Charity Retail Association and Blake Morgan. Tel:

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1 To: Produced by: Charity Retailers Last updated: August 2018 Contact: Charity Retail Association and Blake Morgan Tel: There are a range of activities carried out by charity retailers. Each of these provoke legal and financial implications for the parent charity. This brief uses guidance acquired from the charity law specialists Blake Morgan to explain the main tax and legal issues anyone operating in the sector should be aware of. Please note that this document is not intended to be legally or technically comprehensive and the Charity Retail Association cannot be held responsible for any errors or omissions, factual or otherwise, arising from reliance on it. This document is not a substitute for independent professional advice. a) Three activities There are three types of activities that are commonly carried out in charity shops. Sale of donated goods Sale of new goods Gift Aid scheme The sale of donated goods and the sale of goods include those donated under the retail Gift Aid scheme - involve the sale of items that have been brought into the shop by people who wish to donate to the charity. The sale of new goods, on the other hand, involves selling goods that the charity shop has "bought in" from a commercial retailer or manufacturer with the intention of selling those items in the shop to make a profit. All three activities involve the sale of goods to members of the public, which means that a number of retail laws and regulations apply. If you require advice on any aspect of retail law and regulation, you should seek professional legal advice.

2 b) Sale of donated goods The sale of donated goods involves two simple transactions. A donor brings goods into a shop and gives them to the charity as a donation. The charity does not pay the donor anything for the goods. Ownership of the goods transfers to the charity at the point of donation. Assuming that the goods are fit for sale, they are put on display in the shop marked with a sale price. If a customer wishes to buy those goods, the charity sells the goods to the customer for the marked price. Ownership of the goods transfers to the customer at the point of sale. c) Sale of new goods The charity shop purchases goods from a commercial retailer or manufacturer. The charity shop usually selects new goods that it considers will sell well in the particular area where the shop is based. Ownership of the goods transfers to the charity shop at the point of purchase. The new goods are put on display in the shop marked with a sale price, which must be more than the amount that the charity shop paid for the goods. If a customer wishes to buy those goods, the charity shop sells the goods to the customer for the marked price. Ownership of the goods transfers to the customer at the point of sale.

3 a) SORP Charity shops are usually either operated solely by the charity or in part by the charity and in part by the charity's trading company. Charity shops usually engage in a combination of the sale of donated goods, the sale of new goods and the retail Gift Aid scheme. The Statement of Recommended Practice (SORP) sets out different guidance for the accounting treatment of each activity. For transparency and to ensure an accurate reflection of the charity's financial activities, it is important to account for the income from each type of activity appropriately. The CRA recommends you discuss the implications with you auditors. Sale of donated goods "income earned from other activities" Sale of new goods "income earned from other activities" Gift Aid Scheme commission "income earned from other activities" Gift Aid Scheme net proceeds "income from donations" b) Sale of donated goods The sale of donated goods is usually carried out by the charity directly, rather than by its trading company. Assuming that the charity simply receives goods and sells them without altering or improving them, this is generally not treated as trading for tax purposes. However, for accounting purposes it is viewed in the same way as the sale of new goods. As soon as the donated goods have been received, the charity has received a "gain". SORP says that "where practicable, donated goods for resale are measured at fair value, which is the expected proceeds from sale less the expected costs of sale" and the gain is accounted for immediately using that estimated fair value. However, it is also acknowledged that it is often impracticable to estimate the value upon receipt, so it is common for charity shops to recognise the gain after selling the goods (i.e. in the reporting period in which they are sold). Assuming that the charity only recognises the income once the goods are sold, the proceeds should be accounted for as "income earned from other activities" in the charity's accounts. The notes to the accounts should also disclose the accounting policy for the recognition and valuation of donated goods (including the bases of valuation used) and the nature and amounts of donated goods recognised in that reporting period. It is very important to ensure that the notes to your accounts clearly identify all of the different types of income that are captured within the category "income earned from other activities" to demonstrate that the charity has not exceeded the applicable small-scale exemption in relation to its Non-Primary Purpose trading activities.

4 c) Sale of new goods The sale of new goods is a Non-Primary Purpose trading activity for tax purposes, so it is often carried out by a charity's trading company, rather than the charity itself, in order to comply with legal requirements and best practice. If this is the case, then the income and expenditure must be accounted for by the trading company (although see also the section on consolidated accounts below). If the sale of new goods is carried out directly by the charity, then this will constitute earned income. It must be accounted for as "income earned from other activities", and should be recognised in the charity's accounts once the income and costs from the sale can both be measured reliably. d) The retail Gift Aid scheme The Gift Aid scheme involves an agency arrangement, so there are two types of income: commission charged for the provision of the service of selling the goods on behalf of the donor, and a donation of the net proceeds. The agency arrangement is a Non-Primary Purpose trading activity for tax purposes, and is often carried out by a charity's trading company. If this is the case, then the commission income must be accounted for by the trading company (although see also the section on consolidated accounts below). However, the net proceeds of sale should always be accounted for as income of the charity. In light of the agency arrangement, the goods never belong to the charity or trading company (as applicable). Similarly, the funds received for the goods do not belong to the charity or trading company (as applicable) at the point of sale. However, once those funds are donated to the charity by the donor (the trigger point for which will depend upon which Gift Aid scheme is in operation), those funds constitute income of the charity. The commission that is charged for the provision of the service should be accounted for as "income earned from other activities" and the notes to the accounts should specify the amount of commission received. The net proceeds of sale (i.e. after deducting commission and VAT), at the point that the donation occurs, should be accounted for by the charity as "income from donations". e) Consolidated accounts For charities that have trading companies, it is common to produce consolidated accounts showing the financial position of the entire "group". For some charities (such as charitable companies or very large charities), this may be a legal requirement. There are specific provisions of SORP that apply to the preparation of consolidated accounts. In particular, the points set out below should be noted:

5 It must be clear from the headings that the statements are consolidated The consolidation should be undertaken on a line-by-line basis Transactions between the charity and the trading company are netted off e.g. 10 paid to the trading company and 10 received from the trading company would cancel each other out Uniform accounting policies should be adopted for similar transactions Specific disclosures are required in the notes to the accounts a) Trading categories In broad terms, trading is where you provide goods or services in return for payment. It is important to understand the law around trading for charities, because there could be tax and VAT implications if you get it wrong. There are four key categories of trading activities for charities: Primary Purpose Trading that directly furthers the charity's purposes. Example: a charitable theatre selling tickets for admission to its performance Ancillary Purpose Trading that indirectly furthers the charity's purposes Example: the sale of drinks in the theatre bar to members of the audience Beneficiary Trading activity is mainly carried out by beneficiaries Example: a farm operated by students of an agricultural college Non-Primary Purpose Trading not linked to charity's purposes, to raise funds Example: the sale of promotional items, such as pens/mugs The profits arising from Primary Purpose, Ancillary Purpose and Beneficiary trading are exempt from tax provided they are applied solely towards the charity's purposes. There is also a tax exemption for small-scale Non-Primary Purpose trading activities. Again, this exemption only applies if the profits are used solely towards the charity's purposes. b) What is small scale? This depends on the charity's size. The adjacent table will help you work out how much income your charity can receive from Non-Primary Purpose trading without being subject to tax on the profits. Total income of charity in the financial year Maximum permitted Non-Primary Purpose income Less than 20,000 5,000 20, , per cent of total income More than 200,000 50,000

6 c) Other key considerations It is always important for charities to take a careful approach to risk in order to protect the charity. So, even if a Non-Primary Purpose trading activity could be carried out by the charity within the small-scale exemption, this may not be appropriate if the activity is too risky. If there is a "significant risk" that the income from the activity will not cover the costs of carrying out that activity it may not be appropriate for it to be carried out by the charity. For further detailed guidance, please refer to the Charity Commission guidance note (CC35), entitled: "Trustees trading and tax: how charities may lawfully trade". This can be found here. If the amount of income that is received from all of the Non-Primary Purpose trading activities carried on by the charity exceeds the maximum amount permitted by the small-scale exemption or the Trustees consider that a particular activity is too risky to be carried out by the charity, then a trading company should be established to carry out the trading activities instead. d) Impact on a charity running or setting up a shop Sale of donated goods This is where people donate goods to the charity but do not sign up to the Gift Aid Scheme, and the charity sells those donated goods in its charity shops. This is generally not trading, so the profits are not subject to tax and the considerations explained above do not apply. The sale of new goods This is where the charity buys new goods from a manufacturer or another retailer and sells those new goods in its charity shops. This is Non-Primary Purpose trading, so the charity needs to think about the small-scale exemption and the risks of the activity. The Gift Aid Scheme This is where people bring goods into the charity shop and sign up to the Gift Aid Scheme. In broad terms, the commission charged is Non Primary Purpose trading, but the remainder of the proceeds are treated as a donation, so it is not trading income. Sale of donated goods This is not a trading activity, so none of the rules about trading apply. Sale of new goods This is Non-Primary Purpose trading, so the small-scale exemption and risk considerations apply Gift Aid Scheme The commission charged is Non-Primary Purpose trading, but the donation received is not trading income.

7 a) Introduction Charity shops selling new goods and/or running a Gift Aid scheme are usually engaged in "trading" for tax purposes. This means that the profit from those activities may be subject to corporation tax unless exemptions are available. But, all charity shops, including those that only sell donated goods, are carrying out a "business activity" for VAT purposes. The tax and VAT position for charities is complex, as they benefit from a number of exemptions. The position is also different if the charity uses as trading company for some of the shop's activities. This section focuses on the tax and VAT position for charities, and does not cover the position for trading companies. NB: The sale of donated goods is generally not considered to be "trading" for tax purposes, so the income is not taxable. However, the sale of donated goods is always a business activity for VAT purposes. b) Key exemptions

8 c) Business rates relief Charities can apply for rates relief of up to 80 per cent for property that is used primarily for charitable purposes. It is necessary to apply to the relevant local council for each property. Some local councils offer discretionary relief (up to 100 per cent). See our webpage Council and charity shops for more information. For charity shops to qualify, the shop must be occupied by the charity and used predominantly by the charity for its charitable purposes. This means that more than half of the shop should be used for the sale of donated goods in order to safeguard the charity's eligibility to apply for relief. Additionally, care must be taken if using a trading company to run part of the shop activities. To protect eligibility for rates relief, it is important that the lease (or title) to the property is in the charity's name, with any trading company operating only under a licence to occupy. The trading company should also not have exclusive use of the shop. d) VAT It is important to consider VAT separately, because the VAT rules apply to "business activities", which has a different meaning than the concept of "trading" for tax purposes. Charities should keep an eye on changes to VAT rates and adjust pricing accordingly. Charities are, broadly speaking, subject to the same VAT rules as commercial businesses. However, there are some exemptions available and certain supplies are "zero-rated" (which is different to being exempt from VAT), which is useful for charities that are VAT registered There is more detailed guidance available from HMRC here. The sale of new goods by a charity, and the commission charged in relation to the retail Gift Aid scheme, will both usually be a "business activity" for VAT purposes. However, VAT only applies to "taxable business supplies". Taxable business supplies are any activities that have a VAT rating (20 per cent, 5 per cent or 0 per cent). To work out whether a charity needs to register for VAT, it is necessary to add up its income from all "taxable business supplies". There are certain types of supplies that are not taxable.

9 They benefit from an exemption. These should not be taken into account when considering whether a charity should register for VAT. Charities need to buy goods and services in order to run their shops, and they may be charged VAT on these purchases. A charity that is VAT registered is able to reclaim the VAT it has been charged provided that the purchases relate to the charity's taxable business supplies. The ability to reclaim VAT is particularly useful in relation to zero-rated activities, as the charity may be able to reclaim the VAT it has paid out on purchases, but is only required to account for 0 per cent VAT on the related sales that it has made. Key points: The sale of goods in charity shops is a "business activity" for VAT purposes. A charity must register for VAT if its turnover from "taxable business supplies" in a year is above the VAT registration threshold (currently 81,000). Not all business supplies are taxable there are some exemptions. In particular, there may be a fundraising exemption available for the sale of goods at auction. It is possible to voluntarily register for VAT, which may be worthwhile if a charity wishes to reclaim VAT it pays on purchases for the shop. If a charity is VAT registered, it must charge VAT on the sale of new goods and also on the commission charged on the Gift Aid scheme. If a charity is VAT registered it may be able to re-claim some of the VAT that it is charged when it buys goods and services relating to its business.