Testing times for charities

At the last count there were over 23,500 registered charities in Scotland who raised a staggering £2.5 billion last year. A large number of these groups, from the smallest to the largest, are now threatened with losing their charitable status due to changes in charity law in Scotland, regulated by the Office of the Scottish Charity Regulator (OSCR). Worryingly, many organisations are entirely unaware of the impact these changes could have on them.

OSCR is responsible for registrations of charities established in Scotland and monitoring compliance by charities with the provisions of the charity law in Scotland. This includes considering whether an organisation has appropriate charitable objectives, and whether it exists to provide a public benefit. The regulator also looks at the proportion of money a charity uses to pay for administration and other costs.

OSCR has recently published a pilot findings report which sets out guidelines on the interpretation and application of the new charity law in Scotland. It includes changes to the criteria for charitable status and OSCR is currently in the process of reviewing the status of all of these charitable organisations.

Legal experts have claimed that the vast majority of charities formed before 2005 will not pass the new test. However, some of the charities to be affected are dormant and redundant and OSCR will be cleaning up the charity sector following years of neglect. All charities will now be subject to a review over a three year period. Apart from the cost of legal fees, as affected charities fight to maintain their status, they also face a much bigger financial threat through tax on self generated income and possible restructuring costs.

Loss of charitable status could prove to be onerous for many organisations.  The direct and indirect tax reliefs available to charities – from tax exemption on many sources of income, to VAT and stamp duty relief on expenditure – are hugely valuable. Loss of Scottish charitable status will not necessarily equate to loss of tax charitable status. HM Revenue & Customs has published tests to determine whether an organisation qualifies for charitable status for tax purposes.

However, organisations losing charitable status under Scottish charity law may lose non-domestic rate relief among other benefits. In addition the potential loss of eligibility to grant funding could also cripple organisations. The loss of tax recoveries on gift aid for donors could act as a disincentive and prove to be an enormous blow.

Not directly related to the OSCR’s review, but quite pertinent for charities, is the impact of tax on trading activities carried out by charities to supplement their sources for funds. Trading includes something as simple as producing a line of goods, for example chocolates, investments or rental income.

If an organisation is involved in trading, it needs to prove that the trading activities are for the primary purposes of the organisation. At the moment around 45% of all Scottish charitable income comes from self generated sources and charities carrying on trading activities should consider restructuring their activities to minimise any potential tax liabilities.

Charities are, by their very nature, dependent upon donations and sponsorship in order to survive. Being a charity provides access to grants from both commercial bodies and other donors. Charity status provides donors an assurance that the money they give will be used in a good cause. Real consideration must therefore be given to the impact a loss of charitable status may have on these valuable sources of income. Donations could dry up if an organisation is no longer a registered charity. Sponsorship from business may be threatened if charitable status is lost.

Also, if an organisation suddenly finds itself in the situation whereby it has to pay tax on its income, does it have adequate records and financial reporting systems in place to meet its filing obligations? These, among others, are issues which many charities across Scotland have never had to previously consider, requiring a more commercial focus to be adopted if they are to be able to continue.

There are things that can be done to ensure that charitable status is protected. Some organisations will have to consider restructuring their activities in order to meet the new criteria. They may have to alter the nature of their work, for example, by creating a subsidiary for their profitable activities. Many of the organisations may be unprepared for this, and need to assess the position sooner rather than later.

So far we have already seen high profile organisations such as John Wheatley College in Glasgow falling foul of the new rules, whilst the fee paying High School of Dundee maintained its status - due to its programme of bursaries and the access to facilities it offers to the community.

The problem for John Wheatley was that it allowed Ministerial involvement in issues such as financial mismanagement. Under the new rules, charities must be fully independent of government. Ministers now have two years to change their involvement with further education colleges, or exempt them from the new rules.

The Voluntary Action Fund (VAF) has also found itself caught out on a technicality and now has to incur legal fees to modify its constitution to bring it in line with the new changes in charity law or risk losing its charitable status.

These examples are just the tip of the iceberg. Many of the organisations who will be impacted by the changes do not realise it yet, and are unprepared to make the necessary changes when they come. The case of John Wheatley and VAF came to light as part of the pilot featuring the first 16 cases to be assessed by OSCR under the new rules. However, more are likely to surface as the regulator woks its way through the list and for some it may take a year or two before they realise they could be affected.

Given the potentially far reaching implications on our charitable sector it is vital that organisations take action now. There is much that can be done to protect charitable status, and most organisations will find a way to meet the new criteria. The picture painted here is a worst case scenario if no action is taken and it is imperative that charities take the time to double check their organisation against the new rules and take the action required to meet the challenges ahead and keep up their good work.

Contact details
Email: Rhona Irving
Tel: +44 (0)131 260 4011