A charity which incurs non-charitable expenditure will, in most cases, lose its tax exemption on an equivalent amount of its income or gains which would otherwise have been eligible for tax exemption.

For example, a charity incurs non-qualifying expenditure of £100 and the amount of income/gains of the charity otherwise eligible for tax exemption is £150. The charity will become liable for tax on £100. This means that for every pound of non-charitable expenditure, a charity potentially loses its tax exemption on an equivalent pound of income.

A charity can specify which sources of income and gains will effectively lose exemption; and it must provide this information within 30 days of being required to do so by HMRC. If the charity does not specify a source then HMRC will do it for the charity. So, for example, as UK dividend income is relievable income a charity may wish to choose that type of income first as no further tax would be payable on it.

If the non-charitable expenditure for an accounting period is more than the charity’s otherwise tax exempt income and gains for that period, the excess is first set against the remainder of the charity’s total income and gains (including for this purpose, non-taxable donations and legacies and other similar receipts). If there is still an excess, it is carried back to the immediately preceding period, where it is treated as being non-charitable expenditure of that period.

This process is repeated until there is no longer any excess non-charitable expenditure or the period to which the excess is being carried back ended more than six years before the end of the year in which the non-charitable expenditure was actually incurred.

HMRC has published full guidance on non-charitable expenditure.