Philanthropy – a family business

Graham Davies is head of family philanthropy at Charities Aid Foundation (CAF). gdavies@cafonline.org

Graham Davies walks us through the considerations British families must make when venturing into philanthropy

Philanthropy is big business for many corporations. Corporate social spending on 'civil society' by Britain's top 500 listed companies was £845m in 2004. But does this spending serve shareholder interests? And can family-owned companies benefit too?

The evidence points to the affirmative. It seems consumers prefer 'socially responsible' behaviour from product providers, employees like to work for 'benevolent' employers, and association with worthy causes reinforces brand image. All three, it is generally accepted now, have an impact on the bottom line.
 
However, The Economist recently reported that this branch of corporate social responsibility (CSR), is at best no more than good management, and at worst, misguided altruism dangerously mis-aligned with a company's core business objectives. Yet, the pursuit of CSR is a rational self-serving activity, given the demands of today's consumers for products with wider social awareness.

Corporate philanthropy versus foundation giving
Coffee giant Starbucks is a case in point. While a target of the anti-globalisation movement, Starbucks has moved to re-invent itself as a socially responsible company through community initiatives with consumers and coffee growers worldwide. This includes donating over $1m in 2003 to 'social programmes' in various places from Columbia to Indonesia, $2.5m to a venture fund mandated to preserve good conservation values in its coffee growing partners, and paying almost double the necessary price for its Arabica coffee beans, concurrently getting the best quality beans.

While global corporations can use CSR to enhance brand image, these benefits can also apply to family-owned business, satisfying family shareholder objectives for community engagement while also 'giving something back'; organised philanthropy allows family companies to celebrate their success in a meaningful way – while reducing their tax burden, improving their communities, repaying supporters in kind, strengthening family relationships and creating a living legacy for successors. As a package, this is very hard to beat. An example of a British family-founded business that has committed to philanthropy by creating a foundation is The Edrington Group, a Scottish whisky company established in the 1850s. In 1961 the daughters of the founder and successors of the company, the Robertson sisters, set up the family's trust with funds from company dividends. Today it supports a range of causes across Scotland, donating some £7m a year.

Consider the taxman
It is worth looking more closely at the tax benefits of a family foundation. While seldom the principal driver of charitable giving by family businesses, it is foolish to ignore the fiscal advantages that can be derived.
 
Taxes affect giving in two ways. High taxes reduce company profits, leaving less money to give away. But tax exemptions allow companies to give more with less reduction of profit; they cut the price of giving. So while tax incentives probably do not cause companies to give in the first place, they may well encourage them to give more generously. The larger the company, the bigger the impact of taxes upon the company – and in theory, therefore, large companies could be doing themselves a favour by considering philanthropy.

The effect of corporation taxes and capital tax laws is to give companies a distinct choice. They can choose involuntary philanthropy (taxation), or voluntary philanthropy (charitable giving), either of which supports the general welfare of the community. Corporate social capital can be viewed as the company's conscious choice for community investment, reflecting either corporate or family business values – or both.

Here comes the maths
The tax position of a family business depends on the legal status of the company, for example, whether it is a partnership or a limited vehicle held through shares.

The donation of quoted shares and securities to charity offers UK individuals the opportunity to avoid of capital gains tax (CGT). Here's how it works: if you are earning £60,000 and give quoted shares valued at £10,000, you would pay income tax on only £50,000 – reducing your tax liability by £4,000. If the shares included a capital gain of £5,000, CGT liability of £2,000 is avoided. Your £10,000 gift to the charitable trust effectively costs you only £4,000.

Taxpayers can also gain relief at their marginal rate of income tax – a double boost from the UK Treasury. For shareholders of family companies, donating un-quoted shares to a family business foundation there is no CGT tax on transfer of the assets to the family business trust, but also no deduction available.
 
Company cash donations to charity are eligible for Gift Aid, with payment being made gross by the company. The payment is treated as a business expense and corporation tax relief is available provided the company has sufficient taxable profits.

On donations of shares (or of other assets with a taxable capital gain) to charity, the liability to tax on the gain is eliminated. If a company gifts quoted securities to charity, there is a further deduction available in the company.

In a partnership, the partners are treated as individuals and cash receipts out of earned income and dividends gift-aided into the family business foundation are deductible for income tax purposes. The foundation receives the capital gift, and in addition, the base rate relief of 28%. The individual receives the difference between the base rate and their marginal rate of tax.
 
As a limited company using cash receipts to endow a family foundation, relief is available on the taxable profit of corporate income. In years of loss or low profit, tax donations cannot be carried forward to offset profit in more plentiful years.

As a general rule, the most tax-efficient way of putting funds into a charity is for a company to make a payment directly to a charity such as the family business foundation or charitable trust. The temptation to remunerate the individual first and then fund the charity should be avoided, as there would be a liability to National Insurance (11% on the employer and 1% on the employee on amount exceeding the upper earnings limit £31,720).

Tax saving or altruism?
Often, setting up a foundation starts as a way to preserve control of a family business and to avoid taxes and inheritance taxes, but they are primarily one of the best ways for business families to support charities in the long-term. It is worth remembering that it might be no easier to build a family foundation than it is to build a successful family business. A practical approach is to establish a family business foundation that will make grants to charitable organisations according to a mission and strategy established by the family and/or foundation board members.

A corporate foundation allows for close identification with the founding family, while also allowing for excellent tax benefits in sharing the bounty during good years. An endowed family foundation allows for total control of the assets and sustained grant-making even during unprofitable years. If the business transfers taxable profits (or any highly appreciated, publicly-traded assets) to its private foundation, it will receive a tax deduction for the income transferred (and for the fair market value of the stock) and will avoid paying long-term capital gains on the future appreciation or sale of assets held within the foundation.
 
In a survey conducted recently by an international banking group, 44% of business owners cited 'making a difference' as the prime motivator for community investment, while only 9% citing "increased tax benefits". Notwithstanding the tax benefits of charitable giving for family business owners, the motivation to increase giving should be and, thankfully, usually is primarily to make a real difference.