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Deeds of Covenant (incl. Fiscal Year)

 

How to persuade the taxman to make a donation to your favourite charity

 

Deeds of Covenant Including Fiscal Year Covenants Explained

 

by Alastair McIntosh

 

 

Published in The Guardian, Manchester, 25 June 1983, p. 20. Alastair McIntosh holds a financial MBA from the University of Edinburgh and is a specialist in charity management. [This article is included on the web mainly as a matter of accounting history, as Gift Aid has since largely replaced the functions discussed here.]

 

 

 

 

 

It is now two years since the Government introduced Important changes to encourage covenanting to charity. The minimum dura­tion of a covenant was reduced from seven years to four, and special incentives were introduced for those paying ‘income tax at a rate higher than the basic 30 per cent.

 

The covenant Income of some charities has blossomed as a result. Dr Barnados have reported a rapid rate of growth in funds from this source, while Christian Aid have spoken of a covenant “explosion.”

Others have reported little change, but one point on which all would agree is that they could do much better if some of the myths and fears surrounding the deed of covenant were dispelled. Further benefits would arise. For instance, if more donors knew of the advantages of ,discretionary and deposit covenants,

 

A covenant to charity is essentially a written agree­ment to donate a fixed sum of money over a period of at least four years. Provided that throughout this time either you, or your spouse, pays income tax, the Inland Revenue will add to your gift. They will refund, to the charity, all the basic rate tax you paid on the money being donated.

 

This increases the value of the donation by approxi­mately 43 per cent. “But why 43 per cent when I only pay tax at 30 per cent?” asks many a bewildered donor.

 

The reason becomes clear if one considers the following example. Out of £100 earned by a basic rate taxpayer, the Inland Revenue will take £30, leaving £70 net income. If this £70 is covenanted to charity, the Revenue will also “donate” the £30 it took, and whereas this represented Just 30 per cent of £100, it is, of course, 43 per cent of £70. The apparent paradox is simply the result of working out the percentage from a smaller base figure.

 

The tax-man is even more magnanimous if you happen to pay tax, inclusive of any investment income surcharge, in a bracket higher than the 30 per cent basic rate. Pro­vided you declare co­venanted giving when filling in your annual tax return form, the difference between basic rate taxation and your

higher rate will be refunded to you personally. This mea­sure was introduced in the hope that it would encourage increased giving.

 

A nunber of brooding fears can make people appre­hensive about covenanting. For example, are covenant forms couched in legal jargon so obscure that you need professional help to fill them in?

 

A few charities have some­what antiquated forms, but most now realise that it is perfectly acceptable to work their deeds of covenant in plain English.

 

A recent Oxfam covenant form, for instance, bears little more than the simple words, “I ... undertake to pay Oxfam each year for four years (or during my lifetime if shorter) from today the sum that will, after deduction of income tax at the basic rate £...”

 

Most charities attach banker’s orders to their covenant forms. It cuts down on administrative work if donors make use of them. Payment may be made annually, or in quarterly or monthly installments if pre­ferred.

 

Another reason why people are sometimes apprehensive about covenanting is the fear that their income might drop. What happens if, as a result of unemployment or illness some other calamity you just cannot fulfill your agreement to pay up over the necessary number of years?

 

Some charities make provi­sion for let-out clauses to be written into the deed to allow for such contingencies, but most of them consider this precaution to be unnecessary. They will usually agree to a covenant being ter­minated if a donor has fallen on hard times.

 

Conversely, if one’s finan­cial fortunes happen to swing the other way, it is simple to covenant more to the same charity. To alter an existing deed of covenant is complicated since it has to be extended for a further four years minimum.  The easiest way is therefore to substitute the old covenant with a new, higher one.

 

If you have any queries about this, the charity you intend to favour will no doubt bend over backwards to advise.

 

Taxpayers inhibited by the necessity to commit them­selves to the same charity for a minimum of four years need not be deterred. They can give by means of a so-called discretionary covenant. A number of charities which specialise in helping other charities run these discre­tionary covenant services:

the Liverpool Council of Social Service was a pioneer in this respect. It is very

much a growth area, as evi­denced by the recent setting up of Charitable Giving Scotland. But perhaps the best-known scheme is that run by the Charities Aid Foundation (CAF). There are slight differences between one scheme and another, so it can pay to shop around.

 

Another underemployed way of giving is through a deposit or loan covenant. This is a method of covenant­ing a one-off lump sum. Some extra administrative work is entailed for the charity, but deposit covenants are worth the effort for gifts of £50 or more. The procedure is that you deposit, say, £100 with the charity as a “loan.” You also sign a letter autho­rising the treasurer to draw on this loan for the four annual payments under the covenant which is signed at the same time for, in this case, £25. The outcome is that the charity has immediate use of the total value of the gift. In addition, it can make four annual tax claims which increase the value of the ori­ginal gift by 43 per cent and at no extra cost to the donor.

 

A further point has just recently been clarified with the Inland Revenue. It can reduce, to less than three years, the time taken to recover tax. If the deed is worded, for example, “I undertake to pay to ... in each of the years ended April

5, 1984 to 1987 inclusive the sum that …” the charity can make the first transfer from the loan account on receipt of the deposit and the remaining three at the begin­ning of each tax year.

 

Precisely how long full tax recovery takes with a covenant expressed in this way depends on how close to the end of the tax year the deed is dated. For exam­ple, if the date is April 5, the charity can immediately claim on income tax paid during the one financial year, and the following day, put in a claim for the second year. The third claim goes in a year later, and the fourth, just two years and a day after the covenant was signed.

 

 

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