If you are a higher rate (or additional rate) tax payer, you can reduce your tax liabilities by donating money to a charity. The Gift Aid scheme is used to claim back the ‘extra’ tax you have paid. Gift Aid is beneficial to both you and the charity you are giving your money to. This article aims to describe and gives an example of how Gift Aid works.
What is Gift Aid?
Gift Aid is a way for charities to increase the value of monetary gifts from UK taxpayers. They do this by claiming back the basic rate tax paid by the donor(individual taxpayer) on the donation. The Gift Aid scheme can increase the value of donations by a quarter at no extra cost to the donor. Using this method, Gift Aid is able to raise enormous sums of money for charities.
As well as charities benefitting from Gift Aid, individual donors also benefit if they are chargeable to higher or additional rate of tax. The donors are able to claim relief equal to the difference between the higher rate of tax at 40% (or the additional rate of 45%) and the basic rate of tax at 20% on the total value of the donation. This means claiming relief of 20% for higher rate tax payers and 25% for additional rate tax payers.
Benefit to the Taxpayer:
David is an additional rate UK taxpayer and decides to make a donation of £1000 to a charity. He lets the charity know that he is a UK taxpayer and agrees to the payment being included in the gift aid scheme.
When it comes time to making his self assessment, David includes this £1000 donation he has made during the year. The effect of this is that the upper limit of the basic rate band is extended by £1000.
So if the basic rate is 20% and the additional rate is 45%, Davids basic rate band extends by £1000 which means that he pays a little less tax on the top slice of his income. He saves tax of £1000 x 25% = £250. (25% because 45% – 20% = 25%)
Benefit to the Charity:
When £1000 is paid to the charity, the donation of £1000 is grossed up to take into effect the net basic rate of tax suffered by David. Putting it simply, to pay £1000 after tax, David has had to earn £1250.
So the £1000 the charity has received in net off Davids Tax and is actually worth £1250 (£1000 x 100/80), gross. As the charity has a tax exemption, and its ‘grossed up’ donation is £1250, it claims tax repayment of £250 (20% of 1250) from the government.
As you can see from the above, giving donations via the Gift Aid scheme is attractive because of the win/win feel.