Charities only retain tax relief if their income is spent on their charitable purposes and tax exemptions are not available for non-charitable expenditure. Non-charitable expenditure includes:
- Investments or loans that do not meet the requirements to be charitable investments or loans
- Losses on non-charitable trading or other non-charitable activities and losses on trades where any profit would not be exempt
- Expenditure that is not for charitable purposes
The following key points should be met when a charity makes a loan to a trading company:
- Assess the loan request as if it were from an external body
- Document the decision
- Ensure that a business plan is drawn up – this needs to show the investment will be a good use of the charity’s funds if the trustees are to be able to agree to the loan
- Execute a loan agreement
- The trading company should pay a commercial rate of interest to the charity
- The interest must be physically paid over to the charity in accordance with the loan agreement
- The charity should consider having a charge over trading company’s assets
The consequence of a non-charitable investment is that an equivalent amount of charitable income or gains will lose their exempt status going back for up to five years. This can only happen to income or gains that, without the exemptions, would have been taxable. Income that is outside the scope of income and corporation tax, such as legacies, grants and donations without Gift Aid, can never become taxable. However, the gross value of covenanted and Gift Aided donations is potentially taxable, rather than exempt.