Tax relief on a Gift Aid payment works by increasing the basic rate limit
Gift Aid is a scheme that allows charities and community amateur sports clubs to claim from HM Revenue & Customs the basic rate of tax their donors have paid on their money gifts. The net effect is to increase the value of donations by 25%.
Example - Peter
Peter has £42,500 of taxable income in 2019/2020, so is a higher rate taxpayer. He wishes to make a Gift
Aid payment of £2,500.
First, tax relief on a Gift Aid payment works by increasing the basic rate limit, for the tax year in which the payment is made, by the grossed-up amount. If the payment is carried back, this will apply to the previous tax year.
Tax relief on a Gift Aid payment works by increasing the basic rate limit
Second, the position in the case of Peter would be as follows:
(i) The gift is treated as made after the deemed deduction of basic rate (20%) income tax.
(ii) The gift of £2,500 is grossed up by the basic rate tax treated as paid by Peter on his payment, meaning it is divided by 0.8. The grossed-up amount would therefore be £3,125.
(iii) The basic rate tax limit (£37,500 for 2019/2020) would be increased by £3,125 to £40,625 (the basic rate limit marks the point after which higher rate tax is payable). The higher rate tax limit (£150,000) can be similarly increased in appropriate circumstances.
(iv) The effect of the increase in the basic rate limit for Peter is that £3,125 of income that would otherwise be taxed at 40% is taxed at 20%. This means that tax relief is available on £3,125, which equals £625. The rate of tax relief on the £2,500 Gift Aid payment is therefore 25%.
(v) After extending the basic rate tax band/higher rate tax band, a tax recalculation is carried out, which means that overpaid income tax and/or capital gains tax can be recovered. If the amount treated as deducted at basic rate exceeds the donor’s income tax and/or capital gains tax liability for the year in question, the donor suffers tax equal to the tax on the excess.
Technical Connection
Image credit | Ikon
Peter's example
He has £42,500 taxable income. Peter pays £2,500 Gift Aid
Before
£42,500 taxable income
Tax = £9,500
After
£42,500 taxable income
Tax = £8,875
Gift Aid to charity = £625
(20% of £3,125)
Reduction in tax to client = £625
(20% of £3,125)
Total tax payable = £9,500
less £625 = £8,875
Saving: £625
