HMRC updates charity tax guidance

Independent schools have faced substantial tax changes in recent years. Much of the recent focus has understandably been on VAT and business rates. However, schools with charitable status should also take note of HMRC's charity tax guidance update of 20 October 2026.

The October update principally clarifies HMRC's expectations around due diligence, record-keeping and evidence that charitable funds are used appropriately, including payments to individual beneficiaries and overseas organisations. It does not, of itself, withdraw the established direct tax exemptions available to charitable schools.

Why does this matter?

Charitable schools can benefit from significant direct tax exemptions. In particular, HMRC expressly recognises an independent school charging tuition fees for education as an example of primary-purpose trading, the profits from which can qualify for exemption.

Those exemptions are not unconditional. Broadly, they depend upon income and gains being applied for charitable purposes, and non-charitable expenditure can restrict the tax relief otherwise available. 

HMRC's revised Annex II: non-charitable expenditure clarifies the supporting framework. It states that charities must maintain appropriate financial and internal controls, keep accurate audit trails, and undertake appropriate due diligence, monitoring and verification of how charitable funds are used. Checks should be proportionate to the risks involved, with additional verification where risks are higher.

For schools, the focus is on evidencing entitlement to the exemption. Relevant areas may include bursary support and other payments to beneficiaries, grants to partner organisations, and funding provided for overseas projects. Schools should be able to explain the charitable purpose of these arrangements and retain proportionate evidence of how funds are used.

Areas for schools to consider

Separately from the October clarification, many independent schools generate income from activities beyond tuition fees, creating a more complex tax profile. HMRC's guidance continues to distinguish primary-purpose trading from other trading, including commercial sponsorship and fundraising activities, and addresses the allocation of costs and overheads. Property-business income has its own charity tax exemption, subject to the relevant conditions, and should not automatically be treated as taxable trading income.

Schools should review the classification and tax treatment of non-primary-purpose trading and other income-generating activities, including whether any applicable exemption is available and whether a trading subsidiary is appropriate.

What should schools do now?

The October update is a timely reminder for charitable independent schools to review their direct tax compliance arrangements. Areas to consider include:

• reviewing non-primary-purpose trading and other income-generating activities, available exemptions and whether a trading subsidiary is appropriate
• considering significant or unusual expenditure, payments to beneficiaries and overseas organisations, and proportionate evidence supporting their charitable purpose and use
• reviewing the treatment and use of legacies received since 6 April 2026 under the separate April changes, including funds retained for future charitable use
• ensuring that records, controls and audit trails adequately support the school's tax position.

The revised guidance does not signal a withdrawal of established charity tax exemptions. Instead, HMRC has made its expectations clearer around the evidence and governance needed to support them.

For charitable schools, tax compliance and governance are closely connected. Clear oversight, proportionate due diligence and reliable records help demonstrate that funds are applied for charitable purposes and support the school's entitlement to direct tax exemptions.