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How are Foundations and Charities taxed in the UK?

How are Foundations and Charities taxed in the UK? – That will be the topic of today’s article.

Understanding how foundations and charities are taxed in the UK involves exploring offshore tax planning.

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In today’s article, we are going to describe how Private Foundations, Charities, and trusts are taxed in the United Kingdom. However, the main objective is to cover the details regarding the taxation of Foundations.

Before we get to that, let us know some of the fundamental details about the terms related to Foundations, Charities, and trusts, and by doing so, we can have a better understanding of the topic.

How are Foundations and Charities taxed in the UK?
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What is a “Foundation”?

A Foundation is an individual organization/entity, which has been set up for taking care of property or assets for a specific purpose. A Foundation can be established by an individual or a company, while any of them would have the advantage of their legal personality.

Depending on the nature of the Foundation, it can either be referred to as a public Foundation or a Private Foundation.

Public Foundations are also known as public Charities where the primary objectives are mostly charitable and rely on the public fundraising process.

Some good examples of charitable Foundations are the “Make-A-Wish Foundation”, “Bill and Melinda Gates Foundation”, “Susan G. Komen Foundation”, etc., where the main goal is to make the world a better place.

How are Foundations and Charities taxed in the UK?
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You should also consider the fact that the above-mentioned examples consist of both public and Private Foundations.

For instance, the Make-A-Wish Foundation is a public Foundation, whereas, the Bill and Melinda Gates Foundation is a Private Foundation, yet both Foundations work for charitable purposes.

Unlike such Charitable Foundations, Private Foundations often operate in a distinct and specific process. The funding for Private Foundations usually comes from a single individual or an individual’s family, or an entity, where all the donations are subject to a tax deduction.

If we look at the scenario in the United States, both Public and Private Foundations are tax-exempt under 501(c)(3) organizations as stated by the Internal Revenue Service (IRS).

Nevertheless, the major difference between Private Foundations such as the Bill and Melinda Gates Foundation and public Foundations such as the Make-A-Wish Foundation is the source of their financial support.

Like we said earlier, Public Charities get their funding from the public, whereas Private Foundations usually get funded from an individual, family, or corporation.

As Private Foundations are controlled by a single donor, the donor gets to determine the following things:

  • The primary objective of the Foundation
  • People to be included on the board
  • Investment destination for the funds
  • Purpose of the funds, to how and where they should be given.

As Private Foundations are set up to exist in perpetuity, the charitable objectives can continue if the Foundation is operational.

In this way, Private Foundations often become family heirlooms that are passed through generations and managed by the heirs of the previous generation.

How are Foundations and Charities taxed in the UK?
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In most countries, Private Foundations often have the same characteristics which have been described below:

  • One of the major reasons for setting up a Private Foundation is that the donor can donate funds for charitable purposes, where the donors would be offered a tax deduction on the contributions.
  • Private Foundations are often operated by their board of directors or councils.
  • In many cases, Private Foundations usually get their financial support from a single individual, and because of that, they are controlled by the same individual.
  • Charitable distribution should be made throughout the taxable year by Private Foundations.
  • Even though they are tax-exempt organizations in most countries, some countries impose a nominal excise tax on the net investment income.
  • Even though Private Foundations can make grants to public Charities, they can alternatively manage programs, offer services, and organise direct charitable activities.
  • They can also offer help to individuals or families that are suffering due to disasters or having a rough time.

Even these Private Foundations can be categorised into 2 distinct types namely Non-Operating Foundations and Operating Foundations.

The major difference between non-operating Foundations and operating Foundations is that the resources and the operations of that Foundation are dedicated directly to charitable purposes and whether the services are continuous or sporadic.

Non-operating Foundations usually make grants to public Charities, and they are the commonly seen category of Private Foundations.

They even conduct their charitable events which include but are not limited to making grants, scholarship programs, and even make grants to international entities which haven’t been recognised as 501(c)(3) Charities.

Regardless of all these activities, managing their programs is not the main objective of non-operating Foundations.

In general, non-operating Foundations usually make an annual distribution that accounts for an average of 5% of the previous year’s average net investment assets.

On the other hand, operating Foundations should mainly get involved with charitable activities and should be sustainably conducting their projects.

Good examples might include the operation of museums, zoos, and libraries. To make sure that operating Foundations are engaging in such activities, around 85% of the investment income should directly be spent on their charitable events every year.

To take care of charitable events, operating Foundations usually conduct their charitable projects rather than relying on making grants to other entities.

For example, operating Foundations might just buy food and directly deliver it to the people who need it rather than relying on making a grant to a food bank.

  • The Board/Council:
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Like a company, a Foundation would also comprise a board or a council that acts in the same way as the board of directors operate within a company while making sure that the goals of a Foundation are achieved.

The board would be appointed by the founder and then the board we have all the necessary rights for appointing board members or dismissing them, are even revoking the Foundation entirely.

In many jurisdictions, a board member should be a resident professional, who qualifies for certain eligibility criteria.

  • The Foundation Deed or Charter:

Just like articles function within a company, the Foundation is administered based on a Foundation Deed or Charter, and this deed should consist of the following:

  • Name of the Foundation
  • Domicile of the Foundation
  • The purpose of the Foundation
  • Goals of the Foundation
  • The process of appointing or dismissing board members
  • The process of dealing with the allocation of assets in cases where the Foundation is dissolved.

In general, a deed is a public document that is to be filed with the registrar in the jurisdiction where the Foundation has been incorporated.

Nevertheless, in many jurisdictions, a deed just comes up with basic statutory requirements, while the detailed provisions of the Foundation would be provided through a non-public document that is known as the regulations of the Foundation.

The regulations usually consist of details such as the constitution of the board as well as information regarding the present or future beneficiaries.

The above-mentioned documents are to be drafted to make sure that the founder has a significant influence while managing the Foundation and selecting the beneficiaries.

All the information provided above is to be considered carefully for tax structuring.

  • Guardian:
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Foundations have guardians just like trusts have trust protectors, and these guardians make sure that the board performs its duties. The guardian has the necessary power for approving or disapproving the decisions taken by the board.

The guardian also has the power to sanction any specific decision that isn’t permitted by the charter. This necessary to carefully choose a guardian so that the guardian can act in the favour of the founder while safeguarding the Foundation.

The scenario of Private trusts, Foundations, and Charities in the United Kingdom:

Just now, we came to know everything about Foundations, now let us have a brief look at trusts and all the details related to them.

Trust is a relationship between 3 entities namely a trustor, trustee, and a third party. The trustor offers all the necessary rights and the power to hold title to property or assets on his/her behalf so that they can be used for the benefit of a third party.

One of the major reasons that people use trusts is to take care of their idle wealth until they have been passed on to the trustor’s beneficiaries.

They can also be used for other purposes where specific goals can be achieved, and because of that, trusts are versatile financial instruments.

There are 6 major categories of trusts namely living or testamentary, funded or unfunded, revocable or irrevocable.

In the United Kingdom, Trusts are recognized, and all the laws related to supervising the creation, operation, as well as taxation of these Trusts, are perfectly established.

The main types of trusts in the United Kingdom are Bare Trusts (nominee arrangements), Discretionary Trusts, and Life Interest Trusts.

Alternatively, there can be other types of trusts namely Disabled Persons’ Trusts, Bereaved Minors’ and Bereaved Young Persons’ Trusts, and Charitable Trusts.

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First, let us start with the main types of Trusts and then have a brief look at the alternative types of Trusts.

Bare Trusts are the types of trusts where the assets are held by the trustee only for the sake of the beneficiary.

Discretionary Trusts are the types of trusts where the trustees hold the assets for the advantage of a group of individuals, yet all the details regarding the benefits of the proportions to those individuals are completely discretionary (unrevealed).

Life interest trusts are the types of trusts which allow at least one individual to become entitled to further assets as well as property from the trust during their lifetime.

However, just like discretionary trusts, life interest trusts also come with a certain amount of discretion regarding how one when the capital should be distributed among the beneficiaries.

Having discussed the main types of trusts, now let us have a look at the alternative types of trusts.

Disabled persons’ trusts, as the name itself suggests, offer benefits to disabled individuals from becoming subject to preferential tax treatment.

Bereaved minors’ and bereaved young persons’ trusts are the trusts that have been established by deceased parents for the children and come with benefits related to preferential tax treatments.

Charitable Trusts are the types of trusts which are involved with Charity events or similar activities depending on the indications made by the trustor.

A Trust can either be established by a will or during the lifetime of an individual. The common types of trust that I created with the help of wills are discretionary trusts and life interest trusts.

Taxation of Charities:

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According to the law of England and Wales, Charities can be established in various legal forms such as follows:

  • Companies, which are usually limited by guarantee instead of shares
  • Trusts
  • Charitable incorporated organizations, which are specifically designed corporate vehicles for Charities
  • Unincorporated associations used for simple Charities, while not having any significant activities or liabilities.

All the rules and procedures for governing the establishment as well as maintaining the Charities in England and Wales are generally described in the Charities Act 2011.

To qualify as a Charity, an organization must follow any of the purposes that have been listed below while operating for the benefit of the public.

Charitable purposes:

  • Prevention/relief of poverty
  • Improvement of education
  • Improvement of health
  • Promotion of religion
  • Promotion of racial harmony
  • Promotion of equality
  • Promotion of diversity
  • Relief for people belonging to categories such as youth, elderly, unhealthy, disabled, dealing with financial hardship, etc.

To qualify for the public benefit test, any identifiable benefit to the public or a sector of the public should be offered by the Charity.

In the UK, all Charities are to be registered with Charity Commission and her majesty’s Revenue and Customs.

Apart from that, all the Charities in the UK must follow the following rules:

  • Maintain accounting records
  • Provide all their accounts and the trustees’ annual report to the public upon request
  • Provide all the data to the Charity Commission every year

To a Charity in the United Kingdom, certain types of tax relief are offered. To benefit from these tax reliefs, a Charity must get recognised by Her Majesty’s Revenue and Customs (HMRC).

On most types of income, Charities aren’t required to pay tax if the money is being used for charitable events or activities.

Even when the taxes are paid (deducted at source), Charities can claim the tax back. For instance, tax benefits can be claimed on bank interest and donations, and this is known as Gift Aid.

When are the taxes to be paid? – Charities are required to pay tax when the income received by them does not qualify for tax relief or when the income has been spent on lawn charitable purposes.

The tax returns are to be completed by the Charity when the Charity must pay tax.

Tax relief for Charities – being a Charity or a Foundation, there is no necessity for paying tax on most of the income or gains when the Charity is getting involved with charitable events, and this is known as Charitable Expenditure.

This means Charities can avoid tax on the following types of income or gains:

  • Donations
  • Trading profits
  • Rental income
  • Investment income
  • Profits derived from the sale of an asset (properties and shares)
  • Profits derived from the disposal of an asset (properties and shares)
  • Purchase of properties

As said earlier, to get tax relief, a Charity is to be recognised by Her Majesty’s Revenue and Customs (HMRC).

Charities are required to pay tax on the following:

  • Dividends that were received from a company in the United Kingdom before 6th April 2016.
  • Profits that have been derived from developing land or property.
  • Purchases. However special VAT rules apply to Charities.

Charities are required to pay business rates on non-domestic buildings, yet they are offered an 80% discount.

Any income or games that have been used for non-charitable purposes are taxed, and this is known as a Non-Charitable Expenditure.

If taxes are to be paid, Charities are required to complete a tax return, and in certain circumstances, a tax return is mandatory when the HMRC requires a Charity to do so.

Taxes that have been deducted can be claimed back on certain spendings such as donations or bank interest.

To qualify for tax relief, Charity should be:

  • Based in the countries UK, EU, Iceland, Liechtenstein, or Norway.
  • Founded for charitable purposes only
  • Has been registered with the Charity Commission or any other similar regulator.
  • Managed/operated by fit and proper persons
  • Recognised by Her Majesty’s Revenue and Customs

The tax has been deducted for Charities on income such as donations, then Charities can claim Gift Aid and claim back those taxes through the following methods.

  • Online with the help of Charities Online service
  • With the help of software that works with Charities Online
  • Through post the help of chr1.

Tax treatment for Foundations:

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In most cases, the Foundation is not generally subject to tax in the place of domicile because those jurisdictions usually impose lower taxes or may be considered Zero Tax Territories.

Nevertheless, the local tax laws are still needed to be taken into consideration, especially when establishing a Foundation. It is also important to take note of tax rules regarding overseas territories from which the income is being derived by the Foundation.

The price of tax analysis of the founder as well as the beneficiaries in the home jurisdiction is an aspect that’s not to be taken lightly.

Tax rules are provided clearly in civil law jurisdictions compared to common law jurisdictions where there may not be a clear interpretation regarding the taxation of founders and beneficiaries.

For example, in the United Kingdom, taxes may either be imposed on a Foundation while considering it as a trust or a company based on the facts of the case.

The distinction between trusts and companies is very crucial while a Foundation is being taxed, and because of that reason, a Foundation should be structured appropriately from the beginning.

The primary factor that affects the taxation of Foundations is the degree to which a founder has control over the management as well as the assets owned by the Foundation.

In the UK, some Foundations where the founder has a higher degree of control are considered mere nominee arrangements.

When considered as a trust, the ascription of income, as well as the gains, may happen when the founder seems to have an interest in accordance with the tax laws in the country of residence.

When considered as a company, management as well as control of the Foundation while establishing the non-residence status of the Foundation.

As Foundations have a complex nature, they might be an appropriate opportunity for tax planning purposes, nevertheless, the constitution of the Foundations must be considered carefully to reach the set goals.

As for where a Foundation can be incorporated, we have provided the destinations where they are currently available.

  • Jersey
  • Anguilla
  • Antigua
  • Austria
  • Bahamas
  • Cyprus
  • Liechtenstein
  • Malta
  • Netherlands
  • Antilles
  • Nevis
  • Panama
  • Saint Kitts
  • Switzerland

Some important distinctions for Foundations are as follows:

  • Foundations are required to be incorporated while their charter is made available as a public document.
  • Foundations are separate legal entities.
  • A trustee is required to have beneficiaries who possess the necessary rights for enforcing the trust against the trustees. On the other hand, the Foundation does not require any beneficiaries.
  • Even in the cases when Foundations have beneficiaries, they possess very limited rights. The guardian of the Foundation makes sure that the council is supervising the Foundation while abiding by the objectives and the beneficiaries have no recourse.
  • Trusts are a viable option where there is a possibility for claims by forced heirs, nonetheless, some jurisdictions provide similar protection for Foundations as well.
  • Trusts are fixable compared to Foundations especially when appointing new trustees. This might not be possible with a Foundation as very few territories allow this.

Bottom Line:

Foundations are very useful tools for individuals who want to transfer their assets into a separate organization so that others can benefit from them.

However, people who intend to have a higher degree of control might just go with trust as it is rather advantageous for them.

To be more precise, Foundations are deemed to be beneficial for the people who are residing in civil law jurisdictions where they are popular.

The taxation of Foundations is indeed a complex matter, and therefore, the founder must pay a lot of attention during the constitution of the Foundation concerning the tax treatment of the founder as well as beneficiaries (in their country of residence).

We hope that you can find all the necessary information regarding Foundations, Charities, and the process of how they are taxed.

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