The Government has published draft legislation designed to impose stricter requirements on charities and donors claiming charity tax reliefs, as part of its Legislation Day output on Monday 21 July 2025.

For more information on Legislation Day and other related private client developments, read our summary note. 

In line with its commitment to “close the tax gap” (being the gap between tax owed and tax paid), the Government announced at the Autumn Budget 2024 a series of small but significant tweaks to the anti-avoidance provisions in the legislation on charitable investments and donations. The Government also publicised its intention to introduce changes, via guidance, to impose stricter sanctions on charities who persistently fail to meet tax obligations.

These put into place the results of the previous Government’s consultation in 2023 and so are not one of the current Government’s leading commitments on tax. Nonetheless, at a time when tax revenues are under more pressure than ever following the rollback of the Government’s proposed welfare reforms, HMRC has inevitably pressed ahead with legislating for the (relevant) changes, which are due to come into force in April 2026. 

The changes primarily target tax avoidance by charities and donors and so, for the majority, should have little practical effect. Nonetheless, all charities should be aware of the changes to ensure that their records and reporting align with the new rules. 

The Government’s policy paper on the changes states that they will affect all UK charities, but to date only the draft income tax legislation, which applies to charitable trusts, has been published. The explanatory notes to the draft Finance Bill state that further legislation will be required to amend the corporation tax legislation, which applies to charitable companies. It is assumed the two regimes will be identical, as all charities generally receive the same UK tax treatment whatever their legal form. 

More objective (and wider) test for tainted donations

The tainted donations regime is designed to prevent donors from claiming income and capital gains tax relief where they make a gift to a charity from which they or a linked person in turn derive a financial benefit. 

The current test determines whether a donation is tainted based on the donor’s motivation. This is therefore a highly subjective test, which makes it difficult to enforce. 

The draft legislation proposes to widen the scope of the test in two ways.

1. Whether a donation is tainted will depend on both the donor’s motivation and the result of the arrangements. The second limb of the test is objective, which will increase the scope for HMRC to argue that a donation is tainted where evidence that it was tax motivated is lacking or ambiguous. 
2. A donation will be tainted where the donor derives “financial assistance” rather than a “financial advantage”. The term “assistance” is defined widely and can come directly or indirectly from the charity. It includes (but is not limited to) a loan, guarantee, indemnity or any form of investment – even where it is on arm’s length terms.

The Government’s position is that this change should not affect genuine charitable donations, and it is true that most charitable donations will not be caught. 

However, donors and charities should both ensure they keep detailed records of any gifts and related financial consequences. For non-cash gifts, specialist advice should be taken to ensure any risk that the tainted donations regime will apply is fully explored. 

Extension of the charitable benefit requirement to all categories of charitable investments

It might be thought that charities are generally exempt from tax on investment returns, irrespective of the type of investment. However, in order to enjoy tax free returns charities may invest only in approved charitable investments. Otherwise, the investment is deemed to be “non-qualifying expenditure”, and the charity loses its tax relief on the amount of the investment. 

This rule does not tend to cause practical issues for most charities because the categories of charitable investment expressly approved include most common types of investment for charities with reasonably standard investment portfolios.

There is also a broad “catch all” category of charitable investments. Charities may make investments not specifically included in the other 11 categories, provided that these are (i) for the benefit of the charity; and (ii) not motivated by tax avoidance (regardless of whether the tax benefit would accrue to the charity or to another person) – referred to as “Type 12” investments. 

The Government is now proposing to apply a similar requirement to all charitable investments (not just Type 12 investments). For any investment to be “approved” it must be “made for an allowable purpose” which will be the case if “it is reasonable to draw the conclusion, from all the circumstances of the case, that the investment is made for the sole purpose of benefitting the charitable trust”. The specific requirement that the investment must not be motivated by tax avoidance has been removed; but it is assumed that if a charity makes an investment with a tax avoidance purpose this will not be made for the sole purpose of benefitting the charity. 

The policy paper summarising the measure notes that this will simplify the rules on charitable investments, as the same restrictions will now apply to all 12 categories. While that is true, this change may subject charities to increased scrutiny, particularly where investments are made which are not found in a “structured” portfolio. 

Charity trustees should take care to record the rationale behind any investment decisions carefully in the minutes of the relevant trustee meeting, and to ensure their investment policy records how each category of investment benefits the charity. 

Potential for further reduced income tax relief for charities with non-charitable expenditure 

Charity expenditure is split into two categories for UK tax purposes: charitable and non-charitable. Charitable expenditure relates to charitable purposes. It includes making grants, running the charity’s operations or paying professional fees for advice to the charity. Non-charitable expenditure is, broadly, anything else. 

Where a charity has non-charitable expenditure, it cannot claim tax relief in respect of an equivalent amount of its otherwise tax-exempt income and gains (known as “attributable income and gains”). Attributable income and gains include Gift Aid and payroll donations, rental income, profits from primary purpose trading, interest and capital gains (for example, on investments). So, if the charity spends £1,000 on non-charitable purposes, it will lose tax relief on £1,000 of its attributable income and gains. 

From April 2026, attributable income and gains will also include legacies. The effect of this is that the pool of charity funds available to match against its non-charitable expenditure will be larger, and so there will be scope for tax relief to be further restricted where charities have non-charitable expenditure. 

While the policy objective behind the change is clear, it does not align naturally with the UK tax code. It is not necessarily logical for inheritance tax relief (where the tax burden would otherwise fall on the deceased’s estate) to be equated with charitable income tax relief (where the tax would otherwise be payable by the charity). 

Practically, however, the changes to the definition of attributable income and gains may not make much difference to charities’ tax position unless their non-charitable expenditure already exceeds their attributable income – which for most charities is not the case. 

Sanctions for failure to meet tax obligations

As part of the 2023 consultation, HMRC proposed to introduce greater sanctions for charities who persistently fail to comply with tax obligations, such as filing their annual return, but who still benefit from tax reliefs, for example, Gift Aid. In their Autumn Budget 2024 announcement, the Government indicated that this would be addressed via changes to the “fit and proper persons” test, meaning that a manager of a charity who persistently fails to comply with the charity’s tax obligations, such as the “timely filing of returns”, will fail the "management condition". This may ultimately result in the withdrawal of tax reliefs. There is no definition in the legislation of a “fit and proper person” and HMRC’s approach to assessing this is instead set out in detailed guidance. 

In the Legislation Day announcements, the Government confirmed that “HMRC are working on changes to guidance that improve the powers of HMRC to compel compliance through sanctioning trustees and managers”, with draft guidance to be published “later”. It therefore remains to be seen what exactly the draft guidance will look like and when exactly it will be implemented; however, if the expected changes are made, these are likely to act as a very big “stick” to some charities.

Concluding remarks

Overall, these upcoming changes to the charity tax landscape are expected to affect the minority but should be a reminder to all charities of the importance of careful record-keeping and compliance with (other) obligations.