What does the Labour Budget mean for the third sector?
The dust is beginning to settle following the first Labour budget in 14 years, and whilst the charity sector did not feature heavily in Rachel Reeves’ speech, there are several consequences for the third sector which are worth highlighting.
Flying under the Radar
The third sector has largely stayed out of the picture, with the budget instead focussing on Inheritance Tax, Capital Gains Tax, and National Insurance amongst other tax changes and spending commitments, a summary of which can be found found here. However, a few of the changes introduced by Labour, whilst not directly aimed at the third sector, do have an impact.
VAT on Private Schools
One of the main headlines to come out of both Labour’s manifesto and subsequent budget promises was the implementation of VAT on private school fees. This will see the standard rate of VAT at 20% added to private school fees from 1 January 2025. Private schools in England will also lose charitable business rates relief from April 2025, a policy which has been in place in Scotland since 2020. The government expects to raise £1.725 billion a year which they will direct towards public finances and education. This change is not unexpected and many in the private education sector have been preparing for this change well in advance of the budget announcement last week. It is estimated that the plans will lead to fees rising by an average of 10%, and will see about 35,000 students moving to state schools over the longer term - around 6% of the current private school population, according to the government.
The wider impact for the third sector is that it could see the charity sector slip into a ‘two-tier’ tax structure, where one set of tax rules applies to one part of the sector, with the rest of the sector taxed under another set of rules. This opens the possibility that other types of charities will be singled out for different tax treatment in future. The government has therefore created a situation where certain charities, picked for political reasons, are now treated differently for tax purposes from the rest of the sector: a move which parliaments have historically shied away from.
The private school sector has been vocal in their concerns about implementing the VAT charge. The Independent Schools Council (ISC), membership of which includes most independent schools in the UK, have already submitted a legal challenge against the VAT decision. This claim will focus on breaches of the European Convention on Human Rights, more specifically Article 14, the prohibition of discrimination, and Article 2, the right to education. It states they are acting on behalf of parents who cannot find an alternative education for their children in the state sector, including families with children with special educational needs.
Whilst this legal action is ongoing, the real impact on private schools continues, with many schools in Scotland restructuring fees or their organisations as a whole to meet the increased costs.
Increase in National Insurance Contributions for Employers and Minimum Wage Rates increase
A significant tax change introduced by the Budget was the increase in National Insurance Contributions for employers. The increase is set to raise £20bn a year, making it one of the biggest single tax-raising measures in history. From next April, employers will have to pay NI at 15% on salaries above £5,000, instead of 13.8% on salaries above £9,100 currently. The government also confirmed the National Living Wage paid to over-21s will increase by 6.7%, while the National Minimum Wage for 18- to 20-year-olds will see a 16% increase. Many businesses have highlighted the impact this will have on them and the knock-on effect to salary increases.
The Office for Budget Responsibility has estimated that employer national insurance changes will result in “an average annual tax increase in excess of £800 per employee”.
This change applies in equal measure to charities who are employers, as it does to businesses. Much like those in the business sector absorbing the cost into their profits, this change will see charities absorbing the additional cost of salaries in their fundraising goals. Coupled with the increase to the minimum wage levels, employee outlays have expanded across the board for the third sector, which in turn could have a knock-on effect on employee numbers and salaries.
Social Investment Vehicles
The Autumn Budget’s opening title is ‘Fixing the Foundations to Deliver Change’. Whilst many of the outcomes look to raise funds to address the financial “black hole” that the Chancellor claims to have identified, the government has also committed to developing a social impact investment vehicle to tackle complex social problems. The government aims to bring together socially motivated investors, the voluntary sector and government to engage with the sector, and commit to addressing foundational issues that many in the third sector are tackling tirelessly. Our article on philanthropic collaboration provides further context for the requirement of all third sector bodies, private individuals, and the government to work together to address difficulties experienced in today’s society.
Consultation outcome for tax compliance
As part of the Budget paperwork, the government also delivered its final response to the consultation process for tax compliance within the third sector. The consultation sought views on several proposals aimed at ensuring tax reliefs for charities are working as intended. Following responses from the consultation, the government has decided to make incremental and minor changes to preserve tax reliefs for the compliant majority and protect the reputation of the third sector. The main takeaways from the consultation are as follows:
‘Tainted’ Donations
The consultation firstly addresses the shortcomings of the tainted charity donation rules. The rules apply when individuals make large donations to charity and derive significant financial benefits by entering into arrangements linked to their donation. To address this, they will legislate to lower the bar for challenging a transaction from a requirement for there to be ‘financial assistance or financial benefit’ to “financial advantage” received by the donor. They also propose to replace the current motive test with an outcome test. They will test the outcome of a series of transactions in the round, to allow for a more objective assessment of the result of the interaction between the donor and the charity. Comprehensive guidance on how this will be implemented and applied will be provided by the government and HMRC, to ensure that the third sector is supported in these changes.
The Fit and Proper Test
The consultation proposed withholding payments of Gift Aid and disapplying other tax reliefs when charities fail to comply with their reporting and filing obligations. The consultation responses highlighted that, for many charities, tax expertise, resources and knowledge are limited among volunteers and trustees, and a withholding of tax reliefs to incentivise tax return filing would be disproportionate. The government therefore proposes instead to change the fit and proper persons test so that a manager of a charity who persistently fails to comply with the charity’s tax obligations will fail the management condition. The government will also review the possibility of simplified filing requirements for charities to address the issues many in the sector face in dealing with tax reporting.
In summary
The changes announced on 30th October were significant for many across the country and, whilst the third sector was not explicitly addressed, there are changes which will have an effect on the sector. Most significantly, the increase in National Insurance Contributions by employers will see an increase in costs for charities with employees, many of whom are already working within tightening economic circumstances.
Please get in touch with your contact at Turcan Connell or any member of the Charity Law Team to discuss how these changes may impact you and your charity.