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The International Journal
of Not-for-Profit Law

Volume 3, Issue 2, December 2000

A publication of the International Center for Not-for-Profit Law

Table of Contents

Letter from the Editor

Articles

Church and State Relationships in German "Public Benefit" Law
By Dr. Christine R. Barker

Evaluating Tax Incentives for Donations to Public Benefit Organizations
By Paul Bater

Freedom of Association: Recent Developments Regarding the "Neglected Right"
By Leon E. Irish and Karla Simon

The Government of Israel's Control of NGOs: Legal Dilemmas and Structural Constraints
By Nitza Nachmias and Amiram Bogot

Reviews

Introduction to the Non-Profit Sector in the Balkans
By Jenny Hyatt
Reviewed by Douglas Rutzen

The Third Force
By Ann M. Florini
Reviewed by Karla Simon

Weak Democracy and Civil Society
By Imco Brouwer
Reviewed by Sam Charron

Case Notes

Central and Eastern Europe:
Poland

Latin America and the Caribbean:
Venezuela

Middle East and North Africa:
Egypt | Tunisia

North America:
the United States

Newly Independent States:
Moldova
| Russia

Country Reports

Asia Pacific:
Regional
| Australia | the Philippines

Central and Eastern Europe:
Hungary

Latin America and the Caribbean:
Regional | Dominican Republic | Guatemala | Peru

Middle East and North Africa:
Bahrain | Israel | Palestine | Yemen

Newly Independent States:
Kazakhstan | Ukraine

North America:
the United States

South Asia:
India | Pakistan

Sub-Saharan Africa:
Ghana | South Africa

Western Europe:
Belgium | France | Germany | Ireland

International Grantmaking

Conducting Overseas Site Visits
By Victoria B. Bjorklund and Jennifer I. Goldberg  

- - - - - - - - - -

Editorial Board

Evaluating Tax Incentives for Donations to 
Public Benefit Organizations

By Paul Bater, International Bureau of Fiscal Documentation

This paper was originally presented at ICNL's Sofia Conference, May 2000

A. Introduction

Before considering what tax incentives are appropriate for donations to public benefit organizations (PBOs), it is worth recalling that it is by no means universally agreed among states worldwide that such tax incentives are either necessary or a priority when assessing competing demands on limited government resources.

In an ideal fiscal climate, governments would be able to afford to offer PBOs a comprehensive package of tax incentives covering not only donations but also relief from tax on other sources of income and from tax on the purchase or importation of goods and services. In practice, most states have to decide between differing priorities, and PBOs need to take account of this when seeking better tax treatment by determining which tax reliefs are most valuable to their development. In countries where the vast majority of the people have little or no disposable income, exempting PBOs from tax on their income may be more conducive to their development than providing tax incentives to their donors.

There is broad agreement that genuine donations that do not produce a valuable benefit for the donor should not be treated as taxable income of the PBO. But economists are divided in their assessment whether tax incentives to encourage such donations are justified. Those opposed to tax incentives argue that donations are simply one form of personal expenditure and that it is not the proper function of government to seek to influence individual decisions on the application of such expenditure. Those in favour of incentives counter that it is unfair to tax people on income or assets that are not retained for their personal benefit but are applied as a substitute for, or a supplement to, government expenditure for the benefit of society as a whole.

Once a government has decided that it wishes to encourage donations to PBOs, it then has a choice between allocating public expenditure directly or using the tax system to provide an indirect subsidy. It is likely to be impractical to use public expenditure to make grants to individual donors, but it would be feasible to provide a system of matching grants that are made to PBOs that receive donations. To governments, such a system has the advantage that it is easily costed and monitored, and the amount of public expenditure required can be readily adjusted upwards or downwards. Conversely, donors and PBOs will usually favour the use of tax incentives because such incentives are less susceptible to changes in government policy, and generally involve tangible benefits to donors that can be marketed by PBOs.

B. Options for Encouraging Donations

Perhaps the first issue to be addressed in the design of tax incentives for donations to PBOs is whether the incentive should apply to all PBOs or to one or more restricted categories of PBO. Governments may well wish to restrict the number of organizations that can benefit from such incentives on the grounds of the cost to the public revenue, but there is also a concern that a donor may be able to influence the PBO concerned or otherwise benefit from the donation to an extent that is contrary to public policy, e.g. where a PBO is no more than a vehicle for an individual’s personal opinions. Hence, restrictions on the eligibility of PBOs to receive donations that qualify for tax incentives tend to take the form of a requirement that the donor has no connection with the PBO, or that the PBO is supported by the general public (i.e. its funds are derived mainly from public rather than private donors), or that the activities of the PBO fall into a class that is generally accepted to be of broad public benefit to society (e.g. the provision of health care or education). It should also be noted that this issue does not necessarily involve an all-or-nothing decision between granting tax relief for donations to a limited category of PBOs and denying any tax relief to donations to all other PBOs; it is equally feasible to design a system involving the grant of limited tax relief to donations to all PBOs, with the exception of a special category of favoured PBOs whose donors are eligible for enhanced tax relief.

The form of individual tax incentives necessarily varies according to the nature of the tax concerned. In the case of donations to PBOs, the relief most commonly encountered is relief from income tax. But countries that impose taxes on the ownership or transfer of wealth, or impose a separate tax on capital gains instead of including such gains in the definition of taxable income, will also need to consider granting relief from these taxes for donations. Relief can take the form of complete exemption from tax or the imposition of tax at a lower rate than the standard rate. It is inevitable that such reliefs will tend to favour wealthy donors; however, if the rich are to be encouraged to support PBOs it is likely to be necessary to provide a broad framework of relief from the taxes that they pay (there is little point in granting relief from income tax if the donor has to pay another tax instead). Relief from wealth taxes is particularly important if the aim is to stimulate large, one-off gifts of the kind that establish foundations or endow museums. In such cases, it is also important to ensure that the tax relief is not limited to cash gifts but extends also to gifts of shares and other investments; this might be limited for practical reasons, e.g. to avoid disputes over the value of the shares, to gifts of shares that are listed on a recognised domestic or foreign stock exchange.

The special category of cultural property should be noted. Most nations are concerned to preserve their cultural heritage, and many find it desirable to offer their citizens some incentive to give their cultural treasures to national museums or galleries or other approved cultural institutions (whether owned by the state or by a PBO). To be effective, such incentives should at least provide some relief from wealth or gift taxes; it is more difficult to extend relief from income tax to such gifts because of the inevitable difficulties in valuing cultural property.

So far as cash gifts to PBOs are concerned, relief from income tax could take the form of a deduction, a credit or a rebate. In the case of deductions and credits, the tax relief is given to the donor; under a rebate system the PBO benefits from the relief. The rebate system suffers from the disadvantage that there is no direct tax benefit to donors that can be marketed to them, but if donors are satisfied that there is a sufficiently strong link between their donation and the rebate to the PBO this may not be an insuperable obstacle.

The debate regarding the merits of giving income tax relief in the form of a deduction or a credit essentially involves a choice between equity and efficiency. In a tax system which imposes tax on income at progressive rates, a deduction will generally give a higher rate donor a greater tax benefit than a credit. However, although the credit method promotes a more equal distribution of tax relief among all donors, it is far from clear that it will lead to a greater increase in giving to PBOs than if the deduction method is used, and comparative research is constrained by the limited number of states that have used the credit method.

Some states restrict tax relief to donations that exceed a minimum amount and/or do not exceed a maximum limit. The maximum is normally defined in terms of a fixed amount or a percentage of taxable income. Sometimes the impact of the maximum limit is mitigated by allowing donors who exceed the limit to carry forward the excess donation for deduction, subject to the same limit in each year, over a number of subsequent years. If the minimum limit, which is likely to affect all but the richest donors, is set at more than a nominal amount there could be a considerable reduction in the cost to the government but this is not necessarily the main reason for imposing a minimum. Of equal, if not greater, importance is the desire to avoid the administration involved in documenting and monitoring large numbers of donations of a very small amount. This is also a matter of concern to PBOs who may well consider that the costs involved outweigh the benefit of the tax relief. On the other hand, the justification for setting a maximum limit, which will normally impact only on richer donors, is invariably the need for a ceiling on the cost to the state – backed sometimes perhaps by a moral concern that it should not be possible for someone to eliminate their income tax liability completely by means of charitable donations. Arguably, it is harder to sustain the case for a maximum limit once the rationale for giving tax relief for donations is accepted, because it negates equal treatment of all donors and because research suggests that the size of larger gifts is particularly sensitive to the amount of tax relief available. Moreover, the concern about the cost to the government is often overstated; even in those countries that do not impose any maximum limit, the examples of wealthy individuals giving a substantial part of their annual income to charity in one year, let alone on a regular basis, are few and far between.

Whatever method is used, it will be necessary to adopt rules to prevent abuse of the system. Such abuse typically takes the form of an arrangement for the donor to receive a valuable benefit, either from the PBO or from a third party, as a result of the donation. In the case of business supporters, the position becomes more complex because it is frequently necessary to establish whether the payment forms part of a sponsorship agreement (which generally entitles the sponsor to a deduction for the payment on the grounds that it is similar to an advertising or marketing expense) or a donation. Where it has been established that the payment is a donation that involves no benefit to the public, the state is clearly justified in refusing to allow any tax relief for the gift. The more difficult issue is where to draw the line between such artificial arrangements and the relatively insubstantial benefits that a PBO may want to offer to its supporters. Given that it is common practice for PBOs to provide their supporters with free literature (e.g. annual reports, quarterly or monthly journals, and occasional bulletins) relating to their cause, it makes sense to have a rule that enables benefits of nominal value to be disregarded by the tax authority when assessing the donor’s entitlement to tax relief. But PBO fundraisers today aim to attract supporters by offering more valuable benefits, e.g. discounts on a range of goods and services provided by the organization, so there is a case for saying that, provided that the value of the benefit does not exceed a stated amount, it can be disregarded. In situations where the donation exceeds the value of the benefit (as will normally be the case), the state can also apply a rule that disallows only the value of the benefit rather than the whole donation, enabling the donor to claim tax relief on the excess amount.

There will inevitably be cases where no abuse is involved but, by reason of an honest mistake, the donor or the PBO does not meet the conditions for making a valid gift that is eligible for tax relief. If the tax relief has already been given to the donor, who should pay the penalty for the mistake ? Logic suggests that if the tax relief has been given to the donor (albeit incorrectly), the donor should pay back the tax to the state. But the PBO could well take the view that it would suffer bad publicity as a result and may prefer to have the option of paying the tax on behalf of the donor with a view to preserving its good image with its supporters. The law should be sufficiently flexible to permit this.

C. Evaluating the Costs and Benefits of Tax Incentives for Donations

How effective are tax incentives in stimulating more donations to PBOs ? Research on this subject has been carried out in several developed countries without producing any firm evidence that , taken as a whole, the people of a particular country are motivated to give more money to PBOs by tax incentives. To some extent, this should not surprise us. It is well known that many people give to PBOs for humanitarian reasons and/or as an immediate response to an appeal to their generosity, rather than after a more calculated consideration of “what is the benefit to me ?”. There is also a long-standing belief (cf. the parable of the widow’s mite in the Bible) that the poor are comparatively more generous than the rich; by definition, the poor are less likely to be influenced by tax considerations. Nevertheless, there is reason to believe that, once an individual has an inclination to make a donation, the size of the donation can be influenced by the availability of tax relief. This is particularly likely to be true for richer donors.

The benefits can also be measured relatively easily, most obviously by collating the data relating to deductions or credits claimed on individual and corporate tax returns, and comparing it to the figures for donations received reported by PBOs in their annual accounts. There is also likely to be a further benefit that is less easily identified and measured, namely the ability of donations to a particular PBO above a certain level to attract or trigger further donations or grants to that PBO, usually as part of a programme of matched giving or other matched funding.

Assuming that the case that tax incentives can help to deliver demonstrable increases in public or private donations to PBOs is accepted, the state needs to be able to measure the real cost of providing the incentives. The cost of granting tax relief on donations should be readily ascertainable from the records of the donors’ tax returns, but this is only part of the picture. The state is likely to recover a significant part of that tax cost to the extent that the donations are used by the PBO to deliver public benefit services. This is so because the personal nature of many public benefit services typically involves their delivery by employees of the PBO, and an increase in the total expenditure on staff remuneration (whether due to the recruitment of additional staff or an increase in the pay of existing staff) will generate higher income tax and social security receipts for the state. Even in the minority of cases where an increase in donations received is not reflected in higher employment expenditure, it is likely that the incoming resources will be used to purchase goods or services that are needed to carry out the PBO’s activities; such purchases will invariably give rise to liability to sales taxes or VAT which is wholly or partly irrecoverable by the PBO. Measuring accurately the benefit to the state of these additional tax receipts is intrinsically difficult, but it should be possible to produce a respectable estimate of the benefit by collecting data reported in the annual accounts of PBOs regarding the proportions of incoming resources that are paid out in the form of employment costs or purchases of goods and services that are liable to turnover taxes.

From this point of view, it would be helpful if PBOs reported in their annual accounts the amount of the taxes that they incur in the form of irrecoverable turnover and employment taxes, and the amount of employment taxes that they collect on behalf of their staff. This would serve also to dispel the popular misconception that PBOs do not pay any taxes at all, and emphasise the economic (as well as the public benefit) contribution that they make to society.

D. International Aspects

A central aspect of the issue of how to define public benefit is whether public benefit should be measured in national or international terms. It is understandable that many governments and citizens take the view that “charity begins at home”, but mankind’s humanitarian impulses know no geographical boundaries. Even in the poorest countries, the occurrence of a natural disaster in a neighbouring state will often trigger a wave of donations from people in those countries. Often, those donations will be paid to and distributed by a well-known PBO in the donor’s country. But those donations can only qualify for tax relief if public benefit is defined to be broader than the national interest.

The responses of states to this question generally fall into one of three categories:

The last option implies an acceptance that we all belong to an international community in which the provision of assistance to others in turn benefits ourselves, at least in a moral if not a material sense.

Granting tax relief for donations to domestic PBOs operating overseas is a purely domestic issue that a state can resolve without considering the position of other states. Now let us consider the case of the cross-border donation. There are two common scenarios for each state to consider:

The issues in each case are quite different.

In the first case, let us assume that the state does not impose any restrictions on PBOs accepting donations from foreign donors (which is certainly not always the case). The initial reaction may well be that it is not necessary to offer any tax relief to foreign donors, particularly if they are entitled to tax relief for the donation in their home country. But if they have sources of income in your country there is a case for giving them equal treatment with resident taxpayers by allowing them tax relief for their donations (subject to the same limits and restrictions as apply to resident donors). Moreover, if the state is attempting to use the tax system to stimulate charitable giving it should bear in mind that tax is likely to be an important consideration in determining the size of a foreign donation. And if the donation takes the form of goods rather than cash, the goodwill of foreign donors can be eroded by the imposition of onerous customs duties on the importation of goods used for genuine public benefit purposes.

In the second case, a number of different approaches to this question can be discerned in the policies adopted by states around the world:

The rationale for the majority policy (denial of tax relief in all cases) is typically that the definition of public benefit in other states does not correspond to the domestic definition, that the state has no means of ensuring that the foreign PBO uses the donation for genuine public benefit activity, and/or that there is no benefit to the donor’s state. The fact that this is true in some but by no means all cases suggests that these reasons are at least partly attempts to justify a policy that is intended to limit the cost to the state of granting tax relief. The problem of differing approaches to defining public benefit can be substantially resolved if states were to examine which aspects of public benefit they have in common: it is likely, for example, that most states would accept that the relief of poverty and the provision of education and healthcare to all citizens are of public benefit. The issue of lack of control over a foreign PBO is more difficult to address, but similar problems are posed in the cross-border regulation of business activities which are not regarded as insuperable. The price that PBOs have to pay for progress in this field may be an increase in regulation of cross-border activity, but this could be justified by the benefits of additional tax relief. In the meantime, the option that is most likely to prove an acceptable compromise to both states and PBOs is a policy of encouraging the use of domestic intermediary PBOs.  

 

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