Getting tax relief on a charitable donation can either reduce the cost of the gift to your own pocket, or it can benefit the charity more than it costs you because the tax-man tops up the value of your gift in the hands of the charity you choose.
As with all tax matters, there is a right and wrong approach. In the US all gifts to charity are automatically tax-deductible, and the Charities Aid Commission is looking at ways to introduce a similar system here. In the meantime there are several schemes that can maximise the charity benefit at the Revenue's expense.
The Give As You Earn scheme is dependent upon you being employed and your employer having made an arrangement with a charity agency. If this is the case you can give up to pounds 1,200 of your earnings away each year with full tax relief. Otherwise there are two main options, depending on how much you want to give away.
If you have less than pounds 250 to donate in a tax year then the only tax- efficient way is to enter into a deed of covenant, in effect transferring your income to the non-taxpaying charity. The donation is made net of tax and the charity can then reclaim tax at the basic rate of 23 per cent from the Inland Revenue. If the donor is a top-rate taxpayer at 40 per cent he can also claim an extra 17 per cent tax relief.
The system means it costs a top-rate taxpayer pounds 60 to provide a charity with pounds 100 income, while it costs a basic-rate taxpayer pounds 77. Similarly, a top-rate taxpayer could provide a greater income to a charity for the same net outlay as a basic-rate taxpayer: that is, a net cost of pounds 77 would fund a gross covenanted payment of pounds 128.33 to charity.
The deed of covenant has to exceed three years in duration, so most people choose a four-year covenant, although there is nothing to stop you stipulating a longer period. Individuals can also give a charity the equivalent of a lump sum by covenant. This is done by combining an interest-free loan with the covenant. The interest-free loan is provided, together with the first instalment, at the start of the four-year covenant period and is repayable in three equal annual instalments. The charity benefits because it has the cash up front.
These same broad principles apply to the other method of tax efficient charity giving, namely Gift Aid. In this case an individual has to give at least pounds 250 and the amount given is treated as net of tax at 23 per cent, which can be recovered by the charity from the Inland Revenue. Further relief at 17 per cent can be claimed by a top-rate taxpayer.
There may be both capital gains tax and inheritance tax reasons for giving away capital, both assets and cash. If these are given to a charity there will be no capital gains tax or inheritance tax to pay.
If you are thinking of giving away a chargeable asset to a charity you must first think of capital gains tax. If the asset were to be sold and a loss occur, then a better strategy would be to sell the asset, create a loss for capital gains tax purposes and then give away the cash to the charity.
All gifts to charity are exempt from inheritance tax whether made during your life or at death; so if it is the cats' home you want to benefit, be sure it is run on a charitable basis.
q More details on these schemes are available from Inland Revenue leaflets numbers IR75 and IR113.
q John Andrews is president of the Chartered Institute of Taxation and partner at Coopers & Lybrand.Reuse content