In this edition, we comment on:

• the judgment in Butler-Sloss & ors v Charity Commission, and the Charity Commission’s recent reaction to this case, providing some clarity on the extent to which charity trustees may allow their objects and wider moral considerations to influence their investment policy;
• changes to the charity annual return;
• HMRC’s recent clarification around the rules on gift aid in respect of naming rights and third party administration fees;
• the recent expansion of the Dormant Assets Scheme; and
• the inheritance tax relief which applies where an individual leaves 10% of their estate to charity on death.

If you would like further information or advice on any of the topics mentioned in this update, please contact a member of the charities team.

Responsible investment and charities – High Court provides clarity

On 29 April 2022 the High Court handed down its eagerly awaited judgment in the case of Butler-Sloss & ors v Charity Commission [2022] EWHC 974 (Ch), clarifying the extent to which charity trustees may allow their objects and wider moral considerations to influence their investment policy.

Although the case concerned the implementation of a responsible investment policy by charities with an environmental focus the decision has wider application.

Background to the present case

The two charities involved had general charitable purposes. However, the trustees had decided to focus on causes relating to environmental protection or improvement and the relief of those in need.

In investing the charities’ assets (which were substantial), the trustees had already taken an approach which excluded certain investments such as fossil fuel companies and favoured others with better “green” credentials. However, they had come to the conclusion that this did not go far enough and were concerned that many of their current portfolio holdings conflicted, or might conflict, with their charitable purposes. Accordingly, they sought the court’s approval for the adoption of new policies which would exclude investments that are not aligned with the goals set out in the 2016 Paris Climate Agreement.

Bishop of Oxford case

The Charity Commission’s current guidance in this area is based on principles set out in Harries v Church Commissioners for England [1992] 1 WLR 1241 (commonly referred to as the “Bishop of Oxford” case).

In that case, the court held that maximising financial return is always the starting point for charity trustees when considering the exercise of their investment powers and suggested that “…the circumstances in which charity trustees are bound or entitled to make a financially disadvantageous investment decision for ethical reasons are extremely limited.” It did, however, accept that there are exceptions to this general rule.

In particular, Sir Donald Nicholls V-C (as he then was) noted that if the trustees “were satisfied that investing in a company engaged in a particular type of business would conflict with the very objects the charity is seeking to achieve, they should not so invest…even if it would be likely to result in significant financial detriment to the charity.” However, he did not anticipate that significant financial detriment would be likely to arise in practice, commenting that “it is not easy to think of an instance where in practice the exclusion for this reason of one or more companies or sectors from the whole range of investments open to trustees would be likely to leave them without an adequately wide range of investments from which to choose a properly diversified portfolio.”

In the present case, however, the trustees had concluded that investments that do not align with the goals of the 2016 Paris Climate Agreement would be in direct conflict with their charitable purposes. Their proposed investment policies would have the effect of excluding over half of publicly traded companies and many commercially available investment funds and, although the proposals targeted an annual return of CPI+5% (which the Charity Commission indicated would be in line with the published rates of return of other large charities such as the Church Commissioners or the Wellcome Trust), the trustees accepted that they were unable to accurately determine the extent of the financial detriment which may be suffered by the charities as a result of adopting the proposed investment policies.

Butler-Sloss v Charity Commission – clarity provided

The claimant charities considered that the Bishop of Oxford case imposed an absolute prohibition on their holding investments which did not align with the Paris agreement. The judge (Michael Green J) therefore carefully considered whether the Vice-Chancellor’s judgment in the Bishop of Oxford case imposed an absolute prohibition on charity trustees making investments which directly conflict with their charity’s purposes. The judge decided that the case should not be read as imposing an absolute prohibition in such circumstances and summarised (at paragraph 78 of the judgment) his understanding of the law in this area.

He began by noting that charity trustees’ investment powers must be exercised to further their charitable purposes, and that this will normally be achieved by maximising the financial returns on the investments that are made. However, “where trustees are of the reasonable view that particular investments or classes of investments potentially conflict with the charitable purposes, the trustees have a discretion as to whether to exclude such investments and they should exercise that discretion by reasonably balancing all relevant factors including, in particular, the likelihood and seriousness of the potential conflict and the likelihood and seriousness of any potential financial effect from the exclusion of such investments”.

In performing this balancing exercise (and specifically in considering the financial effect of making or excluding certain investments), trustees may take into account the risk of losing support from donors and potential reputational damage to the charity.

The judge issued a note of caution about trustees making investment decisions on purely moral grounds – on the basis that there may be differing legitimate moral views on certain issues among a charity’s supporters and beneficiaries.

Overall, if charity trustees act honestly, reasonably and responsibly in balancing all relevant factors, and a reasonable and proportionate investment policy is adopted as a result, the trustees will have complied with their legal duties “even if the court or other trustees might have come to a different conclusion.”

In the present case, the court concluded that the trustees of both charities had performed the necessary balancing exercise properly and so would be permitted to adopt their proposed investment policies.

Outcome for charities

The judgment in this case provides some clarification of the law on responsible investing by charity trustees. Although there is no absolute prohibition on making investments which conflict with a charity’s objects, it is now clear that trustees may (in their discretion) decide to exclude such investments and frame their investment policy accordingly – provided they have taken into account the relevant factors and in particular balanced the seriousness of the potential conflict against the risk of financial detriment.

The judgment still implies some limits on the extent to which moral considerations can be taken into account. The judge’s summary of the law deals with situations where there is an actual or potential conflict between certain investments and a charity’s objects. For charities with no such focus seemingly the Vice-Chancellor’s admonition against trustees using “property held by them for investment purposes as a means for making moral statements at the expense of the charity of which they are trustees” still stands; this may be what lies behind Michael Green J’s caution about making investments on purely moral grounds.

Last year, we commented on a Charity Commission consultation which sought views on draft revised responsible investment guidance. This process was put on hold pending the outcome of this case; however, the Charity Commission announced on 15 November 2022 that they hope to publish updated guidance reflecting the decision by Summer 2023. In the meantime, the Charity Commission have confirmed that, whilst they do not consider that the judgment fundamentally alters existing legal principles, they fully “accept and endorse” the judge’s summary (at paragraph 78 of the judgment) of the law in this area.

For charities focused on environmental causes, this decision, alongside updated Charity Commission guidance (once published), should enable trustees to proceed with confidence in weighing up potential conflicts with their objectives against financial return, and implementing a suitable investment policy which reflects the objects of their charity.

Changes to the annual return

Charities registered in England and Wales are obliged to submit an annual return to the Charity Commission each year, answering various questions about the operation of the charity. In December 2022, following a consultation last summer, the Charity Commission announced various changes to the annual return which will apply to most registered charities with incomes over £10,000 for financial years ending on or after 1 January 2023.

The Charity Commission uses the annual return to analyse year-on-year trends. The changes now being made are viewed by the Commission as an important step in improving the information reported by charities, allowing the Commission to better inform its policy development and regulatory work, as well as directing its proactive activity.

Some of the changes are intended to reduce the administrative burden on charities and to improve clarity, for example, rewording certain questions and improving guidance sections as well as introducing income thresholds for some questions to reduce the workload for smaller charities.

New questions are also introduced, for example, asking charities to select from 14 listed policies and procedures those that they have in place (including policies for financial controls and trustee conflicts of interest). In this context, the Commission states in the annual return guidance and glossary that whilst it recognises that what is appropriate will vary depending on the size, character and activities of the charity, it expects most charities to have in place policies and procedures covering a wide range of topics, including those noted above, plus risk management, trustee expenses and social media (in some cases).

Next steps

This month, the Commission plans to publish a guide to the new questions set, including further details on the information requested and why the Commission is asking for this.

In Spring 2023, the Commission proposes to expand enrolment to the new My Charity Commission Account service (launched in November 2022). Relevant parties will be encouraged to create an account on this platform if they have not already done so.

In early summer 2023, the annual return filing portal will open through the My Charity Commission Account platform. Charity trustees will be expected to submit their 2023 annual return and future annual returns via this route.

HMRC clarify rules on gift aid - naming rights and third party administration fees

Gift aid is probably the most widely known charitable tax relief, which applies to cash gifts to charities by individual donors. Charities commonly wish to acknowledge the generosity of their donors; however, care must be taken here as a charitable donation will not qualify for gift aid if any benefits provided to the donor exceed certain limits.

Prior to 2019, it was generally accepted that naming a building or part of a building after a donor would not be considered a benefit for the purposes of gift aid. However, in August 2019, HMRC updated their guidance notes, with ambiguous wording raising concerns that HMRC’s view on this had changed.

Following discussions with professional bodies, HMRC published updated guidance in April 2022 which confirms that:

• a simple acknowledgment of an individual donor’s generosity, for example, in a printed brochure or a commemorative plaque; and/or
• naming a building or part of a building after an individual donor are not considered benefits for gift aid purposes, provided in both cases that such courses of action do not act as an advertisement or sponsorship for a business.

In January 2023, HMRC further updated their gift aid guidance to clarify that where donations are made by credit or debit cards using digital platforms which may incur an administration fee, the gross donation paid is eligible for gift aid. Technically, the administration fee reduces the amount actually received by the charity, but the guidance clarifies that the charity may treat these fees as charitable expenditure, meaning the gross amount attracts gift aid, provided that the other usual conditions for gift aid are met and the charity is able to demonstrate a clear audit trail of administration fees.

These are both welcome clarifications.

Expansion of the Dormant Assets Scheme

The Dormant Assets Scheme (DAS) was initially set up to allow banks and building societies to channel funds from dormant accounts towards social initiatives, whilst still protecting the original account owners’ legal rights to reclaim the amount that would be due to them had a transfer into the scheme not occurred. The scheme is administered by Reclaim Fund Limited (RFL) who manage the receipt of dormant assets into an authorised fund and retain sufficient cash to meet any reclaims while distributing the rest to social and environmental initiatives via the National Lottery Community Fund.

Following government consultation, the DAS has recently been expanded to include certain assets from the pensions, insurance, investment and wealth management and securities sectors.

Under the expanded scheme, it may be necessary for assets to be liquidated before being transferred to the fund. This would ordinarily be classed as a disposal for capital gains tax purposes, resulting in either a gain or a loss for the original owner. However, since the dormant asset owner cannot be located and does not know that the transfer to the scheme has occurred, it is clearly not appropriate for the individual to pay tax at the point of transfer to the scheme (or to record a loss). To address this, the government has introduced legislation at Schedule 6 to the Finance Act 2022 to ensure that the monetisation of a dormant asset and/or involuntary transfer of a dormant asset to RFL does not give rise to a disposal for capital gains tax purposes. This means that the original owner of the dormant asset has no obligation to declare the monetisation of a dormant asset.

The DAS is a hugely valuable scheme which has so far enabled over £800m to be released to support social and environmental initiatives across the UK, with the money split between England, Scotland, Wales and Northern Ireland. In England, expenditure is ring fenced for initiatives focused on youth, financial inclusion or social investment, and to date, over £650m has been allocated to these three causes. Reports suggest that there is a total estimated value of £3.7bn of dormant assets in the pensions, insurance and investment sectors, so it is encouraging to see the government enlarge the scheme to include these other asset classes.

Inheritance tax relief on leaving 10% of an estate to charity

In addition to, or instead of, lifetime charitable giving, many individuals choose to make charitable donations which take effect on their death. Indeed, research published by Smee & Ford in June 2022 revealed that the number of wills that included a gift to charity increased by almost 11% in 2021, as compared to 2020. Clients are often aware that charitable gifts are themselves exempt from inheritance tax; however, it is less well known that such donations can also reduce the inheritance tax rate on the rest of their estate.

This inheritance tax relief was introduced by the Finance Act 2012 to encourage charitable giving. In broad terms, where a person leaves 10% or more of their estate to charity on their death, the inheritance tax rate on the rest of the estate not passing to charity is reduced from 40% to 36%.

How does the relief work?

The relief is calculated by reference to what is called a “baseline amount”. The legacies in favour of charity must be equal to or exceed 10% of this baseline amount in order for the relief to apply. In simple terms, the baseline amount is the gross value of the individual’s estate minus any available nil rate band (the portion of an individual’s estate charged to inheritance tax at 0%), exemptions (e.g. the spouse exemption) and reliefs (e.g. the relief for business or agricultural property).

In applying the relief, the deceased’s estate is divided into separate “components” – (i) trust assets in which the deceased had a life interest (the “settled property component”), (ii) jointly-owned assets which pass automatically on death to the co-owner, e.g. joint bank accounts (the “survivorship component”), and (iii) other assets held absolutely and solely by the deceased (the “general component”). The relief can apply to one or all of these components.

A simple example:

Mr Smith has an estate worth £1m. He is a widower and on his death his estate will pass to his children. Mr Smith’s estate comprises his house and shares in a trading company listed on AIM worth £300,000 which qualify for business property relief from inheritance tax. His full nil rate band of £325,000 is available (but there is no transferable nil rate band from his wife due to various lifetime gifts which she made shortly before her death).

What is Mr Smith’s baseline amount?

His estate does not include any assets within the “settled property component” or the “survivorship component” so the baseline amount for the “general component” is calculated as follows.

The baseline amount is £375,000. In order to qualify for the relief, Mr Smith must therefore leave at least £37,500 to charity.

Assuming Mr Smith leaves £37,500 to charity, the division of his estate will be as follows:

Contrast the position if the legacy to charity was not made and the whole estate passed to the family.

The effect of the relief is that, where 10% is given to charity, the cost of the gift is borne as to 24 pence in the pound by the family and as to 76 pence in the pound by HMRC.

Where an individual intends to give 4% of their estate to charity, that gift can be increased to 10% without the beneficiaries suffering any reduction in the value of the benefits they receive.

What is evident from the above example and the way in which the baseline amount is calculated is that the amount an individual needs to donate to charity in order to qualify for the relief (at least in the case of estates to which reliefs and/or exemptions are available) can be considerably less than it first appears.

Types of assets which qualify

There is no restriction on the type of assets that may qualify for this relief. This is more generous than the rules for charitable reliefs on lifetime giving.

Overseas charities

The recipient organisation must satisfy various conditions before the relief can apply. For example, it must be established for charitable purposes only, as defined under English law, and recognised as a charity by HMRC. Due in large part to differences in what qualifies as a "charitable purpose" in other jurisdictions, few non-UK organisations have been recognised as charities by HMRC and so, broadly, only gifts to UK charities are likely to benefit from the relief. However, if an individual wishes to leave 10% of their estate to a non-UK charity, it may be possible to make this gift indirectly, via a UK charity which is able and willing to give the money to the non-UK charity. A UK charity can make a payment to a non-UK body provided that the UK charity takes adequate steps to ensure that the money will be used for purposes which are charitable, as a matter of UK law, and provided that those purposes fall within the objects for which the UK charity was established.

How to take advantage of the relief

To take advantage of this relief, it is fairly straightforward for individuals to incorporate a general clause into their will which leaves a legacy of the appropriate amount to charity.

An alternative would be to leave the estate to a discretionary trust. Armed with a letter of wishes from the person making the will, the trustees could make an appointment (within two years of death) in favour of charities qualifying for the relief. This would also give flexibility in cases where there is concern that due to a change in circumstances there may not be sufficient assets left to provide for the family.

Finally, where a person dies and their will does not contain the necessary drafting to ensure that the relief is available, it would be open to the beneficiaries to alter the will for inheritance tax back to the date of death. This would be done by a deed of variation and may be particularly worthwhile where a will leaves, say, 9% to charity and an extra 1% given under a deed of variation will then bring the charitable legacies up to 10% and hence bring the rate of inheritance tax on the remaining part of the estate down to 36%.