9: Approved charitable investments, tax avoidance and charities dealing with connected organisations – lessons from the Reb Moishe Foundation case
On 21 July 2020, the Tribunal gave judgment in the case Reb Moishe Foundation v HMRC  UKFTT 303 (TC) on the question whether a charity loan made for investment was an approved charitable investment for charity tax purposes. The decision offers important guidance on the test as applied by HMRC, while the case and an earlier Charity Commission inquiry into the charity offer useful reminders for charity trustees on maintaining good governance.
The Reb Moishe Foundation (the Charity) is a charitable trust. The Charity became subject to a Charity Commission inquiry and HMRC enquiry after making a £2 million loan facility available in 2006 to a private company, Gladstar Limited (Gladstar), at a time when one of the two trustees of the Charity, Mr Plitnick, was also company secretary of Gladstar, meaning that he had a conflict of interests / loyalties.
The facility was agreed on terms that the loan was repayable on demand or on default, interest was payable at 24% pa and the loan was guaranteed by Gladstar’s parent company (a Gibraltar company). The Charity agreed to a reduction of the loan interest rate to 10% in 2010. In 2013, the other trustee died and Mr Plitnick, who had also become a director of Gladstar, carried on alone, in breach of the Charity’s constitution. There was no evidence of the trustees obtaining financial advice about the loan facility or the interest rate reduction.
The relationship between the Charity and Gladstar appeared to be very close. In the Tribunal judgment, it is said that Mr Gertner, a director of Gladstar, ‘occasionally stood in for’ Mr Plitnick in trustee meetings and that Mr Plitnick only became a director of Gladstar in 2010 ‘to cover for Mr Gertner’s absences abroad’.
Gladstar was also a significant donor to the Charity, meaning that Gladstar was able to claim tax relief on its donation(s) and on the interest paid on the loan, but was able ‘within a few days of it being paid out’ to get the ‘money returned to where it had started’ via the loan facility.
The Charity Commission opened a compliance case into the Charity in November 2014, stepping it up to an inquiry in May 2015. It reported in February 2018, finding serious misconduct and mismanagement in the administration of the Charity, including failure to identify and manage conflicts of interests and failure to protect and manage the Charity’s assets, and that decisions made favoured Gladstar rather than the Charity.
HMRC opened an enquiry in July 2013, after the Charity filed tax returns for the tax years ending 5 April 2006 – 2010. HMRC issued letters and closure notices in 2015 and 2016 finding the loan was not an approved charitable investment. The HMRC enquiry was put on hold while the Charity Commission inquiry was conducted. The Charity appealed to the Tribunal in November 2018, after an independent review confirmed the HMRC decision and attempts at Alternative Dispute Resolution failed.
Approved charitable investments
The Tribunal had to consider whether the loan was an approved charitable investment, in this case ‘a loan or other investment as to which an officer of Revenue and Customs is satisfied, on a claim, that it is made for the benefit of the charitable trust and not for the avoidance of tax (whether by the trust or any other person)’.
The decision is of particular interest because it offers guidance on the legislative test for approved charitable investments, both as to how HMRC should approach the test and how the Tribunal should deal with any challenge to HMRC’s decision. Both are important for charities, which have to consider when making investments whether they will fall within the types of ‘approved’ investments set out in tax legislation.
These decisions can be difficult in ‘Type 12’ cases, as in the Tribunal case, where the proposed investment does not fall in the other more ‘standard’ types of investments (such as shares listed on a recognised stock exchange), but instead must satisfy the more uncertain test of whether an HMRC officer will be ‘satisfied’ that the investment is made for the benefit of the charity and not for the avoidance of tax (whether by the charity or any other person). These decisions crop up often when considering social investments or investment in a charity’s trading subsidiary company. If the charity trustees get it wrong, they risk opening up the charity to a tax liability (and potential regulatory intervention, as in this case).
How the statutory test should be applied
- Apply the legislation not guidance – The Tribunal criticised the approach of HMRC for their letters to the Charity being ‘notable for their lack of focus on the legislation’, focusing instead on HMRC’s published guidance (also, it seems, causing HMRC to give contradictory views over whether or not it accepted that the loan was for the benefit of the Charity). The Tribunal was clear that ‘what is important is not whether or not the loans complied with HMRC guidance, but whether or not they fall within the test set out in’ the legislation.
- The test itself – The Tribunal analysed the test as comprising two separate tests – is the loan an investment as to which an officer of HMRC is satisfied, on a claim, that it is:(1) made for the benefit of the charity; and
(2) not for the avoidance of tax (whether by the charity or any other person).
Ie each component should be considered separately and both must be satisfied.
How the Tribunal deals with a challenge to HMRC’s decision
- The Tribunal decided that the wording of the test, requiring the HMRC officer to be ‘satisfied’, indicated that the Tribunal had only a supervisory jurisdiction – ie it could disturb the finding of HMRC’s officer only if the Tribunal considered the officer’s decision unreasonable.
- To do this, the Tribunal needed to ask:
- if the officer took into account facts which should not have been taken into account;
- if the officer failed to take account of facts which they should have taken into account; or
- if the decision was so unreasonable that no properly instructed officer could reasonably have come to that conclusion.
The Tribunal considered that, had it been required to make the decision, it would have found that the loan was for the benefit of the Charity, but that the motivation for the transactions was for the avoidance of tax by Gladstar. Although it had found fault with aspects of the process applied by HMRC, it decided, therefore, not to interfere with HMRC’s decision as, had all the relevant factors been taken into account, the officers would inevitably have reached the same decision.
The loan failed as an approved charitable investment in this case due, as noted, to the finding that the motivation for the loan was avoidance of tax by Gladstar. It is important for charities to remember that the second limb of the test here is that the investment is not for the avoidance of tax whether by the charity ‘or any other person’. In this case, there was no finding of a tax avoidance motive by either of the trustees. Charities should be alive, therefore, when considering investments, to the possibility of a tax avoidance motive by someone else in relation to the transaction.
In this case, one warning sign for the Charity identified by the Tribunal was the circular nature of the arrangement, which enabled two tax deductions by Gladstar while, as the Tribunal found, ‘the money returned to where it started, within a few days of it being paid out’. The other was, as the Tribunal referred to it, the ‘closest of connections’, through Mr Plitnick, between the charity and Gladstar.
The message here is to maintain good governance – had the Charity managed its governance effectively, addressing the conflicts of interests and maintaining proper independence of the Charity from Gladstar, the problems here might have been averted.
The Commission issued a policy paper, Charity tax reliefs: guidance on Charity Commission policy, in 2015 which encourages charities to claim tax reliefs (properly) but also to be aware of the risk of tax avoidance (or evasion) arrangements. It has also published guidance for charities with a connection to a non-charity, as well as guidance on conflicts of interests.
The Tribunal’s decision that it has only supervisory jurisdiction on the test in this case has implications for other challenges to HMRC decisions on ‘Type 12’ investments, but also potentially for appeals on other tests worded in a similar manner – eg the exercise of the Commission’s powers under charity legislation is often expressed in such terms.
The finding could also present a hurdle for charities seeking to challenge an HMRC decision that an investment is not ‘approved’ as it can be more difficult to persuade a court or tribunal to interfere in a decision than to obtain a different result if the court / tribunal were able to remake the decision itself.
However, the Tribunal’s robust criticism of HMRC’s ‘failing’ in seeking to apply its guidance rather than the test as set out in the legislation may prove helpful, especially when combined with the supervisory approach in the decision – HMRC will know that, if challenged, they will be expected to demonstrate that they applied the legislation and to explain the factors taken into account in reaching their decision.
None of this is to suggest, however, that HMRC’s guidance can or should be ignored. The legislative test offers no guidance on how a charity should demonstrate that an investment is made for the benefit of the charity and not for the avoidance of tax (which may be by someone else). HMRC’s guidance offers some sensible suggestions on this; the case provides a useful prompt that HMRC’s guidance is not definitive on the question.
It might be considered striking that the Charity Commission was not satisfied that the loan and interest reduction were made in the Charity’s best interests, whereas the Tribunal and HMRC accepted that they were for the Charity’s benefit. The different views reflect the different bases for the decisions. While the Tribunal and HMRC were applying a broadly commercial test, the Commission’s finding is based more in the fact that the charity trustees were not able to demonstrate a clear basis for their decisions, which were also compromised by unmanaged conflicts of interests, and hence unable to demonstrate that the decisions, at the time they were made, were made in the best interests of the Charity. Trustees should remember that they may be called upon to explain a decision, possibly many years after the event – having a proper decision-making process and recording that decision (the Commission has useful guidance in It’s your decision) will help if they find themselves in such a situation.