when s/he fills in a tax return, the Revenue allows them to reclaim the £2. I'm sure by now you can divide these numbers by 8 to get to the tax relief received by both donor and charity on each pound!
The new 50 per cent tax rate
The principle is just the same here – in fact by now you should be able to do the calculation yourself. £10 is earned, £5 is taken in tax. Donor gives £8 to charity, charity reclaims £2. Donor reclaims £3.
I have been in conversation with donors where we start with the proposal that they might give a £1m. But they couldn’t possibly afford that, they say. “But how would £120,000 each year for five years be, we ask?” Oh, yes, that might be possible. To which of course we then point out that this will be worth a million after five years with the tax relief. Not that hard, really, and the only things we talk about at that point at the gross amount given, and the net cost to the donor.
What’s wrong with the composite rate?
The composite rate is flawed because this breaks the link between what the donor actually paid in tax and what the charity reclaims. This causes a double problem. Firstly gift aid would essentially become a government reward for successful fundraising by charities. It could therefore be dangerously vulnerable to public spending cuts.
Income tax rates, on the other hand are remarkably stable. And although a reduction in the income tax rate does mean less money is claimed by charities, it also means more money is taken home by donors. (The unprecedented transitional relief given last time the tax rate was lowered simply let charities off the hook and obviated the need to go back to donors to ask them to adjust their giving. While welcome from a cash flow point of view it seems to me it was a lazy option and in any case it ends this year.)
The second problem with the composite rate is that unless payroll giving and the tax relief available on gifts of shares and property were also changed, then there would be two different rates of tax relief available depending solely on how someone decides to give. Thus more tax relief would be available to a higher rate taxpayer if they used payroll giving or shares than if they gave through a composite gift aid scheme.
The fundamental point is that you cannot change gift aid without also changing the other methods of tax effective giving. This principle has been accepted by HM Treasury at the last meeting of the Gift Aid Forum. And if this is the case, then the review is in danger of becoming a wholesale review of the entire system of tax relief on individual giving. I’m not averse to that, but let’s be open and honest about this, rather than do it by accident
What's wrong with the charity claiming the higher rate tax?
There are two things wrong with this. Firstly, as shown in the recent study by Bristol and Warwick universities some donors like to claim the higher rate tax relief themselves. Thus allowing the charity to reclaim it instead could materially change the amount of money the donor decides to give. I don’t believe that for many very high value donors it would materially change the amount received by the charity.
Added to this would be the need for the charity to collect information about whether or not the donor does pay higher rate tax. For a start the donor may not want to tell the charity that s/he Is a higher rate taxpayer. Indeed they may not even know when they make their gift whether or not they will have a liability for higher rate tax in that year.
Fundraisers might assume that everybody is paid in the same predictable monthly way that they are. But this is simply not the case – there are people who drop in and out of paying higher rate tax from year to year, there are people who earn enough to pay higher rate tax but whose pension contributions or giving bring them back down into basic rate tax. And in future there will be people who are paying two different rates of higher rate tax. Do charities really want to get into the business of having to ask their donors for all this information?
Some charities complain at the moment about the complexity of running the gift aid scheme, this would be as nothing compared with the complexity of collecting and processing higher rate tax relief.
So what’s the solution?
For me no one has yet made a compelling case as to why the current system is so broken that it needs fixing. Of course the heritage scheme needs improving, the benefits limits are peculiar, but these are all minor matters in comparison to what is being proposed. The current system does, however, require a highly acquisitive attitude to getting gift aid declarations from donors, and competent administrative systems to process it. That'll be the subject of the next blog.
