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Understanding restricted funds

Restricted funds can be a challenging area for charity finance teams, but knowing how to recognise them and manage them is essential to avoid being in breach of the law.

Under charity accounting rules set out in the Statement of Recommended Practice (SORP) charities must account for their incoming and outgoing resources as two different types of funds. These are restricted funds and unrestricted funds.

A survey in 2018 highlighted charities valued unrestricted funds twice as much as restricted fundsi. However, restricted funds form an important part of charity funding and its important finance teams understand the difference.

In the commercial sector there are only unrestricted funds which means as that as long as customers receive what they pay for, commercial entities are free to use the income earned in whatever way they please.

But in the charity sector funds may be restricted or unrestricted. This is because, unlike commercial entities who earn income by providing goods or services to customers, charities often receive money from individuals or institutions (donors and funders) who receive no benefits in return.

Special legal powers

The nature of donations gives special legal powers to the donors and funders whereby they can impose restrictions on how their funds are spent by the charities. Failure to apply restricted funding to the purposes for which they are given results in a breach of trust law.

In addition to exposing the charity to the risk of funding being clawed back, the trustees also fail to fulfil their statutory responsibilities by not managing the charity’s finances effectively.

Below I explain how restricted funds are identified and should be managed to better protect the charity from these potential risks.

Definition of restricted funds

The SORP definition of restricted funds is: “funds held on specific trusts under charity law are classed as restricted funds. The specific trusts may be declared by the donor when making the gift or may result from the terms of an appeal for funds. The specific trusts establish the purpose for which a charity can lawfully use the restricted funds. It is possible that a charity may have several individual restricted funds, each for a particular purpose of the charity.”

Restricted funds are either income or endowment (which can be split into permanent and expendable). Restriction is imposed by the donor and may be:

  • Used for a specified project.
  • For a specific geographical area.
  • Funds raised in an appeal such as for the Ukraine appeals must be used for that purpose.
  • Investment income (if generated from invested restricted funds).

Funds must be spent for the purpose they were given for. They can also be assets, such as a house given to a charity, but the donor will specify what it can be used for.

Endowment funds are rarer; probably less than 10% of charities will have endowment funds. They are funds whose restrictions relate to the capital element of the assets in question. They are similar to restricted funds in that they are permanent with no ability to spend the capital, and expendable with no requirement to spend capital.

Capital can be invested to generate a return to spend on charitable activities and income generated may be restricted or unrestricted, so its important charities check the terms.

Distinguishing between funds

Restricted funds are generally donations and grants, i.e. funders do not receive anything in return. Commercial transactions are generally unrestricted, e.g. sales of goods and services.

Grants are covered under trust law and contracts by contract law. With grants if the charity fails to use the funds as specified, trustees can be personally liable to return the grants; whereas with contracts they could be sued for damages if they fail to deliver on their agreement, which could mean the damages being higher than the contract value. Also, with grants unused funds can be clawed back, but with contracts surpluses can be kept.

Grants are restricted if the purpose is narrower than the overall objects of the charity, and contracts are usually unrestricted, although under the new SORP there is now the possibility for a contract to be restricted. Accounting treatments will be different depending on whether funds are grants or contracts. There are other indicators too that can help charities tell the difference which include:

  • Often the agreement specifies that it is restricted.
  • If the charity needs to regularly report on spending to the funders, and if the charity needs prior permission from funders if they spend outside the budget then typically it is restricted.
  • If the donor requests an audit/accountant’s certificate at the end then it’s 100% restricted.
  • Another tell-tale sign is if VAT applies, the situation is more likely to be a contractual arrangement, and therefore funds are unrestricted.

The key is the terms and conditions, and charities must read the small print. It’s very important that the programme and /or finance team identify when a restricted fund is received to be able to account for it accurately and avoid mistakes being made.

Income recognition

There are three golden rules of restricted grants and donations: entitlement; measurement and probability (i.e. if more likely than not likely to get it then should be recognised as income). A charity can recognise income when all three criteria have been met.

Donations are generally recognised on a receipt basis. No pledges should be accrued, as pledges are not legally binding and so there is no entitlement until received. Whereas grants are recognised on a receivable basis and charities can usually recognise the full amount on the date of the agreement if there are no conditions for grant claims. If there are conditions then they are recognised when the conditions are met.

One example could be: the charity has applied for £12,000 to buy a mini bus, but when does the charity recognise the income? The answer is it’s when the charity receives the letter saying the grant has been awarded. It should not be deferred until the mini bus is purchased, because once the funding is confirmed, the charity has control of when the purchase can be made.

Management of restricted funds

There are four general principles for managing restricted funds. The first is that charities must have systems and controls to ensure the funds are spent on purposes the funds are given for and they can be monitored.

Second, it is recommended charities use separate project codes/cost centres in the accounting system where possible; or keep the records on another database. Third, direct expenditure should be identified such as staff costs and other purchases. Finally, charities should also consider overheads and support costs.

Charities then need to consider what processes are in place to identify restrictions in funding and what the processes of allocation of expenditure are, remembering that elements of restricted expenditure include staff costs, invoices and overheads.

Charities should also be aware that it is possible to transfer funds between restricted and unrestricted. For example, if the costs for the project are greater than the restricted funds then unrestricted funds would be needed to cover the difference. For transfers between restricted funds and from restricted funds to unrestricted funds permission must always be sought from the funder.

Here are some common pitfalls and how to avoid them:

Changes in funding arrangements

Statutory funding from governmental bodies, either central or local, has increasingly been moving from grants to contracts. It is now very common for charities having to submit bids for contracts for services (unrestricted) which they have been providing for years via grant funding (restricted).

It is worth being aware that often the change of the classification of the funding and corresponding expenditure is not picked up by the finance team, especially in the first year following the change of funding framework.

Finance teams are advised to advised to always review the terms of conditions of new funding agreements and not to assume that, just because the services to be delivered and the funding amounts remain the same, the funding arrangements have not been revised.

The change is usually welcome by management, as it allows greater flexibility on how the funding is used and there are fewer financial reporting requirements to consider.

Tax implications

The change of funding arrangements could also lead to VAT implications. Grants are outside the scope of VAT, and input VAT of any corresponding direct expenditure cannot be recovered. However, contracts are generally taxed at 20% unless exempt, which allows charities to improve input VAT recovery. Moreover, if a charity fails to charge VAT on contracts where output VAT is due, it could lead to tax liabilities for the charity. It is therefore worth seeking professional tax advice if receiving funding where the VAT status is ambiguous.

Being over-cautious

Finance teams often allocate only direct expenditure to restricted funds especially when the terms and conditions of the funding are less specific. For example, a charity may receive significant donations for a specific appeal, and the finance team allocates only the direct costs of the appeal to the funds.

Management should consider allocating support costs, too, which is totally acceptable so long as the basis is reasonable and appropriate. This will help avoid unspent funds at the end of the appeal and help with full cost recovery.

Restricted funds can be a complex area, but one that the finance team needs to fully understand.

Sayer Vincent’s Vivien Ma – restricted funds are either income or endowment (which can be split into permanent and expendable).
"Grants are restricted if the purpose is narrower than the overall objects of the charity, and contracts are usually unrestricted…"
"There are three golden rules of restricted grants and donations: entitlement, measurement and probability…"

Responding effectively to cost of living pressures

Late last year, the Charity Commission published updated guidance for trustees and charity managers about managing financial difficulties arising from the cost-of-living pressures. With the cost of living crisis not going away anytime soon and with little time for many charities to have recovered from the Covid pandemic, there are several options which are available, and which should be considered, to help decide the future of a charity.

Complying with duties

For charities which are facing difficult financial decisions now, even decisions about their own future, it is important that trustees continue to comply with all of their duties and to make all decisions in the best interests of the charity. Trustees should read the government’s essential guidance for trustees to remind them of their responsibilities. This reminds trustees that when making decisions, they should:

  • Act within their powers under the governing document and law.
  • Act in the best interests of the charity to carry out its purpose.
  • Act with prudence to manage charity resources responsibly.
  • Act with reasonable care and skill and take appropriate, specialist advice when needed.
  • Manage conflicts of interest.

Trustees who act in breach of their legal duties can be held responsible for any consequences that occur as a result, including any financial loss which the charity incurs. If a trustee themselves is experiencing financial difficulties and is made bankrupt or enters into an Individual Voluntary Arrangement, then they could be disqualified from being a trustee unless they are authorised to continue by the Charity Commission.

As they face these difficult times clearly trustees and charities may need to have some fairly frank and open conversations, but it essential for the long term success of the charity.

Before making any decisions, trustees need to decide if these will be in the best interests of the charity. The Charity Commission has published 15 questions which trustees should ask themselves in the context of finances and resilience to help with decision making.

This will help them to make decisions which balance the risk between the need to cut costs and preserve funds to help beneficiaries in the future and meeting the immediate needs of beneficiaries now.

When making decisions, trustees need to assess risks and during periods of financial difficulty, risks could include:

  • The charity’s ability to carry on with financial constraints, whilst safeguarding and protecting beneficiaries from harm.
  • Whether it is prudent to sell assets or investments or to borrow against them, to release funds to cover existing expenditure.

There is no guarantee that even after considering all of the facts available at the time that trustees will make the “right” decision. The Commission recognises that things may still go wrong, despite the best efforts of the trustees in acting in the charity’s best interests. It is therefore important to record in detail decision making processes. Trustee and subcommittee meetings should be clearly minuted.

Trustees and charity managers should be evaluating the financial position of the charity and ensuring all trustees have access to real time financial data. Where charities are facing financial shortfalls, there is a greater need to keep all operations and finances under regular review.

The cashflow implications of all decisions should be considered which means: looking at all of the payments that the charity needs to make over various different timescales, what funds are available to meet those payments when they are due and what income the charity expects to receive over the same timeframe. Best and worst case scenarios can help.

Contingency fund

Cashflow forecasting will enable all the trustees to decide if the charity is at a risk of running out of cash and to enable them to plan operations accordingly. New projects, for example, should have a contingency fund built in to cover unexpected costs.

Cashflow forecasting will also help the charity to predict when it is likely to return to “normal” operations and fundraising levels, or if that is not on the horizon, whether options such as merging with another charity or even closing need to be considered.

For charities with temporary cashflow issues, minimising immediate costs is a starting point. Look at where you can stop or put a hold on any non-essential expenditure but take into account any cancellation costs.

There might be other, cheaper ways of operating and where significant cost savings can be made. For example, the use of technology which if just used for hosting meetings reduces both staff time and travel costs. Look at whether staff can be deployed elsewhere and if there are any who want to take a period of unpaid leave or if they would like to reduce their working hours. If staff can be seconded to different operations within the charity, consider the legal implications of this first.

Consider whether it is possible to partner with other charities with similar aims to share facilities, resources or to negotiate cheaper, bulk buying deals, although there may be VAT implications for payments between charities.

Renegotiating loan repayments

If you have any outstanding borrowing, talk to lenders to see if loan repayments can be renegotiated. If you are pausing any charity operations, you will need to consider the contractual obligations which could prevent this or could leave you in breach of terms with further financial repercussions.

Many charities have financial reserves which can be used to help it get through difficult periods. Depending on how those reserves are held, it is important to consider whether this is in the longer term best interests of the charity or if the loss of income, or the loss in value of selling now, negates this.

Many charities also have both restricted and unrestricted funds. Unrestricted funds can be spent by trustees in any way they see fit to achieve the charity’s purpose, but restricted funds, as the name suggests, means they can only be spent in accordance with the restrictions in place.

Charity Commission or donor permission will be needed to change how restricted funds are spent. Trustees will also need their permission to lift restrictions which enable the disposal of designated land or buildings. Charities with a permanent endowment can in certain circumstances consider total return on investment, spend or borrow from them, and there are Charity Commission rules to follow.

Trustees should also look at ways to boost charity income. If the charity has regular funders or donors, consider whether they can be approached to increase their funding. They might be supportive or happy to relax restrictions or agreements they have placed for the use of grants or payments.

Emergency appeals

Charities could also launch an emergency appeal specifically to cover an increase in demand for services. As part of this, look at new or increased grants or loans from other charities or benefactors.

Where a charity has a trading subsidiary, trustees should consider whether this is performing as well as it can. If it is no longer financially viable, trustees need to consider its longer term role in supporting their aims as an income generating activity.

There is practical help from the government with help for fuel costs. This has been extended to non-domestic customers including charities until 31 March 2024, although the level of support has been reduced. Check if your charity is receiving all the support it can and if it is paying the correct amount of VAT on fuel and other purchases.

More collaborative working or a merger could be an option for some charities operating in similar fields, and you can search the register of charities held by the Charity Commission to find potential partners. This often helps charities to use funding or resources more efficiently.

Orderly closure preparations

If, after considering all the options available, the trustees decide that the charity must close, then preparation for an orderly closure to protect the best interests of the charity is advised.

Steps to take include checking the charity’s governing document for any requirements or restrictions on closure. This may also specify a process for closure and how any assets left after costs are to be used.

There will be costs involved with closure such as terminating contracts or leases early, redundancy payments, cost of transferring assets or services to other providers. It will also be necessary to consider how plans are communicated to staff, beneficiaries, donors, partners and wider stakeholders.

If the charity is a company or CIO (Charitable Incorporated Organisation), then there are legal requirements to meet, and advice is available from the Charity Commission about the process to follow. Appointing administrators to help with the closure and who will take over to ensure all the legal mechanisms are followed is also an option in more complex scenarios. Don’t be afraid to ask for advice from professionals.

Reporting serious incidents

Finally, the Charity Commission reminds trustees that serious incidents including issues relating to financial pressures and the associated consequences should be reported.

There is clearly much for charity managers and trustees to think about currently. If you would like advice or support don’t be afraid to reach out and take the advice and support available from a wide variety of sources.

Kreston Reeves’ Susan Robinson – as charities face these difficult times clearly they may need to have some fairly frank and open conversations.
"For charities with temporary cashflow issues, minimising immediate costs is a starting point."

The impact on charity tenants of green leases

Cop 26 was a game changer. It seemed that almost overnight corporate Britain started to “walk” its ESG/sustainability “talk”. Ominously however, Big Business has started to push its sustainability ambitions down the line to its suppliers and corporate partners (including their nominated charities), in order to demonstrate more holistic compliance with its ESG (environmental, social and governance) commitments.

The fact that the built environment (offices, retail outlets, warehouses, residential accommodation, etc) represents almost 40% of society’s carbon emission highlights why net zero is proving such an important issue and one which will start to impact all charities:

  • Directly, in relation to their own carbon footprint.
  • Indirectly in relation to ensuring a charity’s sustainability performance underpins its fundraising strategies - especially when targeting larger companies for whom ESG is a major corporate issue (especially financial and international corporations).

A fast growing declaration of “green intent” on the charity sector’s agenda in recent years is the emergence of “green leases”.

Environmental obligations

A green lease is a lease which includes a range of environmental obligations, energy efficiency benchmarks and eco-centric sustainability programmes agreed between a landlord and a tenant. The obligations are designed to encourage both the landlord and the tenant to reduce the environmental impact of ownership and occupancy of a property – thereby making it more sustainable.

Green leases incorporate clauses which have a direct impact on specific responsibilities/obligations on both the landlord and the tenant. These obligations refer to the sustainable building management and occupation of a property. Clauses include issues such as energy efficiency measures, waste reduction/management and efficient water management.

However, given the fact that every building is different (in terms of age, construction, energy efficiency ratings, etc) and that every landlord and tenant has different sustainable and net zero goals, there is no such thing as an off-the-shelf green lease.

As with all leases, a green lease can be negotiated at various stages of occupancy before securing an agreement between a landlord and a tenant. For example:

BEFORE THE LEASE HAS BEEN AGREED the landlord and tenant can mutually agree to environmentally sensitive clauses which could be enforced under the lease. These can be specific and allow for simple enforceability, or broader in scope and designed to commit both parties to principles, rather than setting specific rules and evaluation criteria.

DURING THE TERM OF THE LEASE a landlord and tenant can agree to improve the sustainability of the lease. Many leases require a tenant to comply with the requirements coming from the landlord. As these are often incorporated into the lease by reference, they are legally binding and, if a landlord choses to do so, they might amend the regulations without the tenant’s consent and without the need to renegotiate the terms.

Alternatively, the landlord and tenant could agree to a MEMORANDUM OF UNDERSTANDING (MoU). This involves both parties giving a non-binding commitment to work together to improve the environmental impact of a property. It could range from sharing information on energy consumption, to committing both parties to consider environmental best practice, energy and water efficiency, and adopting waste reduction measures.

One proviso of an MoU is that both parties work together in good faith. It can however be terminated at any time.

EPC rating

At its simplest, green lease commitments ensure that both parties will co-operate to improve the sustainability of a building.

A good starting point is the property’s Energy Performance Certificate (EPC). The Government has that announced that by 2030, the minimum EPC standard for any commercially occupied building will be “B”. However, a lower standard of “C” has to be achieved by 2027. The current grading is A-G; commercial properties with a rating of F and G cannot be leased.

The magnitude of this challenge was recently highlighted by Colliers, a firm of property consultants, who concluded that in London alone, about 20 million square feet of commercial space falls below the minimum EPC standard of “E”, whilst only 20% of properties are currently classed as “A” or “B”.

Given the fact that 80% of buildings standing today will still be in use in 50 years’ time, it is no wonder that this major issue has surreptitiously stalked all management teams in the private, public and charity sector.

Landlords’ obligations

It is the responsibility of the landlord to improve the EPC rating of a building.

In multi-tenanted buildings, it is likely that landlords will be responsible for providing a number of building-wide “green” services.

At the top of the list would be the safe management of waste to protect both the environment and human health. This includes waste segmentation protocols for recycling, reuse and/or recovery, as well as the disposal of waste which does not fall into any of these categories. In addition, the landlord is normally required to ensure that waste and refuse collections from the property are co-ordinated to reduce congestion and fuel emissions and duplicate journeys.

Another landlord responsibility would be ensuring that environmental performance infrastructure systems and protocols are in place. This is designed to encourage tenants to consider improving their energy consumption, green energy selection, water consumption, waste management, generation and/or emission of greenhouse gases.

Then there would be ensuring the property features metering equipment to measure the environmental performance of the building. The intel can be shared with the tenant(s) - via the service charge billing documentation, for example.

Also, there would be inclusion of any tax levies/environmental charges and outgoings relating to energy consumption.

Tenants’ obligations

One of the obligations on tenants will probably be to collaborate on environmental initiatives (see above) as well as adhere to sustainable use obligations, which optimise the property’s environmental performance.

In addition, green leases usually require tenants to comply with the environmental policies of the building they occupy, or attend sustainability forums set up to review the environmental and sustainability policies for the estate and to agree future “green” targets.

During the period of the lease a tenant may have to agree to new terms designed to improve the sustainability of the lease. Most leases require a tenant to comply with the rules introduced by the landlord. As these are often incorporated in the lease, they are legally binding. If a landlord choses to, they could amend the rules without the tenant’s consent or without scope to negotiate the terms.

Before even negotiating a green lease, tenants must understand the historic and anticipated energy consumption of the property.

Energy baseline

Reviewing the last 12 months utility bills, or even copies of recent bills, will establish an energy baseline. If it is a new build, tenants should ascertain what the anticipated utility costs will be. Given this data, tenants can work with their landlords and agree energy usage reduction goals. Some consultants recommend setting reduction milestones of at least 10% and agree a roadmap of sustainable practices with the landlord.

Collaboration with other tenants is a potent success determinant. Occupiers in a multi-tenanted building should ensure that they communicate regularly and work together on issues such as:

  • Shared energy reduction goals.
  • A commonality of green lease terms, across the building - and working together, persuade the landlord to improve terms (if necessary).
  • Ensuring the landlord complies with their agreed obligations.

Dark or light green

As the adoption of green leases grows, some organisations have opted for either “soft” commitments (“light green”) or “hard” commitments (“dark green”).

Light green clauses may not be legally binding, or they might be limited in scope, or may include the setting of obligations, but without any targets or legal status.

Dark green clauses are usually legally binding, substantial in their level of commitment and broad in their scope. They might include obligations and targets formalised through Heads of Terms (between the landlord and the tenant) which become legally binding - with a breach potentially resulting in financial penalties, or recourse to a dispute resolution process.

The compelling reason

In addition to being good for the planet, as well as for future generations and, underpinning longer term energy reduction measures (especially germane given the current energy price volatility), green leases can also improve a charity’s finances, reduce utility costs, underpin fundraising strategies (especially if targeting PLCs or environmentally sensitive consumers). They have also proved to generate positive employee (attraction and retention) benefits.

However, like any lease, green leases are a legally binding contract. So do try to ensure that the legal team and the property advisers you select are able to negotiate the best (green lease) terms and agree an equitable green lease (whilst limiting your “green liabilities”).

Phil Winckles and Richard Beaumont – green lease obligations are designed to encourage both the landlord and the tenant to reduce the environmental impact of ownership and occupancy of a property, thereby making it more sustainable.
"Occupiers in a multi-tenanted building should ensure that they communicate regularly and work together on issues…"

Charities entering into mortgages

Coronavirus has created a short term need for borrowing for a great deal of organisations – and charities are not exempt.

Short term cash flow issues need to be addressed quickly to ensure the long term future for charities, and, therefore, many charities are considering entering into loans, including mortgages over their properties.

On the other hand, charities may also wish to own properties for retail or business administration purposes, i.e. premises to operate from.

While a large proportion of transactions will always remain the same irrespective of who the charity is, nevertheless there are some key questions charities and their trustees will need to consider before buying property or entering into mortgages.

DO THE TRUSTEES OF A CHARITY HAVE THE POWER TO OWN PROPERTY? The short answer is yes, any charity can own property. However, many charities may wish to limit their own ability to do so. A charity’s governing document will state whether specific consent will be required in order to buy property. Ordinarily, consent is not required. However, there are situations where charities do need to seek consent from the Charity Commission or the court.

CAN A CHARITY ENTER INTO A MORTGAGE? The first thing to consider is whether the charity has the power to borrow and to enter into a mortgage as security for the loan. This power may be expressly stated in the governing document for the charity or can be implied. The default position would be that the charity can borrow. However, if no expressed or implied power can be relied upon, an order from the Charity Commission or the court will be required.

Charities Act requirements

A registered charity can only place a mortgage on land in accordance with the Charities Act rules. If the transaction does not comply, it may be void. The rules require registered charities to follow strict procedures, which, while relatively straightforward, must be complied with in order to avoid the loan becoming invalid.

If a registered charity is entering into the mortgage as security for the repayment of a loan, it must receive written advice by a qualified person who does not have a financial interest in the making of the loan. This should be given before the loan documents are approved and signed.

The mortgage documents should also state that the land belongs to a charity and that the relevant advice has been given. The advice should state why the loan is required, whether the loan is reasonable and whether the charity is able to repay the loan.

The requirements for trustees

The charity’s trustees should consider the advice given and make a decision as to whether the loan would be a suitable investment to enter into. On the basis that the above requirements can be fulfilled, the process is likely to be straightforward.

However, the trustees will be under an obligation to act reasonably and in the best interests of the charity, which means that if they do decide to buy property, they need to ensure they understand the implications of the purchase and take both legal and financial advice.

ARE CHARITY TRUSTEES PERSONALLY LIABLE WHEN BUYING PROPERTIES? When entering into legal documentation, trustees can expose themselves to liability for all the covenants they agree to under the title documents, mortgage and any lease. In order to protect the trustees, a solicitor will try to limit their personal liability.

Unless a charity is incorporated, the trustees of a charity will be personally liable for the full amount borrowed, plus any interest or charges. Your solicitor would usually ensure that the facility agreement includes a limitation of liability clause to ensure that the loan is limited to assets owned by the charity. However, if this is not included, trustees may find themselves personally liable for charity debts.

Servicing loans

Trustees of the charity should also be aware of the continuing need to service their loans. This includes collecting and sending all monthly payments; keeping a clear record of all payments and balances; ensuring that taxes and insurance payments are up to date; and following up on any late payments. This ensures that the charity maintains its creditworthiness and is in a position to take further loans, if required.

Ultimately, the liability of a charity trustee depends on the constitution of the charity itself. There are four main types of charity: a charitable incorporated organisation (CIO), a charitable company (limited by guarantee), an unincorporated association and a trust (also unincorporated).

Broadly, a charity trustee can find themselves liable for losses if they have breached their duty to the charity: in the case of an incorporated charity, if they traded wrongfully or fraudulently; and in the case of an unincorporated charity, if they entered into contracts on behalf of the charity.

No separate legal identity

An unincorporated charity is not a corporate body and for this reason, does not have its own separate legal identity. It cannot be sued or sue in its own name and cannot hold property or a contract in its own name. If an unincorporated charity is insolvent, there is no mechanism for placing it into an insolvency process. Therefore, one or all of the trustees may have to petition for bankruptcy or enter into an individual voluntary arrangement.

Practical arrangements should be made by the trustees of a charity in order to limit their liability. These can include:

  • Limiting individual liability under contracts to include the assets of the charity only.
  • Allowing the trustees to be indemnified out of the assets of the charity within the trust deeds.
  • Taking out trustee indemnity insurance/director’s liability insurance.
  • Becoming an incorporated charity in order to create a separate legal identity.
  • Regularly seeking financial advice.
  • Ensuring that your constitution allows quick decisions to be made and that adequate records are made to avoid any potential claims against the trustees.

Following completion

Following the completion of the loan, the charity should also note that if further advances are to be made, the charity trustees must repeat the above process of obtaining appropriate advice and this is usually insisted upon by the lender.

Nelsons' Nathan Wescott – the first thing to consider is whether the charity has the power to borrow and to enter into a mortgage as security for the loan.
"A registered charity can only place a mortgage on land in accordance with the Charities Act rules."

Being aware of common VAT pitfalls for charities

VAT is a difficult area to navigate for organisations of all sizes across a wide variety of industries. Very often, business owners find themselves knowing very little when it comes to ensuring they are paying the correct amount of VAT on their goods and services - and for charities in particular, this situation can be even more complicated.

Chancellor Rishi Sunak has announced there will be a three-month VAT holiday for all businesses in a bid to help organisations amid the coronavirus outbreak. This tax break, which will affect every organisation in the country, including charities, represents a £30 billion cash injection into the economy and comes as part of a wider set of unprecedented measures to help protect jobs across all sectors.

Despite these short term solutions, charities often find themselves second-guessing their VAT responsibilities, and once these measures are stopped by the government, charities will once again need to ensure they are compliant with the many regulations in this area. So this is a good time for charities to refresh their knowledge of how VAT normally affects them.

It is not uncommon for charities to make mistakes in this important area, leaving them vulnerable to penalties or wasting important funds that should be utilised for the valuable causes they serve. Very often, charities quite simply get the notion of VAT completely wrong, either because they are failing to pay the correct sum, or because they are missing out on numerous benefits.

Here, we will put the spotlight on VAT for charities, focusing on the most common mistakes made in this area, as well as how to overcome them.

VAT registration for charities

First, we must consider what VAT means specifically for charities. VAT affects charities in several different ways:

  • Charities regularly receive income from a variety of sources, and some of these may be liable to VAT if the charity is VAT registered.
  • Such charities will be able to claim relief from VAT on some of the goods and services they buy, regardless of whether the charity is registered for VAT.
  • Many goods and services purchased by charities will be subject to VAT regardless of whether the charity is registered for VAT.
  • Charities which are registered may be able to reclaim some of the VAT they are charged from HMRC, leading to considerable savings.

Charities must register for VAT with HM Revenue & Customs (HMRC) when their taxable turnover is more than £85,000. In some cases, a charity may wish to register if its turnover is below this, for instance, in order to reclaim VAT on their supplies.

In order to calculate taxable turnover, add up the total value of everything you sell in a 12-month period that is not:

  • Exempt from VAT.
  • Outside the scope of VAT.

VAT cannot be charged on goods that are exempt, such as the provision of welfare services. In addition, VAT cannot be reclaimed on any goods and services that have been designated as being in relation to exempt business activity.

Furthermore, income from any non-business activities is considered to be ‘outside the scope’ of VAT. This includes things like:

  • Donations, where nothing is given in return.
  • Grant funding that is given to support charitable activities where nothing is given in return.
  • Activities where the charity does not make a charge.

A charity which is registered for VAT must charge it on all standard-rated and reduced-rated goods and services it sells. Similarly, a charity does not charge VAT on any income from non-business, zero-rated or exempt sales.

When it comes to paying VAT, a charity will pay VAT on all standard and reduced-rated goods and services it buys from VAT registered businesses. VAT registered businesses can sell certain goods and services to charities either at the reduced rate or zero-rated.

The danger of assumptions

A considerable number of charities are unaware that they should be paying VAT. This may sound surprising, but many of such charities are under the impression that the levy does not affect them because of the nature of the work carried out.

However, it is important to remember that because an activity is charitable does not mean it falls outside of the VAT system. For this reason, it is very important that charities look carefully at the activities carried out, and the methods they use to carry these out, in order to ensure they are in keeping with VAT obligations.

Very regularly, there are charities which have wrongly assumed that there is no requirement for them to register for VAT. However, it is imperative that charities are aware of the VAT status of each of their income streams and activities. This could include proceeds earned in a charity shop, should they run one.

It is important to note that while they may not be subject to pay 20% VAT, charities still need to register if regulations state they have to.

Ignoring the benefits

Another common error made by charities is their failure to recognise what reliefs and benefits are available to them. As mentioned above, there are a number of reduced VAT rates - such as the 5% rate - as well as certain payments that are exempt from VAT, allowing charities to focus more of their funds on the causes they support.

Charities are able to enjoy lower rates on a wide variety of payments, including fuel and power. Energy suppliers will charge 20% VAT as standard, which means the charity will need to go back to them to explain that they have been charged any additional cost in error. However, without that prior knowledge, they could find themselves paying too much.

Charities also pay the reduced rate of 5% on the following fuel and power:

  • Charitable non-business activities, such as providing free childcare.
  • Providing residential accommodation, such as care homes, children’s homes and hospices.
  • Small scale use equating to a maximum of 1,000 kilowatt hours of electricity, or delivery of up to a maximum of 2,300 litres of gas oil.

Advertising is another area whereby charities could be paying too much VAT. However, if a charity is to enjoy the benefit of not paying VAT, they will need to provide a certificate to the supplier of the advertising space, as exemption does not happen automatically. The vast majority of the time, charities are unaware that they should not be paying VAT on advertising.

Charities also qualify for a large number of goods and services at zero-rate, including:

  • Aids for disabled people.
  • Construction services.
  • Drugs and chemicals.
  • Equipment for making talking books and newspapers.
  • Lifeboats and associated equipment, including fuel.
  • Medicine, or ingredients for medicine.
  • Resuscitation training models.
  • Medical, veterinary and scientific equipment.
  • Ambulances.
  • Goods for disabled people.
  • Motor vehicles designed or adapted for a disability.
  • Rescue equipment.

In addition, charities do not pay VAT on goods imported from outside the European Union (EU), as long as they are benefiting people who are in need by providing:

  • Basic necessities.
  • Goods to be used or sold at charity events.
  • Equipment and office materials to help run your charity for the benefit of people who are in need.
  • Goods to help deal with disasters within the EU.

In order to purchase goods and services described above at a reduced or zero-rate for VAT, charities should provide all suppliers with evidence of their charitable status. This can include a letter of recognition from HMRC, or a Charity Commission registration number for charities in England and Wales.

A certificate of declaration that confirms your eligibility for relief can also be used in some circumstances. These can be found through HMRC.

Potential HMRC sanctions

While there are a number of notable differences regarding the manner in which VAT is paid by charities and regular business, the sanctions faced by charities if they do fail to adhere to regulations are largely the same. If such mistakes are made, for instance, by failing to register on time, or registering but not declaring, HMRC will usually impose a penalty in the event they believe the charity has been careless in its approach.

The wider landscape

While the level of knowledge that charities hold relating to VAT and their responsibilities is undoubtedly low, there are small steps that charities can take to avoid the most common pitfalls. Charities must engage with VAT, rather than burying their head in the sand in a bid to avoid this significant aspect of their everyday operations.

There are a number of benefits and exemptions in place to allow charities to dedicate the majority of their time and resources on the worthy causes they set out to protect. By keeping abreast of the ways that VAT can impact these day-to-day dealings, charities can prevent wasting much needed funds to pay sanctions to HMRC. Having more knowledge in this area can save a great deal of time and effort in the long run.

The VAT People’s Rob McCann – very often, charities quite simply get the notion of VAT completely wrong, either because they are failing to pay the correct sum, or because they are missing out on numerous benefits.
"A considerable number of charities are unaware that they should be paying VAT."

Getting the balance right to manage financial strains

Charities face challenging times with senior management teams and the board of trustees having to constantly juggle financial and operational resources, in order to meet the organisation’s aims and objectives.

It is always a battle to keep objectives and sustainability in balance. However, in this increasingly complex world, these factors are brought into even greater focus as charities seek to manage and minimise the impact of any unforeseen events on the organisation.

When they happen, their impact provides a stern test for the management team, so it is important to be aware of the potential risk factors to financial wellbeing. These include:

  • Funding uncertainties.
  • The current economic climate.
  • Increasing demand for services.
  • Public sector funding cuts.
  • Pension scheme deficits.
  • Unplanned spending.
  • Increased staffing costs including minimum wage rises.
  • Setup or change costs.
  • The impact of technology.

While most management teams and boards of trustees have the experience of managing day to day and longer term sector issues, dealing with the impact of sudden change and the resultant risks - such as deficits, the reduction or withdrawal of major contracts, legislative changes and even fraud - requires a completely different approach and set of skills.

Addressing head-on

The issues will not disappear on their own. It’s vital to address them head-on unlike one outgoing chief executive who left a note for his successor saying: “There are £200,000 liabilities that aren’t in the accounts. It would have made them look bad if I had included them.”

Avoiding the hard decisions could to lead to the charity being overwhelmed and ultimately precipitate its failure.

When things do start to cause concern, it is crucial to consider using specialist outside knowledge where the professional has had experience of similar issues and can advise on the steps to take to recover, or turn around, the organisation.

Understanding the board

Seeking advice early is crucial and helps protect the board of trustees from criticism. As the charity sector is unique, and heavily regulated, there may be limited opportunities and solutions available to address difficult situations.

Don’t wait to act until time, and the necessary funds, have run out. This severely reduces the options and can lead to complete disaster as we saw with Kids Company.

A professional adviser understands what is, and what is not, possible. They will guide the management team and the board to take the informed decisions to meet the needs of the beneficiaries and regulators. They will also be able to help identify potential funding opportunities.

The sector has the ability to generate funds which is not available to others. I’ve yet to hear of anyone run a successful emergency fundraising appeal for their local widget manufacturer while animal welfare on the other hand…

When an adviser is appointed, as well as understanding the issues, it is important they quickly grasp the dynamics and balance of the board of trustees and its relationship with the chair and the chief executive, both of whom will be pivotal figures in the turnaround.

Trustees’ attitudes and skills

An adviser will also remind the trustees that their role brings certain responsibilities towards the benefactors and the creditors alike. It is important that the skilled adviser takes the individual trustees’ attitudes and skill sets into account.

It is fair to say that there are several identifiable types of trustees. The “founder” and “evangelist” are passionate about the charity and want to assure its survival. They believe that certain projects are fundamental to the organisation.

The “user” has a limited view and is driven by their experience of using services such as those offered by the charity. The “careerist” sees the trusteeship as part of their personal and professional development. They are happy to be seen on the board but are, generally, of no practical use in a turnaround.

Finally, there is the “professional” who will treat the turnaround in the same way as any other problem to be solved and is key to making any turnaround work. They will, usually, give the necessary additional time to the charity to see the issue through.

For certain trustees, the ramifications of making the wrong decisions, especially when tied through collective responsibility, could have implications with their profession’s code of conduct and potential loss of their license to operate. In these difficult times, they need to be able to maintain clear and rational thinking and not get too tied to the emotions which led them wanting to become a trustee in the first place.

As part of any review, the adviser will have also to consider whether the skills balance among the trustees is right and whether change is needed.

Identifying the issues

It is important to understand the cause of the problems. While some factors will be self-evident, it is important the adviser considers whether the charity’s own needs have been neglected while delivering the charity’s aims and objectives; or if a drive for sustainability and commerciality has diminished the original ethos.

The long term success of all charities requires that there is a balance between objectives and sustainability. Too great a focus on aims will cause the charity to become unaware of the requirements of the climate in which it operates. Whilst too keen an eye on the money will cause the charity to lose its “soul”. Either scenario will contribute towards to financial distress.

It is important not to be drawn into using reserves to solve the “rainy day” issues because using them to fund deficits on a general basis sets a dangerous precedent and must only be used as part of a longer term plan.

It is incumbent on trustees to restrict this course of action and forecasts need to be regularly monitored and challenged. Reserves in themselves are finite and, if their use becomes a regular occurrence, it signals that there may be problems.

Finding alternative funding is an important part of any recovery or turnaround strategy. Do not underestimate the amount of goodwill likely to be forthcoming from funders and benefactors to raise money, particularly linked to a specific project or asset.

Several strategies to raise funds can be used ranging from engaging directly with the public for donations; approaching known benefactors who will not want to see the services and support offered disappear; and even service commissioners may be prepared to make early payment in order to protect the charity.

Using the trustees’ networks, which may include like-minded individuals, can also be important in implementing the recovery plans.

The adviser may also be able to identify grants and “soft” loans which are available especially if linked to specific aims and, of course, there is always the possibility of selling assets for disposal or even sale and leaseback.

Seek alternative solutions

After all considerations, a merger may be the best outcome. A discreet approach to charities with similar aims and objectives may help discover if this is a viable alternative.

Initial discussions are likely to involve a triage process so the other charity can understand the opportunity and consider whether they have resources to protect and grow the enlarged organisation.

An approach saying simply “We need help” is unlikely to be successful. Why would they want to take on your issues just because you cannot devise a solution? Think of the actual benefits to the merger partner.

Depending on the severity of the position, particularly if services are in peril, it might be possible to achieve a merger within days. However, in most circumstances, it is more likely take at least a couple of months.

As well as the level of reserves, the board should also consider the money it has in the bank. There have been situations where trustees believe that they can continue until they run out of cash. Then they ask for advice. As mentioned earlier, that is a recipe for disaster which will almost certainly lead to a catastrophic failure.

Insolvency a momentous decision

Should all efforts fail, the adviser may believe that an insolvency process is the only solution. It is a momentous decision for the charity and the trustees. Just like a director of a commercial company they are responsible for the organisation’s success or failure so they will have to account, and take responsibility, for their decision making. The adviser will be working to ensure that insolvency is the last resort.

Working closer together

As the impact of austerity continues to increase the financial and operational pressures across the sector, it is imperative that the senior management teams and board of trustees work closer together to ensure that forecasts and plans are robust and that the services provided are as efficient as they can be.

Plans and forecasts should be regularly reviewed. If the plan isn’t working as anticipated action must be taken. Resolving not to allow deficits already incurred to be charged against reserves only works for those who are able to maintain iron discipline in the face of extreme pressures or temptation.

As soon as any concerns are raised it is important to talk to an experienced adviser who may be able to act as a guide over a rocky period. Leave it and it may be too late.

Bimor Advisory’s Matthew Dunham – while most management teams and boards of trustees have the experience of managing day to day and longer term sector issues, dealing with the impact of sudden change and the resultant risks requires a completely different approach and set of skills.
"When an adviser is appointed…it is important they quickly grasp the dynamics and the balance of the board of trustees and its relationship with the chair and chief executive…"
"Do not underestimate the amount of goodwill likely to be forthcoming from funders and benefactors to raise money…"
Deloitte advert

Monitoring and organising expenses better in your charity

Charities have even more reason to be cost effective than for profit organisations, as every pound saved is a pound which could be used to further their cause. However, there are numerous challenges involved in managing money within charities as a result of multiple stakeholders and payment methods. These challenges are exacerbated by the unpredictability and volatile nature of fundraising. However, charities can utilise digital technology to support fundraising and manage finances more effectively.

The UK Government’s 2018 paper Civil Society Strategy: Building A Future That Works For Everyone notes that although 72% of charities see digital’s potential to deliver their strategy more effectively, only 32% have a strategy of how digital can help achieve their goals. Now is the time for charities to invest in digital financial technology to empower staff and volunteers to spend, reduce fraud, gain real time spend visibility and reduce administrative burdens.

Empowering staff and volunteers

The running of charities necessitates staff and volunteers making hundreds, if not thousands, of expense payments a year. The status quo is for individuals to pay upfront and be reimbursed at a later date. In addition to this being a burden to staff and volunteers alike, it is not always possible for them to make necessary payments if they do not have the required funds available.

For smaller value payments, charities often utilise petty cash, a small amount of discretionary funds in the form of cash used for expenditure. However, petty cash cannot be used to make larger payments and with charities often not working out of one centralised location it is often impossible for staff and volunteers to access funds. Neither reimbursement nor petty cash allow for the payment of high value items in emergency situations, commonly adding to stress in urgent situations.

By utilising a financial technology solution which incorporates prepaid debit cards, charities can provide staff and volunteers with debit cards onto which they can transfer funds. Funds can commonly be transferred manually or automatically using pre-set rules. This empowers staff and volunteers to make required payments without the burden required for reimbursements. Moreover, it allows for larger funds to be transferred instantly in the case of emergencies.

Prepaid cards can be issued for each individual and/or use case and can be locked and unlocked as required. This can prove very useful when charities have a high level of volunteer churn. Cards can be passed from one volunteer to another or funds can be removed and cards can be blocked of those volunteers who have left.

Control and fraud reduction

Common practices of reimbursement and petty cash mean charities are unable to control staff and volunteer spend. This commonly results in overspending and fraud.

By utilising financial technology, charities are able to set bespoke budgets and spending rules, removing the risk of overspend and volunteers alike. The ability to set budgets in addition to reducing overspending can help charities to remain within pre-budgeted spend. The ability to set spending rules for example, maximum daily spend, location and expense category based restrictions, enables charities to control spend.

The Third Sector publication noted two of the top five common types of charity fraud as: the misuse of charity money in the form of “pocketing cash to misusing charity credit cards”; and false expenses by “claiming over-inflated, non-existent or inappropriate expenses or overtime”.

The Charity Commission earlier in the year published a report suggesting that most charity fraud cases are enabled by the organisation having a lack of appropriate controls. In analysing a sample of 20 charity fraud cases it found that in 19 of these an absence of appropriate controls was the primary enabling factor.

Financial technology firms, by allowing budgets and spending rules to be set, allow charities far greater security and hugely reduce the likelihood of fraud occurring.

Monitoring cash flow

With multiple individuals making payments on charities’ behalf and multiple payment methods, it is nearly impossible for management to have real time visibility on spend across the organisation. It often takes months for claims to be submitted and invoices to be settled.

The inability to have real time visibility on spend makes managing charity money extremely challenging. This challenge is exacerbated with incoming funds being uncertain and volatile. The combination makes budgeting and the optimisation of spend difficult to say the least.

Financial technology allows for charities to gain real time visibility on charity-wide spend. Making is possible for charities to track budgeted vs actual spend, react to spend agilely and forecast spend with increased accuracy.   

Reducing administration

Current practices of reimbursement and petty cash mean charities spend endless time asking staff and volunteers to fill out expense reports and chasing them for receipts which have often been lost. Manual reconciliation is a time consuming and unproductive administrative burden.

Moreover, if there is a suspicion of fraud or any illegitimate transactions, charities must temporarily cease operations and manually verify the recipients of proceeds, which is a time-consuming and often problematic process. In fact, a late 2017 survey by RSM that included over 100 charity participants found that 40% were spending over 30% of their administrative spend on manual transactional processing rather than “strategic investment in the team”.

The latest expense management solutions include in-app receipt capture and the ability to add notes and tags to transactions in real time. Meaning there is no need to retain receipts of fill out expense reports. Expense reports are automatically prepared and can be downloaded in a couple of clicks, saving staff and volunteers a considerable amount of time and allowing them more time to get on with delivering their charitable work.

Soldo’s Luca Scagliarini – the inability to have real time visibility on spend makes managing charity money extremely challenging.
"By using a financial technology solution which incorporates prepaid debit cards, charities can provide staff and volunteers with debit cards onto which they can transfer funds."
Deloitte advert

Judging how much cash a charity should hold

Charities may have a range of sources of income, including investments in a portfolio, income from property, a government grant, and donations and legacies. Accumulated cash – which represents unspent past income – can be used to fund future expenditure – for example a major project or to permit services to continue when current income falls short of requirements.

But the question of how much cash to hold may not be as simple as it at first appears. Getting the answer right depends on good governance, a solid understanding of risk – and an awareness of the charity’s legal obligations.

Charity trustees have a legal duty to act in the charity’s best interests, manage the charity’s resources responsibly, and act with reasonable care and skill. According to the Charity Commission, trustees who act in breach of their legal duties can be held responsible for consequences that flow from such a breach and for any loss the charity incurs as a result. The Commission has the power to disqualify individuals from trusteeship if they feel this is warranted.

Taking stock of charities

To work out how much cash to hold, it is necessary to consider the charity’s operating expenses, any investment portfolio (particularly if it contains cash separately to that held as working capital), sources of income and the extent of future obligations. The right level of cash will depend on how the charity funds its activities. 

For example, a charity which receives rental payments from the properties it owns (houses, buildings, land, etc.) will receive a regular income and therefore may not need to hold a great deal of cash in reserve; conversely, a charity which is funded by donations may have sporadic and unpredictable income and would be expected to hold higher cash reserves. Similarly, a charity which is undertaking a capital project (for example, refurbishing a building used by its beneficiaries) would also need an extra cash allocation to the project.

Figures provided by the Charity Finance Charity 250 Index suggest that charities which have strong governance (including appropriate cash allocation) can expect strong results. In the most recent numbers available, which cover the year to 30 June 2016, the index reported that over a third of its members experienced double-digit income rises. The largest rise was recorded by Horder Healthcare, with income up by 19% to £29.9 million over the same period.

The Commission's expectations

The Charity Commission expects trustees to implement and monitor a reserves policy; trustees are also expected to explain the policy and compliance with the policy on an annual basis. Reserves are defined by the Commission as "unrestricted funds that are freely available to spend on any of the charity’s purposes" (generally referred to as “free reserves”). These differ from "restricted reserves" such as endowments. In general, free reserves would be expected to be largely represented by cash or near cash (such as low risk listed investments which could be readily converted to cash).

Some charities may receive "lumpy" or unpredictable income, such as legacies arising from a death or an annual grant. Trustees should take this into consideration and remember that a charity’s expenses will typically be regular, so maintaining sufficient cash in reserve to meet periods of reduced income is paramount, especially if the charity is providing life-affecting services.

“Deciding the level of reserves that a charity needs to hold is an important part of financial management and forward financial planning,” notes the Commission in its Charity reserves: building resilience document published in January 2016. “Failure to do this may result in reserves levels which are either higher than necessary, limiting the potential benefits a charity can provide; or too low, increasing the risk to the charity’s ability to carry on its activities in future in the event of financial difficulties, and increasing the risks of unplanned and unmanaged closure and insolvency.”

Be mindful of risks

Although some of the top charities have reported rising incomes in recent years, charity incomes as a whole are dropping, particularly for smaller charities. According to the Small Charity Index, statutory income (i.e. government grants) has dropped nationally by 8% over three years. Some charities are using their reserves, or borrowing money, to invest elsewhere to gain an income.

Where a charity lacks the free reserves it thinks it needs (including cash allocation), the Commission warns that the charity is exposed to greater risk. The Commission expects trustees to be actively addressing this, by implementing a reserves policy, raising the necessary funds, diversifying its funding base and mitigating the risks that might arise if the charity has to close suddenly.

The Commission also warns that in the case of an investigation against a charity, the Commission may take into account evidence that trustees have exposed the charity, its assets or its beneficiaries to harm or undue risk by not following good practice. Insufficient cash over a prolonged period of time can be one of the most significant factors in coming to this conclusion.

The example of Broken Rainbow, a defunct charity which provided support to the LGBT community, provides an illustration of the risks of poor governance. Investigations into the charity’s finances after its insolvency revealed that Broken Rainbow’s trustees had spent virtually all its income (from grants) within three days of receiving them. The money was being used to fund past expenses, leaving little or nothing to fund present or future needs. In the two-year period leading up to its closure, the charity had less than £500 in its bank account on an average day.

Charity trustees should also be aware that because interest rates are currently lower than inflation, holding large quantities of cash for the medium to long term could cost the charity a significant amount of money. Alternatives options should be considered – which might include investing the cash in a portfolio.

Charities in the spotlight

Charities are facing increasing scrutiny from the Commission, which is gaining greater influence. Under the Charities (Protection and Social Investment) Act 2016, the Commission gained the power to issue official warnings, which supplements its existing powers to carry out statutory investigations in the public interest.

The Commission issued its first official warning on 3 July 2017. The warning was given to the National Hereditary Breast Cancer Helpline (NHBCH) after the charity found itself in financial difficulty and failed to comply with the regulator’s action plan. According to the Commission, “[the] charity and its assets had been exposed to undue risk through a lack of appropriate financial controls and its financial model was unsustainable”.

These two cases illustrate the importance of maintaining sufficient cash to cover both working capital needs, and any unforeseen expenses. A charity which runs down the amount of cash it holds in reserve risks opening itself up to financial difficulties and regulatory scrutiny. The NHBCH incident was also significant because it confirms that the Commission is now selecting and checking charities in England and Wales to ensure they operate according to best practice and the Commission’s own guidelines.

Too high allocation

Conversely, a charity’s cash allocation may appear to be too high. If this is the case, donors, beneficiaries or the Commission may raise questions about the way the charity is being managed. Typically this can happen for two reasons: either the trustees have not sufficiently explained why they are keeping reserves, or because they are having difficulty in using their funds. The Commission states that:

“A charity with excess reserves or unspent funds should consider whether they could be effectively spent on the charity’s purposes. If a charity has more resources than it needs to fulfil all of its purposes then the trustees must consider whether the purposes of the charity should be amended to enable the charity to operate more effectively.”

Adding to the pressure on charities to comply with best practice, from May 2018 charities with “extremely aggressive” fundraising practices could be fined up to £25,000 if they do not crack down on nuisance calls, emails or letters. This regulatory change comes into effect under the EU’s General Data Protection Regulation, which is due to replace the existing Data Protection Act.

Although the UK is currently in the process of leaving the EU, the Great Repeal Act includes the same provisions as the new regulation, so it is still likely to become UK law. Charities within the scope of the new rules must comply with new data protection legislation and provide marketing opt-outs.

New project funding

Given the pressure on charity funding and the increasingly prescriptive regulatory environment, charity trustees should ensure that adequate funding will be available for any new project - quite often, this will require that they raise the necessary funds prior to commencing the project. Available assets, including cash, should be held securely with reputable organisations and risk should be given serious consideration.

Some years ago, Icelandic banks offered customers attractive interest on any savings held in an account; but their collapse in the autumn of 2008 caused considerable disruption and loss for depositors.

Charities come in a range of shapes and sizes and they operate in very different ways. The amount of their future commitments, both to beneficiaries and for overheads - such as staff salaries, rent and other fixed costs, should be reflected in the amount of cash they hold.

Strong governance and regular oversight should also be employed to ensure that a charity correctly uses any lump sums it receives, and plans effectively for its future needs. As the Charity Commission notes, a reserves policy will “give confidence to funders by demonstrating good stewardship and active financial management".

Serving the best interests

Ultimately, good governance and oversight are a key part of ensuring that a charity serves the best interests of its intended beneficiaries. Whether holding a large amount of cash or a little, the first step should be to consider whether that sum is appropriate to its needs. If not, trustees should take further action to redress the balance, either by moving any surplus cash to where it can generate the most benefit, or by taking steps to ensure that sufficient cash is gathered to safeguard the charity’s operations for the foreseeable future; for example, by cutting costs or fundraising.

Smith & Williamson's Adrian Wild - the Charity Commission expects trustees to implement and monitor a reserves policy; trustees are also expected to explain the policy and compliance with the policy on an annual basis.
"A charity which runs down the amount of cash it holds in reserve risks opening itself up to financial difficulties and regulatory scrutiny."
"Strong governance and regular oversight employed to ensure that a charity correctly uses any lump sums it receives..."
Deloitte advert

Understanding VAT and charities

Do charities pay VAT? This is a common question, and the answer is “yes”…but it’s not simple. Mistakes are easily made, so it is useful to have a broad awareness of the rules so you can identify situations or transactions that might need further consideration or professional advice.

There is no automatic, blanket VAT relief for charity purchases. Yes, there are certain specific, targeted VAT reliefs that apply to certain supplies to charities, but nothing that allows all purchases to be VAT-free. There is also the need for specific declarations/certification to be issued by a charity in order to benefit from the VAT reliefs that are available.

VAT registration rules

The same VAT registration rules apply to charities that apply to any business. They must register for VAT if their taxable supplies exceed the VAT registration threshold (currently £83,000).

Some charity income is outside the scope of VAT, such as grants and donations, and monies obtained from the supply of education or welfare services. Other income, such as that from trading activities, would be subject to standard rate, reduced rate or zero rate VAT. So even deciding if you have to register is complex.

In some cases, a charity may wish to register for VAT voluntarily, as it can recover VAT paid on its costs and could expect a net VAT reclaim from HMRC. As long as the taxable supplies made are only to customers able to recover their input VAT in full, then the need to charge VAT will not add to customers’ costs.

Another situation where VAT registration may be beneficial is if the charity makes taxable sales that are subsidised, and will be able to recover more VAT as input tax than the output VAT it needs to charge.

Trading activities are often channelled through a trading subsidy. This can mean that both a charity and its trading subsidiary are required to be registered for VAT. Sometimes a VAT group registration might be a better option.

VAT grouping is not something to be rushed into, but it does allow supplies between a charity and its subsidiaries to be disregarded for VAT purposes. Also, when there are significant taxable supplies made through a subsidiary, grouping can boost the total VAT recovery rate for the group’s overheads.

Is a charity in business?

"Business" is an important concept in VAT as it determines if VAT must be charged and if it can be recovered. The normal approach taken by the courts is to look objectively at what a charity does. If it is providing goods or services in return for a consideration (usually, but not necessarily, money) then it is seen as being in business.

If an activity is wholly funded by income that is outside the scope of VAT such as grants or donations it will be a non business activity. VAT is not charged - but neither can VAT be recovered on the costs incurred.

Subsidised activities, where an activity is partly funded by grants and partly by taxable charges or fees, do give entitlement to VAT recovery, but HMRC will sometimes seek to apportion the input VAT recovery. Sometimes, even though an activity is subsidised, it can still be deemed to be a wholly business activity.

VAT and grants and contracts

As can be seen, many scenarios are hybrids and fall between the two extremes of wholly business or wholly non business.

It is often the case that certain arrangements are not correctly described. Just because funding is called a “grant”, if it is actually a payment for something specifically supplied in return, it is not a grant for VAT purposes. Whatever the intention, the facts are also critical.

Another incorrect description is “minimum donation”. If it is a donation, it is freely given, voluntarily. If there is a compulsory minimum required, it is a charge or fee!

A subsidised service where charges are made to customers is still a business activity for VAT purposes. Some HMRC officers try and demand a VAT restriction when they come across any outside the scope income, but this is wrong and should be challenged.

Difficulties can also occur with sponsorship income if the donor insists on recognition. Here it is often arguable whether VAT is chargeable. HMRC will generally not see a dedicated grant making organisation (such as national lottery funding) as receiving a supply, but might well take a different view if the funder is a commercial organisation which benefits from the publicity.

Charity VAT recovery

Charities can rarely recover all of the VAT they incur, but the calculation of recoverable input tax is not an exact science.

The first hurdle to calculating input tax recovery is to ensure that the accounting system is able to identify the VAT incurred, and to allocate the VAT in accordance with whether it can be fully recovered or whether it needs to be subject to a restriction for non business use and/or partial exemption.

If the posting of the VAT incurred is wrong, then the whole calculation of recoverable VAT will be undermined – it’s a case of GIGO – garbage in, garbage out!

Do remember that there is no set method for non business apportionment, but it does have to be fair and reasonable. However, HMRC do like there to be some logic involved and will want to be able to verify the figures. For example, they are unlikely to accept a time based apportionment (staff time).

While an income based method may be an easy, one-step calculation from easily identifiable figures, it might not give a fair or favourable result. It can be hugely distorted by large, one-off transactions such as legacies. HMRC will often agree that such transactions can be excluded from an income based, non business apportionment, but it is best to get this confirmed in writing by HMRC.

VAT reliefs for income

There are too many to list all possible VAT reliefs here. If you want the whole picture or have specific issues, then the HMRC website is a good place to start. I will highlight some pitfalls though!

Charity fundraising events

There is a VAT exemption for charity fundraising events. This allows all supplies made at an event to be treated as VAT exempt, unless they are zero rated (such as programmes).

The exemption can be applied to up to 15 events of the same type, in the same place each year – but if there is a 16th event, the exemption will not apply to any of them!

This exemption is available to charities whether they are registered for VAT or not but beware, the events must be fundraisers, not social occasions.

Sale of donated goods

Charities can sell goods donated to them at the zero rate. However, charity shops are increasingly also selling new goods and moving onto a retail Gift Aid scheme.

The zero rate does not apply to the retail Gift Aid scheme, as in this case the charity is receiving a monetary donation from the donor, on whose behalf the goods have been sold, rather than actually selling donated goods. The retail Gift Aid scheme produces a very different VAT treatment for what was traditionally a charity shop selling only donated goods.

Premises and VAT

Some charity construction work can be purchased free of VAT – usually a new build or self contained annex. The rules here require that the building be used solely for a charitable non business purpose. This is a much stricter interpretation than merely a charitable purpose. In practice, HMRC may allow up to 5% business use.

Similar to the relief for certain construction services, a charity buying or renting premises intended for use for a charitable non business purpose can confirm this to the vendor/landlord and the option to tax will be disapplied. This means that no VAT will be charged on the supply. This option does not apply to retail premises.

Working together and mergers

As charities take on more diverse activities, with both central and local government contracting out services, there are big risks if VAT aspects are not considered correctly. I have seen a charity which sub-contracted to a commercial provider and so incurred an additional 20% VAT cost making the whole project uneconomic.

The merger of two or more charities can also trigger VAT problems. Is there a transfer of a business as a going concern? Are there any options to tax or capital goods scheme items taken on? Are there assets that may cause a VAT cost due to change of use?

From outside the UK

Don’t forget that if a charity receives supplies or services from suppliers based outside the UK, it has to account for the VAT that would have applied within the UK. 20% VAT must be declared as both output tax and input tax, and it may not be fully recoverable. Also, the value of reverse charge services received from abroad can trigger a requirement to be registered as their value counts towards taxable turnover.

As I said…it’s complicated!

Knill James' Alison Sampson - some charity income is outside the scope of VAT, such as grants and donations, and monies obtained from the supply of education or welfare services.
"A subsidised service where charges are made to customers is still a business activity for VAT purposes."
"Charities can rarely recover all the VAT they incur, but the calculation of recoverable input tax is not an exact science."
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The right financial information for the right trustees

Getting the right financial information to the right people (and one could add: at the right time) is fundamental to the smooth running of a charity. So how is this best done? To answer that question, we can start by ascertaining who “the right people” are. And this will depend very much how your charity is structured. But understanding the organisation and its structure may not be that straightforward with some types of charity.

To step back for a moment, there are various models used in charities. These will include:

  • Just a board of trustees, where all trustees have a similar level of interest in the charity’s finances. In this case the trustees will have a shared responsibility for finance.
  • Board of trustees, where one trustee is very interested in the figures and the others look to him or her for leadership on the issue. It is essential to understand that the other trustees cannot actually delegate their responsibility to this lead trustee as such, but there is a recognition that this one particular person is more knowledgeable than the others.
  • A finance and/or audit committee with terms of reference, reporting through to the whole board. Within this structure there may also be one person who is very knowledgeable and interested in the finances, so the other committee members will look to him or her for leadership.

In the circumstances where there are just one or two interested people to whom the others look for a lead, the detailed financial information could just go to them.

Understanding trustees' ability

In deciding who the right people are and how to present the information to them, you need to understand their ability. For example, are they accountants, or do they have a particular skill with financial information? Are they still active, or are they retired with out of date knowledge? Are they business people or directors with a working financial knowledge? Knowing your “client” or trustee in this instance will serve you well in determining the appropriate level of financial communication.

Having said this, it is valuable to recognise that non-financial people will still require at least an overview of the charity’s finances, in order that they too can make informed decisions.

There are other factors to consider also, such as the size and complexity of the organisation, and the number of key income streams. With income, most charities normally only have one main revenue stream (even if they would like more), so income reporting can be quite straightforward.

A charity’s objectives also need to be taken into account, as there may be three or four key types of charitable expenditure - so summarising these is a constructive exercise.

Reliable information

Financial information has to be reliable, which means it must be up to date, be sourced from relevant and authentic accounts, and has been properly prepared by financially competent people.

In most cases, trustees will need this information so that they can be fully aware of the charity’s financial position, and make informed and sometimes quick decisions. Trustees want to be able to trust the information they are given and not be questioning its reliability. If the information is not reliable, it will have to be improved as a matter of urgency, as misleading data can result in poor decision making, and may even be masking potential internal fraud.

Information to be provided to trustees should go through a review process before being passed to them. Notes should also be added to the information to clarify any salient issues and to explain any key unknowns or uncertainties, and to highlight where any assumptions have been made.

In reviewing the reliability of financial information, you need to understand the abilities of your finance team and how much you can trust what they produce. You need to be clear on what basis the schedules have been produced: have they been prepared using accruals accounting, or are they on a cash basis? You also need to be sure that the charity’s bank accounts and other control accounts reconcile and that there is a system in place to check that they actually do.

Ultimately, in checking the reliability of financial information there is an acid test you can use once a year: would a trustee be able to reconcile the final management information from the last financial year to the audited financial statements?

Relevant information

Trustees need and want pertinent information that gives them a clear overview of how their charity is performing, rather than being swamped with too much data. If they have an overview and they understand it, strategic decisions can be properly made.

In this regard, you need to ask the trustees what they think of the financial information they currently receive. You can also ascertain what additional data they would like to see as well as what pages, schedules and documents they use most, and whether they would prefer the information in a different format.

Some trustees may not fully understand key schedules, so further explanations may be required where necessary. Consider also changing the format of schedules to make key points clearer. Many of the trustees that I deal with are happy to say that they don’t understand a certain document when asked; this is easy to remedy.

Sometimes information is produced because it has always has been done that way, but this does not mean it cannot be challenged or improved. I had one client that always produced a lengthy cash flow statement, because eight or nine years ago they had had major cash flow problems. On reflection, when we reviewed the information being presented to the board, it was revealed that as there had not been any cash flow issues for over five years, so the collection of cash flow spreadsheets were being ignored by the board members!

The quantity of information should be kept under review. One sees a range of report sizes, from just a single page summary, right up to full bound booklets. You need to consider the number of pages being made available, the time available for the recipients to read them, the level of detail on each page, and whether a one-page dashboard summary would also be useful.

You should also consider including key performance indicators (KPIs) in the financial information, if the charity has them. If there are no KPIs, are there other ways for the trustees to gauge how they are performing? Any KPIs that do exist, even if they are not financial, should appear in the information given to trustees.

Relevant schedules

There is no one-size-fits-all prescription for the amount of information to be given to trustees, as every charity is unique. Having said that, you may wish to include in the trustee pack, where relevant, the following: an income and expenditure summary (which could include several supporting pages if there are several income streams and include comparisons to the budget), a balance sheet, a cash flow statement, and a schedule of performance against KPIs.

You may also wish to include some narrative to explain key variances from expectations or from last year’s figures. If a charity has significant restricted funds, these should be separately identified and you should ensure that the trustees can understand how these funds are being used.

Frequency of information

Financial information should be provided on a regular basis, such as monthly or quarterly. If you have quarterly trustee meetings, some “flash” summary figures in the intervening months will often be useful. And on the subject of meetings, you should make sure that information is provided in advance of these events (usually a week beforehand) so that trustees have time to consider the figures before they meet.

Trading subsidiaries

Where the charity has a trading subsidiary, you will need to consider how you report the results of this, particularly where the numbers going through it are significant.

A trading subsidiary will often have a separate board from the trustees, and with its own separate meetings. In this case, you will need to consider all of the above points relating to charities as they will apply to this separate legal entity, with different people in charge.

A close eye

Charities need to keep a close eye on their financial position to help them remain viable. Where there is uncertainty over any factors affecting the charity’s income, aims and obligations, a measure of clarity over cash flows as well as the profitability of any trading subsidiaries will be important.

Where information is not available to trustees through accurate and up to date accounts, decisions will either be made under a greater degree of risk or will have to be delayed. Only once the relevant and reliable information is to hand can the financial implications of any decisions on such matters as major expenditure, investments and recruitment be fully understood.

Being able to anticipate any short term cash flow shortages allows trustees to take early action, whilst projected cash flow surpluses will assist in deciding when to action new investment, expenditure and recruitment plans.

Having real-time financial data to hand, backed up with cogent narrative, gives charity trustees the best chance of securing success for their organisation. Trustees must remain in control of a charity’s financial position, and the best way for them to do this is through regular access to the right information.

Bishop Fleming's Joe Scaife - where there is uncertainty over any factors affecting the charity's income, aims and obligations, a measure of clarity over cash flows as well as the profitability of any trading subsidiaries will be important.
"In deciding who the right people are and how to present the information to them, you need to understand their ability."
"Information to be provided to trustees should go through a review process before being passed to them."
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