In the March 2011 Budget, the Government sought to add force to its “Big Society” vision and heralded a new inheritance tax incentive for charitable giving.

Further details of the relief were divulged in HMRC’s consultation document, A New Incentive for Charitable Legacies. The document summarises the new incentive as “a lower rate of inheritance tax when leaving 10% of an estate to charity”. Sounds simple enough, but, as we shall see, the strategy has come up against severe criticisms and many doubts have been raised about the new incentive.

As is often the case in seeking to decode the headline-catching announcements made in Budget statements, it is sensible to wait for the finer details. Would “a lower rate of inheritance tax when leaving 10% of an estate to charity” be as simple as it sounds?

The reduced rate of IHT will apply where at least 10% of the value of the net estate is left to charity. In a straightforward case, the 10% threshold would be calculated by working out the value of the deceased’s assets at date of death and deducting any available nil rate band, exemptions and reliefs. The value of the charitable legacy is then added back. The resulting figure is the “baseline” value, against which the amount of the charitable legacy must be compared.

The availability of a full nil-rate band and the various exemptions which may apply could therefore have a significant effect on the threshold level which must be met. Similarly, lifetime gifting can result in a higher threshold which must be met before the estate will qualify for the reduced rate of IHT. Other factors could also impact.

Points for decision

The consultation asked whether the value of only the “free estate”, or of the “aggregate estate” (the deceased’s estate plus other assets included in their “estate” for IHT), should be used. Then, if the reduced rate is to apply, should it apply only to the free estate or should the liability in respect of the aggregate estate be reduced also. The consultation suggested that there must be some correlation between the value on which the 10% test is based and assets which benefit from the reduced rate.

Feedback was also invited on the valuation of assets bequeathed. The value attributed to specific assets bequeathed to charity will have a direct bearing on whether or not the 10% threshold is met, and so the consultation questioned whether the type of assets which qualify might be restricted to exclude hard-to-value assets, to reduce the burden on HMRC and executors agreeing values. It would seem that excluding particular classes or types of assets would be undesirable. One suggestion is that executors could elect to disclaim the reduced rate where the administrative burden of seeking to apply that rate exceeds the potential benefits of the rate applying. The valuation issues also apply to cases where there is a change on value post-death. Addressing such changes would appear to be broadly catered for with existing measures.

Hidden costs

While few would criticise the Government’s aims of seeking to increase charitable giving, many of the responses publicised to date have attacked the method proposed. The Association of Taxation Technicians has stated that the consultation’s title gives a misleading picture of the proposals: “It suggests a straightforward calculation to determine the relief available; unfortunately nothing could be further from the truth”.

The Chartered Institute of Taxation (CIOT) accuses the Government of failing to adhere to its own standards and requirements in relation to consultations, as set out in the Tax Consultation Framework. CIOT also states that the consultation completely ignores the impact of the additional costs of valuations and compliance which an estate coming close to the 10% threshold would need to bear. It further describes the difficult examples given in the document as “the antithesis of simplicity”.

One of the most concerning criticisms raised is the possible (some would argue, likely) effect the new incentive will have on lifetime giving. The attraction of the relief to those who are considering gifting to charity is that, where 10% is bequeathed, £76 in tax is saved for every £100 given to charity. When such attention-grabbing figures are being put forward, it is easy to see why taxpayers may consider foregoing their lifetime expenditure on charity (where the saving on the effective rate of tax is less), and plan instead to use the relief. It is argued that cutting off the valuable income stream generated by lifetime giving could have disastrous consequences for charities.

The proposed 10% relief has provoked thought about the best ways to incentivise charitable giving. Alternatives to the relief have been put forward. The consultation period ended on 31 August 2011. The incentive is due to apply from April 2012 and so, in the meantime, we await details of the draft legislation and to see how the Government will respond to the feedback given. Of course, advisers will need to grapple with the best ways for clients to support charity.

Will the reduction in the IHT rate be enough to encourage testators to introduce (with the likely impact of passing less wealth to family), or to increase, a charitable legacy in their wills? And, even then, will the increased charitable expenditure outweigh the costs of implementation? Are there risks to crucial lifetime giving?

The new relief probably leaves more questions than answers.

SCIOs – what you should know

New this year, SCIOs provide some protection from liability but also introduce new requirements. OSCR’s Martin Tyson sets out the key points for legal advisers

Q: What is the SCIO and why has it been created?

The Scottish Charitable Incorporated Organisation (SCIO) is a new legal form for charities registered in Scotland. The SCIO is a corporate body able to enter into contracts, employ staff, own property, sue and be sued. It therefore provides some protection against personal liability for its charity trustees and also reassurance for creditors and those contracting with it. Unlike charities that are companies limited by guarantee, SCIOs have OSCR as a single regulator.

The Charities and Trustee Investment (Scotland) Act 2005 created the SCIO as a legal form that would offer this protection to trustees, while not subject to the same reporting and regulatory regime as a company.

Q: What makes the SCIO different from other legal forms?

There are a number of important differences, set out in detail in OSCR’s “SCIOs: A Guide”. For example, unlike other charities, the SCIO’s existence depends on its charitable status: it can’t simply ask to be removed from the Scottish Charity Register like other charities, but must seek OSCR’s consent to dissolve, or amalgamate or transfer its undertaking to another SCIO. This is a crucial point to consider before applying to become a SCIO.

Q: What are the advantages and disadvantages of SCIO status?

This should be discussed in detail with the charity client, and a decision on whether to seek SCIO status can only be made according to the specific circumstances. Compared to unincorporated legal forms, the SCIO offers a degree of protection against personal liability. While this is also true of a company limited by guarantee, the SCIO does not require to report to Companies House. The SCIO also provides some protection for creditors and is subject to the same accounting thresholds as unincorporated charities, whereas a company must prepare fully accrued accounts, regardless of its income level or any other factor. A SCIO cannot make use of complex loan instruments in the way a company can.

Q: Does the SCIO place different duties on charity trustees?

On the whole, SCIOs will be regulated by OSCR in the same manner as any other charity entered in the Scottish Charity Register, and the duties of charity trustees are much the same. However, there are some important differences. For example:

a SCIO’s constitution must contain certain basic information and rules about how the SCIO will be governed;

• the members of a SCIO have particular duties;
• the SCIO requires to keep registers of its charity trustees and members, and to provide copies of these registers;
• the SCIO’s documents must refer to its SCIO status;
• there are different rules over applying for OSCR’s consent to amalgamate with another body or to wind up/dissolve a SCIO.

OSCR has produced guidance that sets out these requirements in detail.

Q: Can any charity become a SCIO?

The SCIO is being implemented in phases. Existing charitable companies, and charitable industrial and provident societies, can apply to convert to SCIO status from 1 January 2012. Existing Scottish charities that are any other type of legal form have been able to apply from 1 April 2011, as have new applicants for charitable status.

Q: Does OSCR expect the SCIO to be a popular option for charities?

Yes. To date we have received 87 applications from those seeking charitable status as SCIOs, with the first such body, South Seeds SCIO (SC042244), entered in the Scottish Charity Register on 14 April. SCIO incorporations currently represent about 20% of new applications for charitable status, with a wide range in size and complexity from small community groups to large culture and leisure providers.

We expect demand to increase significantly in the New Year as the next phase of the legislation comes into effect, and plan to undertake significant outreach work among charity advisers and with banks and funders, to highlight awareness of the new legal form and its requirements.

Q: Where can I find further information?

The technical guidance “SCIOs: A Guide”, available at www.oscr.org.uk, will assist you in advising your charity clients. We have also produced a short leaflet, “Working with SCIOs”, to explain the new legal form to those who may enter into contracts with such charities. In addition, OSCR is holding training sessions on SCIOs aimed specifically at professional advisers, as part of its Outreach Programme, with information available on its website.

Dealing with conflict

Trustees often find themselves in a situation of conflict of interest. Policies should be in place to deal with these

Charity boards will regularly encounter conflicts of interest among their charity trustees. Effective management of conflicts is an essential matter of good governance. OSCR’s recent guidance “Who’s In Charge” demonstrates this issue well.

The Charities and Trustee Investment (Scotland) Act 2005, s 66 sets out the statutory duties of charity trustees and provides guidance when conflicts, or circumstances giving rise to a conflict, arise. Clearly a conflict of interest may arise where the interests of any other person or organisation, or the trustee’s own interests, prevent or are capable of preventing the trustee from putting the interests of the charity before these conflicting interests.

While solicitors will be familiar with conflict issues, for a charity board conflicts might well arise where trustees are involved with an associated organisation, competing institutions, potential contractual counterparties, or beneficiary groups.

“Who’s In Charge” should be read by charity trustees for its guidance on dealing with a conflict of interest. OSCR recommends that a clear, documented conflict of interest policy should be adopted by each charity, setting out:

• what a conflict of interest is, detailing any particular conflicts likely to be relevant to the charity
• duties and mechanisms for declaring interests
• procedures for dealing with conflict of interest, such as the circumstances where a conflicted charity trustee should withdraw from decision making and the procedures for decision making in such a case.
• It is good practice for a register of charity trustees’ interests to be maintained, and for records to be kept of the implementation of the conflict of interest policy.

A charity’s constitution should be examined, and if necessary revised, to verify that there is a procedure permitting the charity trustees to comply with their collective duty to take such steps as are reasonably practicable for the purposes of ensuring (1) that any breach of another trustee’s duty to act in the interests of the charity is corrected by the trustee concerned and not repeated; and (2) that any trustee who has been in serious or persistent breach of this duty is removed as a trustee.

Charity trustees should be aware that certain structures or relationships are more likely to lead to conflicts of interest, such as when a charity is linked closely to another body, and particularly when the charity trustees are identical to the people in control of a related body.

In such circumstances, charity trustees should demonstrate active management of this conflict of interest. Procedures such as recording of discussions and decisions in minutes should be employed. It may also be desirable to seek additional independent professional advice for an important or high risk decision. However, all final decisions must be taken by the trustees in what, in their judgment, is in the best interests of the charity.

Ensuring no charity trustee falls foul of his or her duty to act in the best interests of the charity is, for many charities, possible only through effective management of such intrinsic conflicts of interest.