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A key asset-allocation consideration is
deciding how to split exposure between
domestic and overseas assets. With the UK
constituting about 3.5% of global GDP and
around 8% of the FTSE All-World Index, it is
obvious that a substantial opportunity-set
resides outside the UK in terms of economic
exposure and access to a much bigger array
of companies.
In addition to providing participation in bigger
markets, overseas exposure offers the
opportunity to diversify risk by minimising
correlation exposure within portfolios.
Understanding the correlation exposure
embedded in portfolios is extremely
important. This analysis needs to be across
asset classes (horizontally), and also looking
at correlation exposure within individual
asset classes (vertically).
Equity exposure
Taking the latter (vertical) approach and
focusing on equity exposure, the key
correlations to consider are, firstly, the
magnitude of economic correlation –
whether investing abroad delivers access
to faster growth and exposure to economic
cycles that are de-synchronised from the
UK. The second consideration is the
quantum of correlation in global equity
market returns and an understanding of
what exposure is represented by the
benchmark equity index. On top of this
has to be overlaid the decision of whether
or not to hedge exchange-rate exposure.
Comparison of global industrial production
data shows that the UK economy is most
correlated to the US economic cycle, is
moderately correlated to the Eurozone
region, and is negatively correlated to the
emerging market economies. This implies
that exposure to the emerging markets
potentially provides not only exposure to
faster-growing economies but also an
opportunity to offset the impact of a cyclical
downturn in the UK.
The obvious follow-on from this is to assess
whether the economic correlation is reflected
in the behaviour of equity-market returns.
Examining regional local-currency returns
(stripping out the impact of currency swings),
we observe that over the last five years the
UK equity market has maintained the highest
correlation to the US equity market.
However, somewhat surprisingly, the data
shows a higher correlation to emerging
markets than Europe. So while the US
economic and market correlations appear
to be connected, the results from emerging
markets and Europe do not correspond
to the economic correlation data.
This imposes an interesting requirement on
investors – understanding the exposure you
are buying when you invest in a benchmark
index. Dissecting the UK index provides
some interesting insights. For instance,
the FTSE 100 is only 23% exposed to
domestically-generated revenues. By
1514
TAX FOCUS INVESTMENT FOCUS
As HMRC seeks to reduce input tax recovery via
the so-called “cost component”, Graham Elliott
surveys the battleground.
In the firing
line
Looking further
afield
contrast, the US SP 500 is 70% exposed
to domestic revenues. Relative to global
equities, the UK market is overweight in
the oil and basic-material sectors and
underweight in technology and industrials.
Consequently, the UK’s sector skew is
more defensive than the major regions,
and the responsiveness of UK EPS to global
industrial production is relatively low. More
importantly, the UK’s exposure to emerging
markets via the banks, basic materials and
oil sectors explains the rise in correlation
between the UK market and emerging
markets alluded to above.
Currency exposure
The other key consideration when investing
overseas is the impact of currency exposure.
If a currency appreciates, it reduces the
return from overseas assets and vice versa.
For instance, All-World ex UK equity-market
returns since 2012 in sterling terms
(unhedged) have appreciated 40%, but if
calculated in local currency terms (assuming
perfect hedging), overseas equities have
returned 59%.
Clearly, failure to hedge overseas exposure
over the last few years has eroded realised
returns from overseas assets. It is also worth
bearing in mind that multinational companies
offer a degree of embedded hedging
protection. This is because they can mitigate
some of the overseas-profit translation effect
by either directly hedging (using their own
treasury departments) or repositioning their
assets and debt. However, currency risk is
hard to avoid given that nine of the largest
20 dividend payers in the UK calculate their
dividends in US dollars or euros, and convert
to sterling at the prevailing rate.
The core rationale for investing in overseas
equities is that it provides opportunities to
participate in larger economies that offer a
much wider selection of quality companies
and business models. It also enables an
asset allocator to diversify portfolio risk and
correlation exposure. In order to do this it is
imperative that the overlay of economic and
market-return correlations are fully understood.
Charities are rightly preoccupied with the
question of how much VAT they can claim
on costs. This usually focuses on the method
of calculating the percentage split between
taxable and non-taxable activities, so as
to apportion VAT on general costs. But the
issue of how to define the use of certain
costs in the first place is not as easy as is
often assumed. Is the cost wholly referable
to a taxable supply, to a non-taxable activity,
or a bit to both? The question is simple but
the answer can be difficult. This is
increasingly becoming a battlefield in which
HMRC seeks to reduce input-tax recovery.
This trend continues as we learn that HMRC
has a new argument up its sleeve, that of the
so-called “cost component”. We know this
because HMRC presented a paper on the
subject in June. But what is it all about?
In simple terms, for a cost to be either wholly
or partly recoverable it must have a “direct
and immediate link” with taxable supplies.
How is this determined? One approach
outlined by the Court of Justice of the
European Union (CJEU) is that the purchase
must be a “cost component” of the intended
relevant supply. Whilst this “cost component”
phraseology is obscure, it could be thought
to mean that the price charged must be
equal to or greater than the sum of such
costs. In other words, the intention must be
for the activity to at least break even in the
long run, even if that intention fails, if the
costs are to be treated as genuine “cost
components”. The tax-payer community has
never seen it in that light because, as is well
known, businesses liable to VAT can run at
a deliberate loss, as is often the case with
charities. Achieving full cost recovery from
the customers is not the intention.
What seems a more sensible view is that,
where a fully commercial and profit-seeking
operation is involved, any choice between a
This is a clear and
present danger for
charities, and needs
to be resisted
taxable and exempt supply being regarded
as using the cost in question needs to have
regard to the extent to which prices of
either supply absorb the said cost. That
makes sense.
The HMRC view
HMRC’s paper goes much further though.
Paragraph 13 says: “A cost is used for the
taxable supplies to the extent that it is
incorporated into their price. Accordingly
the VAT incurred on a cost is deductible
to the extent that the cost is incorporated
into the price of the taxable transactions.”
That seems pretty unambiguous.
But might it only relate to cases where there
is a choice of allocation between taxable and
non-taxable activities? No, rather paragraph
three of the paper says: “This does not just
apply to cases where costs have to be split
between taxable and exempt supplies; it
applies in all deduction situations.” This
seems to mean that VAT recovery will be
limited to the proportion of the cost which is
intended to be recovered in the price of the
taxable supply, irrespective of whether or not
the charity undertakes non-taxable activities,
or the extent to which it does.
The reasoning given is fairly complex, but
note this point in paragraph 11 of the paper:
“In AB SKF [a decision of the CJEU], … the
CJEU observed: ‘If … the cost of the input
transactions is incorporated into the price …
the right to deduct VAT charged on the
input transactions should be allowed.’
The corollary must be that if the cost is not
incorporated into the price, then the right
to deduct is not allowed.”
With respect, I do not agree that the
ostensible corollary they draw follows from
the CJEU’s comment. Furthermore, it takes
no account of the CJEU’s decision in
Commission v France (C-243/03), in which
it held that a subsidy of costs applied by a
charity when determining prices could not
erode the level of input tax recovery on the
costs that had been subsidised.
But the paper does not single out charities,
so why do I think charities are in the firing
line? The reason is that we advisers compare
notes from time to time, and this shows that
there are HMRC assessments against
charities based on this line of thinking. This
is therefore a clear and present danger for
charities, and needs to be resisted.
Figure 1: Total returns of the FTSE All World ex UK index in sterling and
local currency terms
Local currency return Sterling return
2012 2013 2014
100
110
120
130
140
150
160
159.20140.87
90
Philip Lawlor and Nick Murphy explain the key
considerations when investing overseas.
Image:spiritofamerica/Shutterstock.com
Graham Elliott,
Special Counsel/
Transaction Tax
Consultant, Withers LLP
Philip Lawlor, chief
investment strategist,
Nick Murphy, Investment
Management Strategist,
Smith Williamson](https://image.slidesharecdn.com/6d71fe6c-7672-4e0d-8cf3-36587a869858-160111175328/85/Finance-Focus-8-320.jpg)
![charitytimesSeptember_2016[1]](https://cdn.slidesharecdn.com/ss_thumbnails/620c38dd-c090-474e-b242-41eda1ec5ce5-161109171330-thumbnail.jpg?width=640&height=640&fit=bounds)
Finance Focus
- 1. 1 FOCUSFINANCE The magazine forCFG members September 2014 ALSO THIS MONTH: EVALUATING RISK PLANNING FOR SORP INVESTING OVERSEAS PROJECT MANAGEMENT Drawing the line WHAT LEVEL OF RESERVES SHOULD YOU HOLD?
- 2. 3 Caron Bradshaw, ChiefExecutive Contents Member matters 04 We reveal the details of our latest trustees’ annual report, and invite you to take part in our Member Survey. On our radar 06 We evaluate the merits of social investment, and discuss HSBC’s recent decision to close “risky” bank accounts. Ready for lift-off 09 Tom Davies provides tips on how to plan for the new SORPs. Where to draw the line? 10 Don Bawtree and Rui Domingues consider how to set reserve levels under the new SORPs. Trouble on the horizon? 12 Alyson Pepperill suggests how to identify and evaluate the risks to your organisation. In the firing line 14 HMRC is seeking to reduce input tax recovery via the “cost-component”, says Graham Elliott. Looking further afield 15 Philip Lawlor and Nick Murphy explain what charities need to consider when investing abroad. CFG events 16 We reveal details of our new Social Investment Conference, while Don Bawtree discusses audit committees. Time to get agile? 18 Libby Hare weighs up when agile project management is suitable. Production and editing: Slack Communications Design: SteersMcGillanEves If you have any queries about Finance Focus or are interested in writing for us, please contact gareth.jones@cfg.org.uk. Neither CFG nor the authors of individual articles can accept liability for errors, omissions or any actions taken as a result of the content and advice contained within Finance Focus. © Charity Finance Group A Company Limited by Guarantee. Registered in England No. 3182826 Registered Charity No. 1054914 15-18 White Lion Street, London, N1 9PG www.cfg.org.uk What happened to the red tape cull? Once upon a time, an energetic new government was elected. It proclaimed a new age of a smaller state and a bigger society. A world in which civil action would be released from burden, and stupid, unnecessary measures wielded by over-zealous bureaucrats would be a thing of the past. We waited to see what this brave new world would look like, and whether the rhetoric would be matched with action. Certainly, in the early days, things had a real flavour of change. Do you remember the raft of conversations, debates, inquiries and consultations that focused on cutting red tape? The “Red Tape Task Force” and “unshackling good neighbours” were but two initiatives. We were all heartened that, at last, there could be moves afoot which would lead to more efficiency and compliance, and which focused on risk without tying us up in a plethora of meaningless administrative steps. Whilst there have been some noises that seemed to move us in the right direction, such as the setting up of a new form of charity vehicle (the charitable incorporated organisation, or CIO), I’m fairly certain many of you will not be feeling “unshackled”. The language of unburdening charity has not been matched with action. Take the CIOs as an example. On the one hand, the new legislation was billed as a way in which new charities could be set up easily, yet at the same time the message is often that “there are too many charities”, and that people should be dissuaded from forming new charities where ones already exist. Not only will barriers to starting new charities be at odds with the concept of cutting red tape, it also feels mightily inconsistent with the ideology that competition drives up standards. The current Charity Commission consultation on the annual return also appears to be adding to, rather than taking away from, the information that charities are required to manually input when lodging their annual reports and accounts. Remember that most, if not all, of the information that charities have to enter into their return is already contained in their annual reporting. July saw the publication of the Electoral Commission’s guidance on the Lobbying Act. By not excluding charities from this legislation, parliament left a number of you with a raft of new compliance requirements. You will need to determine whether you are required to register, and if so, work out what you need to report thereafter to the Electoral Commission and what evidence you need to keep. We’re going to work through what support we can offer members who are caught and who need some interpretation of the requirements as soon as possible. In the meantime, do look at a rather useful flow chart the Directory of Social Change has produced if you are not sure if you need to register: http://bit.ly/1pumpDm. So what has happened to this banner the government held aloft proclaiming its desire to free us all from bureaucracy? Perhaps it’s buried somewhere under a pile of red tape! CARON’S COMMENT
- 3. 4 5 Welcometoour newmembers andsubscribers! 54 The reportreveals that we have been able to increase overall income (excluding donated goods and services) by some 7%. We’ve put on more events, conferences, training and other face-to-face support, increasing this area of our work by 14% and growing our delegate numbers by 10%. We’ve also grown the number of individual members by 4%, though the number of organisations in membership fell slightly. Against a backdrop of significant pressure for the sector, our journey through last year did, however, bring us to a juncture which required some important decisions and possibly the most profound shift to date in how we operate. This included undertaking a major change programme, developing a new strategy and relocating offices. As a result, we have had to heavily invest our reserves in order to embark on a new direction of travel in supporting the sector. The changes we’ve made will drive up the quality of the products and services we provide to you and the wider sector. This includes broadening the sorts of training we can offer (for example, we can now offer bespoke training for small groups at our new offices in the Angel Islington, London), and maximising the quality of engagement between our corporate supporters and charities. We are now confident that we’re in a position to deliver our ambitious targets for growth and reach in 2014-17, and indeed our first quarter results show we are ahead of budget and targets in the current year. • In 2014/15 we had a target for the year to provide SORP briefings or training sessions to 1,000 people. To date almost 1,200 people have attended or booked to attend a session at a conference or one of our many half-day training sessions, and more dates have needed to be added to meet demand and the needs of our members; • Our Annual Conference in May was the most successful to date in terms of delegate numbers (15% more paying delegates than last year), and there were increased satisfaction scores from attendees and our corporate partners; • We launched two successful publications with positive feedback from members and significant amounts of media and sector interest – Managing in a Downturn and The Pension Maze; • We have grown our member engagement and special interest groups; • We have piloted new models of training delivery, including bespoke “in-house” training. Whilst there is still much to do, we believe CFG is now fit for the future and has a firm platform for growth. We are pleased to tell you about our trustees’ annual report for 2013-14, which is now available on our website at About us Annual reports. CFG: Fit for the future MEMBER MATTERS The latest updates for CFG members plus opportunities to contribute to CFG’s policy work. EU consults on the impact of IFRS As part of a review of the International Accounting Standards (IAS) Regulation, the European Commission has published a consultation on the impact of the new International Financial Reporting Standards (IFRS) in the EU. Charities reporting under these standards are invited to submit their comments on the practical implications of IFRS and any areas which they believe could be improved. Please get in touch if you wish to contribute to a response. Evidence needed on Lobbying Act Guidance on the Lobbying Act has now been published, eliciting comment from across the sector. Aside from deciding which organisations are required to register with the Electoral Commission, there are reports that the Act may cause undue burden for charities in terms of accounting. If you are planning to register, we would like to hear from you about your experience of interpreting the reporting requirements in the guidance. Funding review still open for input CFG has come together with NCVO, the Institute of Fundraising, NAVCA and the Small Charities Coalition to review the impact of the recession on the voluntary sector, and the changes organisations have experienced. We are asking members to tell us their stories through our “call for evidence” at http://svy.mk/1uhNZaQ. If you have any questions about the review, please contact Andrew O’Brien at andrew.obrien@ncvo.org.uk. Charity Commission holds public meeting New Chief Executive Paula Sussex will be speaking at the Charity Commission’s next Annual Public Meeting about the regulator’s work over the past year and her plans for the coming months. The meeting will be chaired by William Shawcross, and will also include a lecture from Dr Frank Prochaska on “the state of charity”. The event will take place on 17 September between 4pm and 6pm at Church House, and is free to attend. To book a place, contact publicmeetings@ charitycommission.gsi.gov.uk. Voice your views Visit the CFG website for more information: Policy Have Your Say Consultations Apologyto CharityFinance magazine In the last issue of our Economic Outlook Briefing we published income information from Charity Finance magazine’s Charity 100 Index, not only without permission but also wrongly attributed to HMRC. We apologise to Charity Finance for this error. If any CFG members would like to subscribe to Charity Finance magazine, where you can read the full Charity 100 and Charity 250 Index reports each month, along with comprehensive analysis and updates on issues relevant to charity finance professionals, please call Killian Cremin on 020 7819 1227 or email killian.cremin@ civilsociety.co.uk. Quote “CFG offer” until 30 September to add a free website upgrade, giving you full access to civilsociety.co.uk. Members Addaction Age UK Berkshire Age UK Enfield Al Kawthar Academy The Albert Kennedy Trust BASIC – Brain and Spinal Injury Centre Brighton and Hove Seaside Community Homes British Nutrition Foundation Broadening Choices for Older People Catholic Marriage Care Community Housing Cymru Crossfields Institute CXK Diocese of Hexham and Newcastle Emboti Forest Peoples Programme Institute of Physics and Engineering in Medicine Life Changes Trust Manchester YMCA Parochial Church Council of the Ecclesiastical Parish of Horsham Pavilion Dance South West Promo-Cymru Sheffcare Single Homeless Project StreetGames UK Surrey Community Action VICTA WPF Therapy YMCA Worcestershire Subscriber UTAX (UK) CONTACT US Email policy@cfg.org.uk to contribute to any of our policy work If you have an interesting story to tell, a particular area of interest or practical tips and techniques to share, we would love to hear from you. To send us your submission please visit www.cfg.org.uk/ac15, fill in the relevant form and follow the submission instructions. Alternatively, if you would like to suggest a topic or speaker please use the session- suggestion form available in the same place. Submissions are open to both charity members and subscribers, and the deadline is 19 September 2014. Don’t miss this chance to shape the programme of our flagship event! Call for papers CFG is looking for interesting and practical sessions for our 2015 Annual Conference that charity finance professionals from a variety of backgrounds and organisations can learn from. CFG Annual Conference,13 May 2015 As mentioned on the page opposite, over the last year CFG has developed a new strategy and invested in a change programme. With that overall framework in place, we have been reviewing the detail of our activities and are looking at how we can improve what we do further in order to better meet your needs. This means we want to find out more about you, what your needs are and how we can help. We’d be grateful if you could give us your views by visiting www.cfg.org.uk/survey14 and answering the questions provided. In return for your time, we’ll enter you in to a prize draw. Five people who complete the survey in full before the deadline will be selected at random to win £50 each in CFG vouchers for their charity to spend on training or events. The survey closes for responses on 2 October. Have your say! CFG’s Member Survey is now open for responses. This is your chance to help us shape our future. Lastchance! Don’tmiss out! We’re delighted to invite you to member meetings in November and December on governance and related issues. These will present an opportunity to ask any questions you may have on the work of CFG and our results, and to explore areas of future development.
- 4. 6 7 Language needsto embrace and invite, rather than bewilder and put off potential participants 66 ON OUR RADAR CFG’s policy work: representing your views to decision makers, plus research, guidance and news from around the sector Where banks have been found guilty of facilitating transactions that have ended up in the wrong hands, they have had their wrists publicly and painfully slapped. This includes HSBC, which has been taken to task for processing payments that supported Hezbollah and Mexican drug lords, with the latter case resulting in a $1.9bn settlement. Elsewhere, BNP Paribas (a French bank) is currently under investigation in the US over the alleged laundering of over $100bn from Sudan. The costs of effective due diligence are high. Tens of millions are spent every year on running checks against sanctions. This is driving a trend away from financial services which are: high-cost to run (in terms of the relevant anti-money- laundering checks required to have some guarantee of security); high-risk (in terms of the potential costs to the organisation that gets it wrong, even with comprehensive checks in place); and which do not deliver sufficient financial return to counteract the aforementioned costs. Hence a number of organisations are no longer falling into HSBC’s risk appetite. In light of all of these factors, it is perhaps no surprise that CFG’s members are reporting that banks’ de-risking processes are impacting on INGOs trying to make international payments, either by formal banking services or by money services businesses, or trying to open and maintain bank accounts that ultimately service overseas beneficiaries. Charities have been deemed “vulnerable” by international regulatory institutions such as the US- based Financial Action Task Force, especially those that are moving funds to areas at high risk of terrorist and money- laundering abuse. Charities that are owed money by the Dove Trust’s online donation platform charitygiving.com will receive around a third of what they were due, following a legal ruling. A judge assessing the case decided that money would be distributed without distinguishing between donations made before and after the site was declared insolvent and an interim manager (Pesh Framjee, pictured) appointed. If this ruling is relevant to your charity, please visit www.charitygiving.com to find out more about how you can claim the outstanding funds. What’s the big issue? Banking risk HSBC has abruptly closed the bank accounts of a number of organisations and individuals (including a number of Muslim charities), as it reassesses its “risk appetite” for engaging with certain clients. This follows other banks de-risking in response to a stringent global counter-terror regime and reputational damage following the financial crisis. 7 Social investment: What’s all the noise about? forms of investment, ranging from pure social investment to impact and “mixed motive” investing. Why wouldn’t you want to make your money work even harder, bringing social as well as financial return to organisations that strive for social change? However, it remains to be seen whether steps to stimulate the market, such as the social investment tax relief, are enough to enable the market to break out of its “embryonic” status. Organisations must make use of the mechanisms available to assess their appetite and need for these products. Whether expectations for this market can be matched in reality will rely on a combination of factors. Language needs to embrace and invite, rather than bewilder and put off potential participants. Departments across government need to recognise that charities and social enterprises have a valuable role to play, and that it does matter that the motives of social investment vehicles are social rather than profit-making. Charities for which social investment is a credible and valuable way of fast-tracking change need to be supported to take the plunge. However those advocating social investment may also need to be much more realistic. Social investment has a genuinely transformative potential for the right charities, but it is not a panacea for all the sector’s funding challenges. Expectations need to be managed! Social investment is not a replacement for lost income, even though it has huge potential. There’s no doubt that social investment is very much the flavour of the month. There is a lot of interest on the supply side from pioneers like Sir Ronald Cohen, as well as banks (like Big Society Capital) and intermediaries. The government is relishing the UK’s place as the world leader in the development of the market. The social market is viewed by its fans as a “fast growing” market which could result in genuinely new money for social good. According to the City of London’s Growing the Social Investment Market: The Landscape and Economic Impact, the social investment market grew by almost a quarter to £202m in 2011/12. Since then there has been a steady increase in the number of social investment deals being struck, yet demand continues to be outstripped by supply. It is understandable to get excited about the notion of social investment. The emergence of the Charity Commission’s CC14 guidance brought about a new focus and perhaps an anticipation that suddenly charities would be free to explore new CFG opposes annual- return questions CFG has responded to the Charity Commission’s consultation on proposed additional questions in the annual return. CFG strongly opposes the requirement to disclose campaigning expenditure and income from both public-sector delivery contracts and private donations. We are broadly in favour of the other proposals, but have stressed the importance of ensuring that the burden on charities is kept to the minimum level necessary to enable the Commission to carry out its functions effectively and keep the public informed. Concern over postage VAT change We have written to the Treasury and the HMRC Charities team jointly with the Institute of Fundraising regarding HMRC’s recent letter to the Direct Marketing Association on the VAT costs for postage. We have raised concerns about the potential impact on charities of applying VAT to single-source-supplied bulk mail, which stems from the removal of postage as an “ancillary” cost. We have asked for reassurance that charities that have engaged in single- sourcing since 2012 are not liable for any unpaid VAT, as these costs would directly reduce the amount of money that charities have to deliver vital services, and in some cases these changes will make charities vulnerable if they have to pay almost three years’ worth of unplanned VAT. We will work with the relevant government departments to influence the decision, with the aim of ensuring that any changes made are appropriate and do not unduly affect the sector. Protection of Charities Bill to be published The Protection of Charities Bill announced in the Queen’s Speech earlier this year, which aims to equip the Charity Commission with powers to tackle abuse more effectively and efficiently, will appear in draft following the summer recess. Having responded to the Cabinet Office consultation earlier this year, we will be keeping a close eye on the Bill’s development and pre-legislative scrutiny. Policy progress Court rules on Dove Trust fundsCFG will be jointly holding a conference on social investment with Big Society Capital on 27 November. Members will have the opportunity to engage in this debate and hear from a range of speakers on topics including engaging your trustees in social investment, loan financing and performance- related financing. For more information please see page 16, or to book your place visit www.cfg.org.uk/socinv
- 5. 8 9 Tom Davies, SeniorManager, Not for Profit Team, Grant Thornton 8 ON OUR RADAR CFG’s policy work: representing your views to decision-makers, plus research, guidance and news from around the sector 9 ACCOUNTING FOCUS The new SORP has been revealed, but how should you be preparing? Tom Davies gives some planning tips. Ready for lift-off Assessing it under these headings will act as a helpful way to identify where additional information will be required, such as from your HR team in relation to calculating your holiday pay accruals, but also where wider discussions with stakeholders such as trustees, donors and lenders will be needed to explain potential financial impacts. Importantly, it will also enable you to plan your own internal resource requirements within the finance team, including any need for additional training. The outcomes for each item could be captured in a table such as figure 2. Naturally, there will be areas under the new SORP which you believe are still open to judgment and differing interpretations, such as the recognition of legacies. With issues such as this, you should use the current audit cycle to take specific examples and discuss them as part of your audit debrief in the current year. This will enable you to address these areas of uncertainty as early as possible. Compared to other sectors, such as higher education and housing, it is clear that the impact of the new FRS 102 and the Charities SORP will be less fundamental on a charity’s financial statements, but as always: Prior Proper Planning Prevents Painfully Poor Production! As someone who grew up in a military family, it is hard not to think of the “7 Ps” military adage, which extols the virtues of proper planning, when trying to provide some practical suggestions for finance teams as they look to adopt the new SORP. Continuing the military theme, teamwork is key, not least in ensuring that you are engaging throughout the transition period with your beneficiaries, stakeholders and auditors to manage the potential impact of the changes on a timely basis. As the vast majority of charities are now in this transition period, what helpful suggestions can I make? Firstly, prepare a transition timetable – smooth transition is dependent upon careful planning. A charity with a December year-end adopting the FRS 102 SORP might produce a timetable that looks something like figure 1. Assessing the impact Secondly, many of you will have already held a number of discussions considering the potential impact of FRS 102 and the new SORP. However, now that the new SORP is published, I would recommend that time is made to sit down with your finance teams to conclude how the new SORP is going to impact your organisation and what your response will be. I would suggest that impact is assessed under two headings: • Financial – which measures the impact of specific items on the financial statements in terms of the effect on the balance sheet or statement of financial activities (SoFA); • Resource – which considers the resources required to address the issue during the transition process. Research and reports Charities‘not explaining their liabilities’ In a recent report, the Charity Commission analysed the accounts of charities that have reported net current liabilities. Out of the 98 accounts reviewed, nearly half (42) had not used their trustees’ annual report (TAR) to explain how they were addressing the associated risks. Among those that did, the planned solutions included restructuring and also merging with other charities. In response, we have stressed the importance of not taking the findings out of context. These valuations are often only a snapshot in time and need be considered within the wider narrative of the charities’ overall finances. A‘Hippocratic oath’ for bankers? The think-tank ResPublica recently launched the report Virtuous Banking: Placing ethos and purpose at the heart of finance, which reviews the way in which the banking industry governs and organises itself and explores how the financial sector can be made more responsive, responsible and ethos-driven. The report addresses problems of the past and considers what paths can be taken to restore ethics to the sector, such as bankers swearing a “Hippocratic oath”. Report suggests drop in volunteering This summer saw the release of findings from the Cabinet Office’s Community Life survey for 2013-14, which indicated that the number of people volunteering formally had dropped from 44% to 41%. Some 27% said they had volunteered formally once a month, compared to 29% last year. Bank fines to be given to charity Approximately £100m of fines levied on the Lloyds Banking Group for the manipulation of financial benchmarks such as Libor will be allocated to military charities. In total, the government is allocating £300m to the Armed Forces Covenant and wider organisations. SORP Committee secretariat announced The Chartered Institute of Public Finance and Accountancy (Cipfa) has been awarded a three-year contract by the Charity Commission to provide the secretariat to the SORP Committee. The role, which was previously held by the Commission and its Scottish counterpart OSCR, includes preparing technical briefing papers and drafting the text of the SORP. Cipfa, which is the accounting body for public services, will take up the role in September and has the option to extend by two years. Charity funds make impressive 10% return According to the VM Charity Fund Monitor from State Street, UK charities made an average investment return of 10.4% over the 12 months to the end of June this year. The best performing assets were property (17%) and UK equities (13%). The worst was cash, which returned only 0.4%. Charity Commission taking harder line The Charity Commission’s 2013-2014 Annual Report, published in July, demonstrates what the regulator describes as a “steep increase in investigatory work”. It reports that 64 statutory inquiries were opened between April 2013 and March 2014, compared to 15 during the previous financial year. In a section titled “tackling abuse and mismanagement”, the Commission declares that it is “now quicker to intervene”, and is taking a “tougher approach”. Three-quarters of mergers‘are takeovers’ According to the first of a new series called the Good Merger Index, almost three- quarters of charity mergers should be classed as takeovers. The study, which is published by the consultancy Eastside Primetimers, examined 189 charity mergers that occurred between January 2013 and April 2014, and found that in only 23% of cases did two or more organisations form a new one. It argues that the rest should be classified as takeovers, because they involved one organisation transferring its assets and activities to another organisation and being dissolved. News in brief... HMRCrewrites VATguidance HMRC has rewritten its guidance on VAT for charities. The revised guidance offers an introduction to VAT for charities, as well as discussing whether activities are business or non-business, the VAT treatment of income received, VAT reliefs on purchases, fuel and power, and VAT on charity events. The guidance can be found at http://bit.ly/VciYF8. DBpensionscode comesintoforce The Pensions Regulator has published its code of practice for defined-benefit pension schemes, which applies to all schemes in Great Britain. The code provides practical guidance for trustees and employers on how to comply with the scheme funding requirements contained in part three of the Pensions Act 2004. Entitled Funding Defined Benefits, the code can be found at http://bit.ly/1sQfDrA. Medicaland veterinarysupplies: NewVATguidance HMRC has rewritten its guidance on charity-funded equipment for medical and veterinary uses. The guidance explains when goods and services purchased with charitable or donated funds by eligible bodies and/or third parties can be zero- rated, what an eligible body is, and the conditions that must be met. The guidance can be found at http://bit.ly/1sNXvzu. Guidance and support 1 JANUARY 2015 31 DECEMBER 2015NOW Set timetable and consider resource planning Consider agreements, terms of loans and other instruments Assess impact of new standard on each financial statement item Assess impact of final FRS 102 SORP Training of staff and others Ensure systems are in place to gather required information Discussions with, and education of, stakeholders Restatecomparative financialstatements Prepare financial statements under FRS 102 Figure 1: Figure 2: FRS 102 SORP issue Financial statement presentation Key changes include: • Reduced number of income and expenditure categories on the face of the SoFA; • Gains/losses on investments included within net incoming resources as opposed to other recognised gains/losses; • Reduced number of headings on the face of the cash flow statement; • Cash flow statement to be reconciled to the total of “cash and cash equivalents”. Potential approach £ – LOW/MEDIUM RESOURCE – HIGHIMPACT: • Prepare skeleton accounts in advance of the first year-end in sufficient time to allow input from the board, and in order to obtain any information that is not readily available; • Review the mapping of the nominal ledger to ensure the trial balance reflects changes to the presentation in the financial statements; • Review accounting policies to ensure they are FRS 102 and FRS 102 SORP compliant; • Consider impact of changes on bank covenants, if applicable; • Communicate changes to wider stakeholders.
- 6. 10 11 Monitoring reserves shouldnot just be an annual exercise as accounts are signed off One of the most common questions to be asked at the CFG Foundation Charity Finance course is “how much should we hold in reserve?” This is also a regular feature of discussions at most audit or finance committees. Despite changes in the economy, the SORP and developments in trustee law, the answer to this question is fundamentally unchanged. The Charity Commission’s guidance (CC19) is not prescriptive on levels of reserves. Recognising the lack of homogeneity in the sector, it does not attempt to define what level of reserves a charity should have. Rather, it states that a charity should have a reserves policy and must be able to justify why it is holding a particular amount in reserve at a particular point in time. The level of reserves should be justified with reference to the charity’s current position and future prospects. If there is a benchmark to apply, it is the basic test of a trustee acting as a “prudent man of business”, balancing the needs of current and future beneficiaries. Despite this, it is inevitable and right that charities are compared. This leads inexorably to using the now familiar mantra of reserves expressed as a proportion of expenditure – a hangover from the initial consultation on the Charity Commission’s reserves publication. In practice, as our own research has demonstrated in the past, even this is terribly fraught, as both the precise definition of reserves and the nature of expenditure to be considered are full of individual variations in practice and underlying fact. SORP changes Charities’ reserves and their presentation will be affected by the new SORPs (the points that follow mainly refer to larger charities adopting FRS 102, though they certainly represent good practice for all charities). One example is that the presentation of the reserves in the annual report is now more tightly defined. Paragraphs 1.48 and 10.91 are key in this respect, and charities should compare their existing reserve policies with this new guidance. Annual reports that refer to reserves in terms of cash, investments or 1110 COVER STORY some other definition created by the charity will need to amend their approach. The Commission’s guidance also makes it clear that monitoring reserves should not just be an annual exercise as accounts are signed off, but that they should be monitored regularly throughout the year. Charities which do not yet adopt the SORP definition will need to consider how best to do this, but it would seem logical to move to the statutory basis rather than have two methodologies running. Some charities build their reserve policies around the minimum that they require to keep going, whilst designating any other funds. Others simply set out the purpose for which all their reserves are held. Charities adopting the former route will welcome paragraph 10.91, which effectively gives official sanction to the idea of a separate “continuity” fund. Income, expenditure and balance sheet In considering how reserves will appear in the accounts, it is worth noting the changes that will affect income and expenditure, and sometimes the balance sheet. Although few of these are operationally significant, they will affect perception. Key changes to consider include: • Earlier recognition of income when its receipt is “probable”, whereas the equivalent criterion under SORP 2005 was “virtually certain”; • Income from some contracts can be classified as restricted income rather than unrestricted income; • Legacies are not only caught by the change in recognition criterion, but also affected by enhanced guidance. Obviously earlier income recognition will boost balance sheets, and therefore reserves. Treating some contracts as restricted may reduce reserves, depending on prior treatment, and will certainly reduce the amount of unrestricted expenditure. This may be significant if this figure is used as a benchmark. Expenditure is relatively unchanged, but beware of the effects of changes in defined- benefit-pension scheme treatments. There are two changes here that will affect expenditure and the balance sheet position. Firstly, FRS 102 changes expenditure by recognising, within expenditure, net interest determined by multiplying the net defined- benefit liability (the defined-benefit obligation net of plan assets) by the discount rate used to calculate the defined-benefit obligation. By contrast, FRS 17 recognised the expected return on scheme assets and the unwinding of the discount on scheme liabilities. The effect on expenditure and surpluses may be significant. In respect of multi-employer schemes where there is an agreed deficit-funding plan, FRS 102 requires a liability to be recognised for the present value of the contributions payable that arise from that agreement (to the extent that they relate to the deficit) with the resulting expense recognised in the profit or loss. This accounting is likely to give rise to much more volatility in the SoFA as deficit funding plans are revised with each triennial actuarial valuation, and previously-assessed liabilities are increased or decreased. The balance sheet, and therefore the reserves, will be hit by what may be a substantial liability. Some organisations will also need to consider the implications of other balance- sheet changes too. Although these will affect less charities, mixed-motive investments and mixed-use properties could both result in changes to the funds that are presented as available to support the free-reserve figure. It may be that this all seems a long way removed from the real world. However, the importance of reserve management is being continually reinforced with stories in the press commenting on charity reserve levels, and of course one of a trustee’s fundamental duties is to avoid insolvency. So however esoteric, this is a subject that needs grappling with. The new SORP provides both a challenge and an opportunity to have another look at this important topic. We hold four different categories of reserves/ funds – endowments, restricted, designated and free reserves. FotE’s current policy on reserves effectively looks only at free reserves. The other fund types do not need to have targets set around them and so we haven’t included them in the current policy and won’t be covering them here. Historically, FotE has had a policy of holding three months of annual expenditure as free reserves. The rationale for this level has been around having sufficient funds available that, if every service should close, there would be sufficient resources in place to wind every service down over three months. This is the “armageddon” rationale, and there are two issues with this: • It assumes that every service will have to be shut down at exactly the same moment; • It assumes that no income at all will be received during any close-down period. So what is the appropriate level of reserves to hold? Fortunately, lots of external guidance is available on setting reserves policies, and we’ve found the following items useful in refining ours: • The Charity Commission has a number of different documents to help charities; • Our current auditors (Mazars) are obviously a good source of more specific information on how to tailor our reserves policy; • Sayer Vincent’s Drawing up a Reserves Policy is a more risk-based approach to setting reserves, using a number of steps to get to a policy outcome. Our first step was to analysis our income risk. Using the Sayer Vincent methodology, this has come out as in figure 1. Without looking at the model, it’s hard to know if the reliability scores are good or bad. But I can tell you that this is a relatively low-risk profile which shows that our income sources are relatively dependable. The next step was to analyse our expenditure commitments. There are lots of ways to slice and dice your expenditure (i.e. by staff costs and other major cost types, or by functional area, or by activity, stream). We’ve decided to look at things by activity and our level of expenditure commitment is laid out in figure 2. Interestingly, this shows that we have a higher level of commitment to our home-support work than to our care-home operations, which we are taking into account when putting together our new policy. The final step is to consider the risks that the charity is facing, using our risk register. In the main, the uninsured risks that we are carrying (i.e. those that require reserves to be held) appear to be around circumstances that lead to the loss of confidence in a single part of our operations, rather than across the whole charity. This gives weight to not having an “armageddon” approach to free reserves. These three bits of analysis don’t feed into a black box that churns out a magical reserves figure. We are using this data to structure our discussions, and that’s the final and obviously most important step. This is the part of the journey that we are at – the conversations: finding out about individual and organisational risk appetites, establishing a risk-based approach to free reserves and balancing the needs of future and current beneficiaries. As I said, we’re not at the destination yet, but my hope is that, by going through this exercise, we can free up around £1.5m for our work. Who wouldn’t want to do that! Where to draw the line? Where to set reserve levels continues to be a thorny question. Don Bawtree considers this along with the consequences of the new SORPs. Friends of the Elderly (FotE) is currently moving towards a new reserves policy. Rui Domingues shares the journey so far. Figure 1: Analysis of income risk Income source Percentage of total income Reliability Care homes 71.8% 144 Home support 20.1% 121 Community services 4.7% 28 Donations and legacies 1.0% 18 Investment income 0.9% 17 Management fees 0.0% 0 Other income 1.4% 17 Figure 2: Spending commitments Income Source Percentage of total costs Commitment Care homes 69.4% 1,110 Home support 18.8% 1,203 Community services 6.9% 10 Fundraising 1.8% 16 Grants 1.8% 85 Isolation / public affairs 0.6% 4 Governance 0.6% 3 Investment management 0.2% 1 Deciding on a new reserves policy Rui Domingues, Director of Finance ICT, Friends of the Elderly Don Bawtree, Partner, BDO
- 7. 12 13 Alyson Pepperill, Chair,Institute of Risk Management Charities SIG, and Head of Oval Charities RISK FOCUS 12 There are many definitions of “risk”, and they revolve around an occurrence which impacts on the delivery of an objective. Risk management therefore looks at how risks can be eliminated, avoided, reduced or accepted by an organisation. Figure 1 provides a process that can be followed to identify the risks that your charity faces. One needs to quantify the size of the risk to the organisation in terms of impact and likelihood of the risk occurring, and then consider how to manage the risk. At a more strategic level, the board and senior management team can view risk management as how you: • Identify and anticipate problems that will stop you achieving your objectives; • Manage the risks your organisation presents to the public, your employees and volunteers, and your trustees; • Maintain the trust and confidence of internal and external stakeholders by running a successful and ethical organisation; • Work within existing budgets to meet your objectives and create financial stability and viability; • Demonstrate that you are a competently- managed organisation. This article focuses on identifying risks for the charity, but the process can be used to identify risks to a new income stream or a special project. Identifying risks Who should participate? In order to gain as broad an insight as possible into the risks facing the organisation, it is important to include a representative from each area (i.e. departments, activity areas and/or income streams) as well as those with an oversight, such as your trustees and executive leadership team. This could be achieved through departmental and management meetings, as well as through online surveys. How can risks be identified? It’s probably easier to provide some guidelines or headings through which participants can structure their thinking and to issue them with an introduction to “what is a risk’’. Figure 2 sets out some common headings: For further assistance, see the Charity Commission’s Charities and Risk Management document (CC26), which offers more examples of risks. Consolidating the risks identified. You should end up with a long list of identified risks through your broad engagement with employees and trustees. In order to reduce this list down to a more manageable and meaningful one, risks can often be grouped and collated as the same risk, or a subset of that risk. Alyson Pepperill suggests how to identify and evaluate the risks to your organisation. Defining or quantifying risk Probably the most simple, structured and time-controlled way forward is to hold a “risk workshop”. You may want an external consultant, such as your external auditor or risk consultant, to attend as an objective facilitator and timekeeper. An alternative way of defining and assessing the risks is for between one and three people to work through an initial assessment. A wider workshop is then used to “test” areas of uncertainty and obtain wider buy-in. The risk workshop will usually be subjective and consensual as you’re predicting whether a risk might occur and the size of the impact on the organisation, rather than having actually experienced the risk or accessed factual data. It is useful if some monetary parameters can be applied. These need to be agreed by the director of finance and encompass: • What a significant financial impact from a single event is equal to; • The size that a series of events that financially impact the organisation across a 12-month period will have to reach to seriously impact on operations. As well as assessing the size of a risk you have to think about how likely it is that a risk will happen. Figures 3 and 4 opposite give some useful guidance on how the likelihood and impact of an identified risk can be measured. Figure 4: Impact scoring example Please note the financial limits selected are for example purposes only. This offers several routes to help you assess the impact of a risk and score it accordingly. Score 1 – Negligible Score 2 – Low Score 3 – Medium Score 4 – High Score 5 – Very high Little or no financial impact (less than £5,000) The financial impact would be losses, or a lost income of no greater than £25,000 The financial impact would result in losses or lost income of no greater than £100,000 The financial impact would result in losses or lost income of no greater than £500,000 The financial impact would be greater than £500,000 Services are not disrupted Some temporary disruption to the activity of one service but not beyond this Regular disruption to the activities for one or more service Severe service disruption on a departmental level or regular disruption affecting more than one department Severe disruption to the activities of all departments No impact on delivery of key objectives It may cost more so there may be a delay in delivering one of the organisation’s key objectives A number of objectives would be delayed or not delivered Many objectives would be delayed or not delivered Unable to deliver most of the objectives No loss of confidence in the organisation Some loss of confidence in the organisation felt by a certain group or within a small geographic area A general loss of confidence in the organisation within the local community A major loss of confidence in the organisation and within the local community A disastrous loss of confidence in the organisation, both locally and nationally These scores can then be plotted on a “risk matrix”, which will help you to visualise your key risks, how to manage them and where to deploy any necessary capital expenditure. Figure 3: Likelihood scoring example Score 1 – Highly unlikely Score 2 – Unlikely Score 3 – Possible Score 4 – Very likely Score 5 – Definite Previous experience at this and other similar organisations makes this outcome highly unlikely to occur Previous experience discounts this risk as being likely to occur, but other organisations have experienced problems in this area The organisation has in the past experienced problems in this area, but not in the last three years The organisation has experienced problems in this area in the last three years The organisation is experiencing problems in this area or expects to in the next 12 months There are effective, tested and verifiable controls in place that prevent occurrences of this risk There are controls in place that whilst not tested, appear to be effective Some controls are in place and generally work, but there have been occasions when they have failed and problems have arisen Controls may be in place but are generally ignored or ineffective No controls in place Figure 2: Example one Example two (Charity Commission) Example three • Financial risk • Operational risk • Natural hazard • Legal regulatory • Governance • Operational • Finance • Environment/external • Compliance (law and regulatory) • Financial risk • Operational risk • Legislative/regulatory risk • Major/new projects Figure 1: RETAINREDUCE ELIMINATE TRANSFER ACCEPT CONTRACT INSURANCEPOST LOSSPRE LOSS IDENTIFY QUANTIFY MANAGE Issues and solutions I Our list of identified risks is way too long to take to a risk workshop. S It is important to group together the feedback from the broad range of contributors as there will be overlap. This should reduce the list considerably. I How do we decide how big a risk is? S You will need some financial guidance to help you assess the impact of a risk and hopefully the tables above also provide some useful guidelines that can be applied to different risks. I We know what our big risks are and don’t need to go through this exercise. S The exercise may spot additional (and especially emerging) risks, which will make it worth the time-investment. I Risks change; are we meant to do this exercise several times over? S Not the full exercise, although you may want to consider doing that every 2-3 years as good practice. However, you will need to keep the output live by thinking about what new risks there are and how the likelihood and severity of a risk can be managed down. The best way to do this is to schedule a quarterly review into the management meeting agenda. I We have undertaken the risk workshop and identified and assessed our risks – is that it? S No, because so far we have not looked at how to manage the risks, what you’re already doing to manage risk or what you want to do in the future. That’s for another article. In the meantime, it would be useful to re-order the risks by their importance within the headings used And remember that not every risk is significant enough to go on the risk register. It could just be someone’s own agenda item! Trouble on the horizon? Key I Issue S Solution
- 8. 14 15 A keyasset-allocation consideration is deciding how to split exposure between domestic and overseas assets. With the UK constituting about 3.5% of global GDP and around 8% of the FTSE All-World Index, it is obvious that a substantial opportunity-set resides outside the UK in terms of economic exposure and access to a much bigger array of companies. In addition to providing participation in bigger markets, overseas exposure offers the opportunity to diversify risk by minimising correlation exposure within portfolios. Understanding the correlation exposure embedded in portfolios is extremely important. This analysis needs to be across asset classes (horizontally), and also looking at correlation exposure within individual asset classes (vertically). Equity exposure Taking the latter (vertical) approach and focusing on equity exposure, the key correlations to consider are, firstly, the magnitude of economic correlation – whether investing abroad delivers access to faster growth and exposure to economic cycles that are de-synchronised from the UK. The second consideration is the quantum of correlation in global equity market returns and an understanding of what exposure is represented by the benchmark equity index. On top of this has to be overlaid the decision of whether or not to hedge exchange-rate exposure. Comparison of global industrial production data shows that the UK economy is most correlated to the US economic cycle, is moderately correlated to the Eurozone region, and is negatively correlated to the emerging market economies. This implies that exposure to the emerging markets potentially provides not only exposure to faster-growing economies but also an opportunity to offset the impact of a cyclical downturn in the UK. The obvious follow-on from this is to assess whether the economic correlation is reflected in the behaviour of equity-market returns. Examining regional local-currency returns (stripping out the impact of currency swings), we observe that over the last five years the UK equity market has maintained the highest correlation to the US equity market. However, somewhat surprisingly, the data shows a higher correlation to emerging markets than Europe. So while the US economic and market correlations appear to be connected, the results from emerging markets and Europe do not correspond to the economic correlation data. This imposes an interesting requirement on investors – understanding the exposure you are buying when you invest in a benchmark index. Dissecting the UK index provides some interesting insights. For instance, the FTSE 100 is only 23% exposed to domestically-generated revenues. By 1514 TAX FOCUS INVESTMENT FOCUS As HMRC seeks to reduce input tax recovery via the so-called “cost component”, Graham Elliott surveys the battleground. In the firing line Looking further afield contrast, the US SP 500 is 70% exposed to domestic revenues. Relative to global equities, the UK market is overweight in the oil and basic-material sectors and underweight in technology and industrials. Consequently, the UK’s sector skew is more defensive than the major regions, and the responsiveness of UK EPS to global industrial production is relatively low. More importantly, the UK’s exposure to emerging markets via the banks, basic materials and oil sectors explains the rise in correlation between the UK market and emerging markets alluded to above. Currency exposure The other key consideration when investing overseas is the impact of currency exposure. If a currency appreciates, it reduces the return from overseas assets and vice versa. For instance, All-World ex UK equity-market returns since 2012 in sterling terms (unhedged) have appreciated 40%, but if calculated in local currency terms (assuming perfect hedging), overseas equities have returned 59%. Clearly, failure to hedge overseas exposure over the last few years has eroded realised returns from overseas assets. It is also worth bearing in mind that multinational companies offer a degree of embedded hedging protection. This is because they can mitigate some of the overseas-profit translation effect by either directly hedging (using their own treasury departments) or repositioning their assets and debt. However, currency risk is hard to avoid given that nine of the largest 20 dividend payers in the UK calculate their dividends in US dollars or euros, and convert to sterling at the prevailing rate. The core rationale for investing in overseas equities is that it provides opportunities to participate in larger economies that offer a much wider selection of quality companies and business models. It also enables an asset allocator to diversify portfolio risk and correlation exposure. In order to do this it is imperative that the overlay of economic and market-return correlations are fully understood. Charities are rightly preoccupied with the question of how much VAT they can claim on costs. This usually focuses on the method of calculating the percentage split between taxable and non-taxable activities, so as to apportion VAT on general costs. But the issue of how to define the use of certain costs in the first place is not as easy as is often assumed. Is the cost wholly referable to a taxable supply, to a non-taxable activity, or a bit to both? The question is simple but the answer can be difficult. This is increasingly becoming a battlefield in which HMRC seeks to reduce input-tax recovery. This trend continues as we learn that HMRC has a new argument up its sleeve, that of the so-called “cost component”. We know this because HMRC presented a paper on the subject in June. But what is it all about? In simple terms, for a cost to be either wholly or partly recoverable it must have a “direct and immediate link” with taxable supplies. How is this determined? One approach outlined by the Court of Justice of the European Union (CJEU) is that the purchase must be a “cost component” of the intended relevant supply. Whilst this “cost component” phraseology is obscure, it could be thought to mean that the price charged must be equal to or greater than the sum of such costs. In other words, the intention must be for the activity to at least break even in the long run, even if that intention fails, if the costs are to be treated as genuine “cost components”. The tax-payer community has never seen it in that light because, as is well known, businesses liable to VAT can run at a deliberate loss, as is often the case with charities. Achieving full cost recovery from the customers is not the intention. What seems a more sensible view is that, where a fully commercial and profit-seeking operation is involved, any choice between a This is a clear and present danger for charities, and needs to be resisted taxable and exempt supply being regarded as using the cost in question needs to have regard to the extent to which prices of either supply absorb the said cost. That makes sense. The HMRC view HMRC’s paper goes much further though. Paragraph 13 says: “A cost is used for the taxable supplies to the extent that it is incorporated into their price. Accordingly the VAT incurred on a cost is deductible to the extent that the cost is incorporated into the price of the taxable transactions.” That seems pretty unambiguous. But might it only relate to cases where there is a choice of allocation between taxable and non-taxable activities? No, rather paragraph three of the paper says: “This does not just apply to cases where costs have to be split between taxable and exempt supplies; it applies in all deduction situations.” This seems to mean that VAT recovery will be limited to the proportion of the cost which is intended to be recovered in the price of the taxable supply, irrespective of whether or not the charity undertakes non-taxable activities, or the extent to which it does. The reasoning given is fairly complex, but note this point in paragraph 11 of the paper: “In AB SKF [a decision of the CJEU], … the CJEU observed: ‘If … the cost of the input transactions is incorporated into the price … the right to deduct VAT charged on the input transactions should be allowed.’ The corollary must be that if the cost is not incorporated into the price, then the right to deduct is not allowed.” With respect, I do not agree that the ostensible corollary they draw follows from the CJEU’s comment. Furthermore, it takes no account of the CJEU’s decision in Commission v France (C-243/03), in which it held that a subsidy of costs applied by a charity when determining prices could not erode the level of input tax recovery on the costs that had been subsidised. But the paper does not single out charities, so why do I think charities are in the firing line? The reason is that we advisers compare notes from time to time, and this shows that there are HMRC assessments against charities based on this line of thinking. This is therefore a clear and present danger for charities, and needs to be resisted. Figure 1: Total returns of the FTSE All World ex UK index in sterling and local currency terms Local currency return Sterling return 2012 2013 2014 100 110 120 130 140 150 160 159.20140.87 90 Philip Lawlor and Nick Murphy explain the key considerations when investing overseas. Image:spiritofamerica/Shutterstock.com Graham Elliott, Special Counsel/ Transaction Tax Consultant, Withers LLP Philip Lawlor, chief investment strategist, Nick Murphy, Investment Management Strategist, Smith Williamson
- 9. 16 171716 CFG EVENTSKeeping you ahead in your career: Highlights of upcoming CFG events across England, Scotland and Wales. Book now at www.cfg.org.uk/events. Social Investment: Financing your charity for the future As traditional sources of funding are squeezed, charities and other organisations are exploring social investment as a new way of funding their activities. Are you ready for SORP 2015? More thought needed on audit committees? Don Bawtree, Partner at BDO LLP, considers the role of charity audit committees and developments in the private sector. Nearly all charities have some sort of committee dealing with finance, but only larger ones tend to have a separate audit committee with closely-defined terms of reference. Many organisations will instead have a hybrid, combining the roles of an audit committee with others such as finance, general purposes, risk or governance. As with so many aspects of charity governance, there is a compromise to be struck between getting the rights skills on board, and the amount of time that the non-executives and management can devote. It certainly seems to be true that audit committees can function more effectively if they are established specifically for that purpose, rather than as part of a wider brief. For instance, an audit committee which also considers risk can quickly become a delegated function of the board, with trustees spending little time considering wider risk. Or a finance committee which encompasses audit can find it difficult to distinguish issues of principle from the practical implications of some aspects of the annual report and accounts’ presentation. There is no formal guidance issued by the charity regulators, so organisations need to look to other sources, both corporate and not-for-profit. As they do so, they will find ample food for thought. Issues include: • Independence – is this so important where the board is entirely non-executive? • Frequency of meetings – are they needed as often in smaller organisation? • Committee composition – the Financial Reporting Council suggests a minimum of three members, but complex charities may need to involve a wide range of experience to be effective. This also needs to be balanced with the continuing challenge for diversity and user representation; • Remuneration – trustees can’t be paid, but independent committee members can be; • Skill base – especially for single-issue charities, how to attract members experienced in financial reporting? • Training – how to keep members up to date with corporate governance and financial reporting requirements? • Reporting – listed companies are being asked under the revised corporate code to report on their activities much more transparently; • How to derive suitable measures – for instance on compliance with any code, or on audit quality, or on effectiveness? There is much to learn from the corporate sector. We have recently produced two reports on the topic looking at good practice and recent trends: http://bit.ly/1kY3qkv. But with the corporate world putting increasing focus on audit committees and their reporting, there is a sense that charities need to be considering this more formally, sharing good practice and learning from other parts of the not-for-profit sector. Which is why we are delighted to be launching a training session on charity audit committees with CFG. We hope that this will be of interest not only to organisations with audit committees, but all charities which are concerned with strong financial governance. For more information and to book, please visit www.cfg.org.uk/auditcommittee Preparing for SORP 2015: An essential overview for charities You’ll receive practical guidance on the main accounting changes that will affect charities, as well as planning tips to help you transition to SORP 2015. Upcoming dates include: 23 September 2014, 12:00-16:30 Cardiff – in partnership with Grant Thornton 9 October 2014, 12:00-16:30 Leeds – in partnership with Grant Thornton 14 October 2014, 12:00-16:30 Manchester – in partnership with Grant Thornton 3 December 2014, 12:00-16:30 Edinburgh – in partnership with Saffery Champness SORP 2015: Charity accounting and reporting for small charities This session is aimed at charities with an income below £1m, but particularly those below £500k, and will focus on the FRSSE – the SORP specifically for smaller organisations. 3 October 2014, 13:00-16:00, London – in partnership with Small Charities Coalition 9 December 2014, 13:00-17:10, Bristol – in partnership with Saffery Champness Preparing for SORP 2015: An essential overview for international charities This session will provide practical guidance on the main accounting changes that will affect international charities. 7 November 2014, 09:00-13:30 London – in partnership with Crowe Clark Whitehill Preparing for SORP 2015: An essential overview for trustees Trustees will gain an overview of how the SORP changes will affect their areas of responsibility, such as the trustees annual report. 11 November 2014, 12:00-16:30 London – in partnership with Kingston Smith 12 November 2014, 12:30-16:30 Birmingham – in partnership with Sayer Vincent Preparing for SORP 2015: An essential overview for smaller charities This session will provide an essential overview of accounting, reporting and external requirements for smaller charities (with less than £6.5m income). 24 November 2014, 12:00-16:30 London – in partnership with MHA MacIntyre Hudson Visit www.cfg.org.uk/sorp for the full list of training dates and to book your place. Many charities and social enterprises providing important services that address key social issues in the UK rely on income generated from traditional sources of funding such as grants and donations. However, following a reduction in the provision of funding, some organisations are looking to social investment as an alternative way to meet their financial needs. The term “social investment” denotes financial activity that not only delivers economic returns but provides significant social benefits as well. There are a number of different forms of social investment including loans, bonds and equity investment. Social investment can enable organisations to develop new or existing income- generating activities. Investors provide different types of financing options to the voluntary sector and will often accept lower returns in order for a greater social impact to be generated. CFG’s Social Investment Conference, run in collaboration with Big Society Capital, aims to provide delegates with an understanding of the financing options available to their charities. The full-day conference is aimed at finance directors, CEOs, finance managers, senior accountants, charity consultants and trustees that are looking to increase their knowledge in this important and expanding area. We’ll be joined by experts from the corporate and charity world, who will provide insights from both the charity and lender perspectives. Kevin Barnes, Director of Finance at Barnardo’s and CFG Trustee, will be chairing the conference. The conference programme will explore key aspects of social investment, including loan and performance-related financing, regulations and guidance, alternative sources of funding and more. Throughout the day there will be many opportunities to network with fellow finance professionals and hear from charities about their experience of accessing different forms of finance. Confirmed sessions include: Charitable trusts: Social investment insights Some charitable trusts and foundations are using social investment alongside grantmaking to fulfil their mission. This session will provide an overview of charitable foundations’ behaviours, attitudes and interests in the social investment market. Trupti Patel, Social Investment Fund Manager, Esmée Fairbairn Foundation Social investment: Regulatory context and trustee perspective A brief introduction to the powers to make social investment, key parts of the Charity Commission guidance (CC14), and the context of the Law Commission Review. This will be followed by an interactive QA session to explore common concerns raised by trustees and how to overcome them. Luke Fletcher, Partner, Bates Wells Braithwaite, Jane Hobson, Head of Policy, Charity Commission 25 September 2014 Inmarsat,London The CFG Investment Conference will cover a wide variety of topics including governance and policy, investment strategy, accounting for financial instruments under the new SORPs, performance and benchmarking, alternative investments and an equity outlook. Join the closing plenary debate to find out more about ethical investment, the advantages and disadvantages, and the different approaches available to charities. The conference will provide an excellent opportunity to exchange ideas and views with fellow finance professionals working in the charity sector. Take time to explore the event exhibition, quiz the experts and network with colleagues at the closing drinks reception. Visit http://cfg.org.uk/inv2014 Investment Conference 2014 Lastchance tobook! View the full event programme and book your place at www.cfg.org.uk/socinv 27November2014 London New event announced! Cyber Security Conference 5 December 2014, CCW, London We’re pleased to announce our first Cyber Security Conference, brought to you in partnership with Crowe Clark Whitehill. As we increasingly rely on digital technology to function, and charities store and process more information online such as donors and beneficiaries’ personal details, there is an imperative for organisations to assess their cyber security. Book at www.cfg.org.uk/ CYB15 to find out more about your cyber and information risks, and how to create the processes and culture to prevent these threats. Big Society Capital is a financial institution with a social mission, set up to help grow the social investment market, so that charities and social enterprises who want to borrow money, or take on investment, can access the finance they need to do more.
- 10. 18 CFG events ata glance For further information on all CFG events or to book, please visit www.cfg.org.uk/events or email events@cfg.org.uk. Conferences 25 September 2014 Investment Conference Inmarsat, London 08 October 2014 Midlands Conference Birmingham Repertory Theatre, Birmingham 16 October 2014 South West Wales Conference Marriott Hotel, Cardiff 27 November 2014 Social Investment: Financing Your Charity for the Future Barclays, London 05 December 2014 Cyber Security Conference Crowe Clark Whitehall, London Members’ meetings LONDON AND THE SOUTH EAST 09 October 2014 Harnessing Technology and Minimising Risk London 06 November 2014 Governance and Performance Management – Open Meeting London 10 December 2014 Making the Leap from Managing to Leading London MIDLANDS 16 September 2014 Motivating and Managing Staff and Volunteers Birmingham 03 December 2014 Governance and Performance Management – Open Meeting Birmingham NORTHERN ENGLAND 18 November 2014 Governance and Performance Management – Open Meeting Manchester SOUTH WEST WALES 18 September 2014 Motivating and Managing Staff and Volunteers Bristol 20 November 2014 Governance and Performance Management – Open Meeting Bristol Training 15 September 2014 Foundation Investment Training London 30 September 2014 Foundation Charity Finance Birmingham 01 October 2014 Foundation Charity Finance Bristol 01 October 2014 Advanced Charity Finance London 02 October 2014 – 09 June 2015 Inspiring Financial Leadership London 14 October 2014 Performance Reporting London 14 October 2014 Advanced Investment Training London 15 October 2014 Foundation Charity Finance London 22 October 2014 Performance Reporting Birmingham 23 October 2014 Trading and the Law London 04 November 2014 Performance Reporting Bristol 12 November 2014 Audit Committee Training London 18 November 2014 Foundation Investment Training London 09 December 2014 Foundation Investment Training Manchester 18 CPD Further your professional development with expert advice and a round-up of CFG events and training. Time to get agile? Libby Hare considers when agile project management is suitable. Traditional or “waterfall” project management is planned around the sequential development of the project deliverables or outcomes, is based on stages, and is generally focused on what needs to be delivered at the end of the project. This means that often you don’t start to gain benefits from the project until its completion. In contrast, agile projects are focused on delivering the products in an iterative way as they are being worked on, so you review and potentially amend the deliverables during the project and should start to see the benefits sooner. Agile’s origins are in software projects, and various methodologies have been developed as a result, such as DSDM Atern, Scrum, Lean and Extreme Programming. Although some are more suited to software development than general projects, and some have more rigorous governance, they all aim to deliver projects more flexibly. All types of agile have some characteristics in common. Agile depends a lot on trust within project teams, and teams need to be empowered to a level where decisions can be made quickly within short, defined timeframes. Equally, collaboration between team members is essential, together with good communications and feedback – both within the team and with other stakeholders. Pros and cons Traditional and agile methodologies are both valid, so how do you decide which to use? You should take organisational culture into account as well as pragmatic considerations. Traditional approaches work well where the project is familiar, where requirements are clear and set, and where there is a definite sequence to events – typically office-moves, hardware procurement and accounting system implementations. Agile approaches work well where there is an acceptance that the requirements may change during the project, where there is a level of uncertainty, and where elements of the project could be delivered during the project itself – such as campaigns, CRM implementations and website development. If the agile approach is the best fit for your project, then you need to: • Establish good governance, with clarity over responsibilities and decision-making; • Ensure that there is a good understanding by all those involved in the project about the way the project will be managed, particularly where external suppliers are involved; • Trust the high-level plan showing the different stages, and leave the project team to produce and manage the detailed stage plans; • Encourage collaboration between team members and allow sufficient time for end-user involvement at all stages of the project; • Accept that there will be a high level of change during the project and ensure that the project team is sufficiently empowered to make day-to-day decisions. Libby Hare, Partner, Adapta Consulting
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