Charitable giving and tax reform: the challenges in regulating the not-for-profit sector

“How much should the taxpayer contribute to the charitable whims of donors?”

This comment was made in an article in the The Guardian on 16 April. It was referring to the fact that the UK Coalition government is under fire for recently announced proposed changes to the tax treatment of gifts to charities and similar organisations.

In the 2012 Budget, the UK government announced a number of measures that are likely to impact on philanthropy. Some of the proposed measures were welcomed by the charitable sector, such as the proposed reduction in inheritance tax on bequests to charities and the changes to “gift aid”, a scheme that enables an approved charity to claim amounts from the revenue where a taxpayer has made a donation to the charity. Those changes will make it easier for charities to claim the tax relief because they will not have to provide proof of the residency of donors and will be able to claim tax relief online. These two measures, and in particular the measure about bequests, were hailed as likely to encourage a culture of giving in the UK.

But hidden within the detail of the UK Budget was another measure imposing a cap on tax reliefs (ie tax deductions) that are otherwise unlimited. The measure applies - but is not limited to - gifts by taxpayers to charities. The cap will operate by limiting the amount that can be claimed as a tax deduction to 25% of taxable income or £50,000 - whichever is higher.

In recent weeks, this measure has been described as likely to put “a brake on philanthropy that may deter future donors”. In response, the Chancellor of the Exchequer released figures showing that top income earners in the UK often pay as little as 10% of their total income in tax and suggested that the access to unlimited tax relief for charitable donations was in part to blame.

The outcry over the proposed UK measure was similar to that experienced in the US when President Obama announced a proposal for a cap on charitable donations for wealthy taxpayers in 2009. The measure was part of the government’s plan to finance changes in the health-care system. The reaction was swift – critics argued that any disincentive to charitable giving would have a severe impact on charities already under severe strain because of the recession.

Although the proposal has been put forward in each Budget since 2009, it has never passed Congress and so has not been implemented.

In both the UK and the US, the decision to try to limit the deduction appears to have been motivated, in part, by the downturn in the economy. This raises the question as to whether the Australian government might follow suit.

The not-for-profit (NFP) sector in Australia is currently undergoing significant reform. Several of the reforms were announced in the Budget in May 2011. These reforms were initiated by several reports, including one by the Productivity Commission, that recommended that charities - and the NFP sector more generally - be subject to regulation by an independent body rather than modest supervision by the Australian Tax Office.

At the same time, it was announced that there would be a statutory definition of “charity” to replace the current position that relies on a 400-year-old statute. These reforms have generally been welcomed by the sector.

More recently, the federal government has announced that it will review the tax treatment of the NFP sector more generally and this includes, of course, the tax treatment of charitable gifts.

Is Australia likely to introduce a cap on donations? I suggest this is unlikely for three reasons.

First, there does not appear to be any evidence that the provisions relating to charitable donations are being abused. Indeed, over the last 10 years, the federal government has been making it easier for taxpayers to undertake philanthropy, in particular by encouraging the growth of private funds (now called private ancillary funds) that can make distributions to endorsed entities. Secondly, the government has established a working group to advise on NFP sector tax concessions.

The terms of reference for the working group include as an objective: “whether there are better ways of delivering the current envelope of support provided through tax concessions to the NFP sector by the Australian government”.

The terms of reference also state that any recommendations should be revenue neutral having regard to support provided to the sector generally. This suggests that the government is not looking for ways to save expenditure or that it is intent on reducing the support for the NFP sector but rather wants to explore ways of providing assistance to the sector in ways that ensure “fairness, simplicity and effectiveness”.

The third - and perhaps most significant reason why a cap on donations is unlikely - is that the working group selected by the government to advise on tax is primarily made up of NFP sector representatives. History tells us that removal of tax concessions is a tricky business. The government is likely to be viewing the current outrage in the UK as a warning about just what is possible in terms of tax reform.

The NFP Project is holding an international conference on 19-20 July called “Defining, Taxing and Regulating NFPs”. Further details are available at: http://tax.law.unimelb.edu.au/notforprofit

Ann O'Connell is a member of the Not-For-Profit Project at the Melbourne Law School. She has also been appointed to the NFP Tax Reform Working Group.