Income tax relief cap will cut incentive to give to charity

Tuesday, April 24, 2012 | Posted by: Chris Tysoe
Categories: Personal, Protecting your wealth | Tags: tax planning, income tax, budget, charity, tax relief, philanthropy, Budget 2012, donations, Chris Tysoe, mansion tax, income tax relief cap, cap, income tax liability, restricting, tycoon tax, minimising

Organising your tax affairs in order to reduce your income tax liability may soon be curbed, in line with Government proposals to restrict income tax relief. But the proposed ‘tycoon tax’ is also causing a great deal of friction, as generous charitable donations by wealthy philanthropists look set to fall out of favour for tax planning (see Update on this at the end of the post). And they’re not the only ones adversely affected…

Chancellor George Osborne recently pronounced his ‘shock’ at the fact that UK taxpayers are organising their tax affairs to minimise their tax liabilities – which partly explains new Government plans to introduce a cap on the amount of income tax relief an individual may claim each year.

‘Tycoon tax’ proposals
The Chancellor revealed the new limit on all uncapped income tax reliefs (also dubbed a ‘tycoon tax’) in his Budget speech on 21 March. This will effectively restrict the amount of income tax relief an individual may claim annually.

The move is purportedly as a direct result of ‘Britain’s 20 biggest tax avoiders’ who have (perfectly legally) been taking full advantage of the current rules. 

The proposed cap, seemingly the preferred alternative to the much rumoured and LibDem-favoured ‘mansion tax’, will be set at 25% of an individual’s ‘income’ (the exact definition of which is yet to be confirmed) or £50,000, whichever is greater.

Which reliefs will be capped?
The cap is intended to apply to all existing reliefs that are not otherwise restricted. So, for example, income tax relief on pension contributions will not be affected by the new measures, as these are already limited by the annual allowance – see our previous post on tax planning with pensions.

But, as initially feared, the new cap will have implications on Gift Aid donations, loan interest relief (including certain loans to acquire shares in a company, for example) and also on the use of ordinary business losses (including losses incurred on qualifying Enterprise Investment Scheme (EIS) shares that have previously been available without limit).

Bad news for start-up entrepreneurs and philanthropists
Primarily any individuals looking to claim income tax relief in excess of £50,000 in any one tax year will be affected. In particular, this move appears somewhat unfair on those entrepreneurial individuals who suffer losses in the early years of a fledgling business. While relief will still be available for the losses, the use of the losses will be restricted by the new measures.

But perhaps the most wide-ranging, and controversial, effect will be on those generous souls who choose to give substantial amounts to charity each year.

Currently, higher rate taxpayers can claim relief on donations to charity under the Gift Aid scheme. Again, while the Government defends its proposals as combating the excessive use of tax reliefs, it seems unfair to apply a cap in such circumstances. You may note that, while there is currently no cap, as such, on qualifying charitable donations, it is a myth that you can reduce your tax liability to nil as claimed. Basic rate tax, at 20%, must be paid by the donor, under the Gift Aid rules.

Regardless, the move could have a significant impact on the behavior of such philanthropic donors, as this popular method of reducing a higher rate tax liability while giving to a worthy cause will be severely limited.

Charity tax relief cap conundrum
Unsurprisingly, the charities themselves are not too impressed by the ‘tycoon tax’ proposals. This capping of relief will almost certainly discourage some individuals from making their donations, at least to the extent that they may have become accustomed.

The Government has stated that it is open to exploring ways to ensure that the measure doesn’t have a significantly detrimental effect on the charity sector. But it is unclear how this issue will be resolved, especially as the proposals would appear to be directly targeted at the widespread practice of attaining tax relief on charitable donations.

We shall just have to wait and see what mitigating measures will be included in the final proposals in order to nullify the potentially significant threat to charity income.

UPDATE/June 2012:
While it is intended that measures to introduce a limit on all uncapped income tax reliefs from April 2013 will still go ahead, the Government has performed a U-turn on its controversial decision to apply it to charitable donations, meaning that individuals will continue to be able to claim income tax relief without restriction on qualifying Gift Aid donations.

If you think you are likely to be affected by the income tax relief cap and would like to speak to one of our advisers, please feel free to get in contact with me in the first instance on +44 (0)1865 799924 or at .(JavaScript must be enabled to view this email address)

Image: (CC) Howard Lake

You might also find these posts useful:

* Pensions – the tax planning vehicle of choice for high earners?
* Read more posts on protecting your wealth
* Budget 2012 impacts on high earners and entrepreneurs