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Tax planning

Technical refresher - Gift aid

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Open-access content Tuesday 17th March 2020 — updated 11.02am, Friday 27th November 2020
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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

 

Alt
This article appeared in our SPRING 2020 issue of Personal Finance Professional.
Click here to view this issue
Also filed in:
Study room
Tax planning

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