The European Commission has threatened the Government with legal action for operating a tax system that it claims discriminates against foreign charities.

Under current rules, known as Gift Aid, British taxpayers are only entitled to tax relief on charitable donations when giving to a charity registered in the UK.

But the EC has warned that failing to offer tax relief on gifts to charities registered elsewhere in the EU amounts to illegal discrimination.

"Gifts to bona fide charities in other member states should get the same tax treatment as gifts made to domestic charities in other member states," Laszlo Kovacs, the EU's Taxation and Customs Commissioner, said.

In a statement, the EC said: "The difference in treatment between gifts made to charities in the UK and charities in other member states constitutes an obstacle to the free movement of capital.

"The discrimination is also contrary to the free movement of persons, as workers and self-employed persons moving to the UK might wish to make gifts to charities established in the member state where they came from. The rules are contrary to the freedom of establishment, as foreign charities are forced to set up branches in the UK in order to benefit from the favourable tax treatment."

British tax rules focus on the place of establishment of the charity rather than the location or locations where it actually operates.

Mark Persoff, a tax expert at Clifford Chance, said: "Recent European Court of Justice case law strongly supports the proposition that the UK's Gift Aid rules are arbitrary, discriminatory and contrary to the EC Treaty.

"The Commission's complaint is therefore well-founded, and it is to be hoped that the UK promptly amends its rules to allow relief for gifts made to bona fide charities established in other Member States."

The EC has given the Treasury two months to respond to today’s formal "reasoned opinion".

If the reply is not considered satisfactory, the Commission said it "may refer the matter to the European Court of Justice."

Mr Persoff said if the Treasury refuses to budge then the EC is "very likely to succeed in any infringement proceedings it will inevitably bring before the ECJ."

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