1. Ensure simple investment instruments, such as unsecured lending, are made eligible.

Transcription

1 Social Investment Tax Relief Consultation Enterprise and Property Tax Team HM Treasury 1 Horse Guards Road London SW1A 2HQ 6 September 2013 Dear Sir / Madam, RESPONSE TO THE CONSULTATION ON SOCIAL INVESTMENT TAX RELIEF The Social Investment Business Group (SIB Group) welcomes the UK Government s commitment to establish a social investment tax relief. It has the potential to transform the social investment market by attracting many more, new investors into the charities and social enterprise sector. The consultation document addresses most of the salient points of a helpful social investment tax relief; however, there are a few issues that should be amended in order for the relief to achieve the aim of encouraging more investment into social enterprise, in particular: 1. Ensure simple investment instruments, such as unsecured lending, are made eligible. 2. The terms of eligible investment should be as inclusive as possible, in particular through increasing the size of eligible investment, and the size of the eligible investees. 3. Indirect investment schemes, such as Collective Investment Schemes and VCT like schemes, should be made eligible for the relief. 4. The relief should apply to all eligible charities and social enterprise investees, irrespective of the sector or industry they work in. 5. The relief should complement and align with Community Investment Tax Relief and Gift Aid in order to present investors and donors with a clear set of options towards supporting charities and social enterprises. 1

2 Please find attached a detailed response from SIB Group that includes a summary of our priority issues, and detailed responses to the consultation questions. Kind regards, Jonathan Jenkins Chief Executive The Social Investment Business Group 2

3 CONSULTATION RESPONSE: SUMMARY 1. The Social Investment Business Group is a Social Investment Finance Intermediary (SIFI). For more information on The SIB Group, please see Annex A. Introduction 2. The SIB Group has invested over 320m into c.1,200 charities and social enterprises, through seven different funds, over the last 10 years. As such, our experience of the market and the issues that charities and social enterprises face in raising appropriate finance is significant. 3. We welcome HMT s consultation on the introduction of a social investment tax relief (SITR) as it will support the growth of the social investment market in the UK. 4. This summary section sets out our recommendations against the five priority areas noted in the covering note to our response. Ensure simple investment instruments, such as unsecured lending, are made eligible 5. The proposal outlines the key principles that define the eligible investment instruments that can be determined as risk capital Our internal records indicate that the majority of our investees have required secured and unsecured lending over the years, and that the market for equity or quasi-equity deals is small While we agree with the imperative to grow demand for risk capital, which is much needed in the charity and social enterprise sector, we believe that the SITR should be focused on supporting the flows of money into where it is most required: simple, unsecured loans. 8. The proposal also makes specific reference to requiring a link between the investor return and the financial performance of the charity and / or social enterprise We disagree with linking the social investor return to the financial performance of the investee. Such a restriction would prevent the use of simple financial products by charities and social enterprises 1 See the broad summary criteria in Box 4.A (p.17) of the consultation at p The SIB Group has in fact made only one quasi-equity deal, and no equity deals, out of a total of over 1,200 (grant and loan) investments. Please note, however, that through the Social Enterprise Investment Fund (SEIF) we have made 14 performance related grants, which could be considered akin to quasi-equity. 3 See section 4.8 of the consultation at p.16 returns offered on social investment should be linked to the financial performance of the qualifying organisation. 3

4 and effectively only provide relief for quasi-equity investment products, such as revenue participation agreements and performance-related debt This in turn would have a number of consequences in that it would: Prevent relief for simple and plain vanilla unsecured lending products that offer a fixed coupon rate that are most needed by social sector organisations; Not permit emerging investment products that align the investor return with the social performance of the organisation, such as social impact bonds; and Limit the social sector organisations that the relief would apply to because quasi-equity is primarily used by larger organisations due to the complexity and cost involved with creating bespoke quasi-equity products (for example, the landmark quasi-equity deal was completed by HCT group which has an annual turnover of over 23m). SIB Group Recommendation 1 Allow for simple investment products (such as unsecured lending) to be eligible by not linking investor return to the financial performance of the charity or social enterprise. Increase the size of eligible investment, and the size of eligible investees 11. A limit of 200,000 (approx. 150,000) of investment into a charity or social enterprise over three years is too low, and will severely restrict the effectiveness of the tax relief. 12. Recent research shows that even now, the average investment size in the social investment market is 264,000, which is substantially in excess of a 150,000 limit SIB Group is looking at establishing new funds that will provide investments between 100,000 and 1.5m. A tax relief should take into account the future strategy of SIFIs in this growing market. 14. The requirement to comply with State aid rules is clear, however, it is requested that if HM Treasury seeks State aid clearance from the European Commission on the relief, that a higher ceiling is argued for, such as 1m annually, as is the case with the Enterprise Investment Scheme (EIS). 4 See the revenue participation agreement between CAF Venturesome and Charity Technology Trust in the NCVO, Commission on Tax Incentives for Social Investment: Analysis and Recommendations, January 2012 at p See Growing the social investment market: Landscape and economic impact, GHK, 2013, p.20. 4

5 SIB Group Recommendation 2 Investigate whether the calculation of State Aid for debt products can be distinguished from equity and quasi-equity to increase possible size of investments permitted in the Finance Bill Regardless of the above calculation, HMT to publicly commit to work with the European Commission to raise the investment limit to 5m for inclusion in the Finance Bill Indirect investment schemes should be made eligible for the relief 15. The proposal restricts investment structures only to nominee schemes, which will miss out a large group of potential investors, as: EIS nominee schemes appeal to very high-net worth individuals with average investment size of 25,000 (by contrast, the average investment size under VCT is around 2,000). Additional consumer protection offered through compliance by the VCT with listing rules of an exchange may help in convincing first-time investors to the social investment market. IFAs may feel less comfortable recommending investments without the comfort surrounding a listing regime, limiting the likely breadth of product distribution. Some investors will need a tax relief with immediate effect rather than wait a lengthy period of time (up to a year) for the initial income tax relief to be used. 16. Extending the reach of the indirect investment structures to include VCTs would broaden the pool of investors available to social organisations to provide risk capital. It would also help accelerate the development of the social investment market through promoting the growth of a diverse landscape of SIFIs. 5

6 SIB Group Recommendation 3 In addition to nominee schemes, permit indirect investment through VCT-like schemes that invest in SITR qualifying investees using SITR investment instruments. The relief should apply to all eligible organisations, irrespective of sector or industry 17. The current EIS rules have deliberately excluded certain activities to avoid purely speculative activities. The aim of SITR however already precludes organisations that would undertake purely speculative activities as they by definition exist for a social and/or environmental purpose. 18. Importantly, a significant proportion of social enterprises operate explicitly in the current excluded activities to address entrenched social problems within or via those industries. As a priority we would highlight the importance of enabling social enterprises with the following trading activities to be eligible for SITR: Financial activities, such as banking, insurance, money-lending, debt-factoring, hire-purchase financing or other financial activities: these are precisely the activities that Community Development Financial Institutions deal in to assist individuals experiencing financial exclusion (9% of charities and social enterprises are engaged in these activities). 6 Property development and leasing and letting assets: these are precisely the activities that community organisations, such as IPS (BenComs), deal in to exercise rights of community ownership under the Localism Act 2011 and to build community cohesion in deprived areas. Operating or managing nursing homes, residential care homes or social care housing, or managing property used as a nursing home, residential care home or social housing: these are precisely the activities that health and social care charities deal in to improve the lives of the elderly and infirm (10% of charities and social enterprises are engaged in these activities 7 and approximately one-third of all social care providers are charities). 6 According to a survey of social enterprises, see The People s Business, SEUK, 2013, at p According to a survey of social enterprises, see The People s Business, SEUK, 2013, at p.18. 6

7 SIB Group Recommendation 4 There is no need to maintain excluded activities for SITR. We would prioritise that SITR should be made available to social enterprises that operate: financial exclusion, social housing, community regeneration and development and social care services. Alignment with the CITR and Gift Aid 19. Community Investment Tax Relief (CITR) is a tax relief launched in 2002 to encourage corporate and individual investments into CDFIs for the purpose of on lending to micro, small and medium enterprises based in disadvantaged communities that are unable to access mainstream finance. 20. SITR, on the other hand, is designed as a relief to encourage individual investments into social enterprises to enable them to become sustainable. 21. The two schemes differ in their structure but are complementary in their purpose to grow the social economy. As CITR investments have to be specifically used for the purpose of on lending through financial intermediaries (CDFIs) the scheme in no way clashes with the intended purpose of social investment tax relief. In fact launching a new relief gives the Treasury a unique opportunity to revitalise and improve CITR so ensure both reliefs work well together in growing the social economy. 22. Regarding gift aid, the proposals recognise that introduction of the SITR may lead some donors to convert their donation into an investment, to either the same or a different charity. 23. Switching of donations to investments is more likely if the rate of relief to the donor is higher with an investment than with a donation. As the proposals stand this seems quite likely for high income donors: the consultation suggests the relief may be set at around 30% (all going to the investor), while a top rate income tax payer receives 25% relief on a donation. If the relief is set too low however it may become unattractive when compared to other tax reliefs available, such as the EIS or VCT schemes. If SITR is set at 30%, it will be important to carefully monitor any impact on charitable donations, and it may be the case that a lower level of relief is more appropriate and is sufficient to attract new investment. 7

8 SIB Group Recommendation 5 CITR should be kept in place, simplified and improved. An improved CITR and a new SITR can be co-marketed alongside each other as social investment opportunities The SITR relief rate of 30% should be kept under review to monitor its impact on Gift Aid. 8

9 CONSULTATION RESPONSE: DETAILED RESPONSE TO QUESTIONS Question 1 Do you agree with the proposed criteria for assessing options for the social enterprise tax relief? Please provide comments as appropriate. 1. Yes. 2. Our views on compliance with State aid rules have been made above, in the summary section (para.14). 9

10 Question 2 Would adopting a definition of social enterprise comprising Community Interest Companies, Community Benefit Societies and charities that are registered with the charity (or other principal) regulator and also recognised as charities for tax purposes exclude organisations that might reasonably be included, or include organisations that in your view should be excluded? If so, please say why. 1. The definition should be more inclusive as it will exclude: Social enterprises that are companies limited by guarantee (CLGs that are not registered as a charity) and companies limited by shares (CLS). Trading subsidiaries that are not charities or social enterprises, but which are majority owned (>51%) by a parent charity or social enterprise to operate commercial activities. 2. A significant proportion of social enterprises are CLGs (not registered as a charity). In fact, SEUK s latest State of Social Enterprise Survey (July 2013) revealed that 51% of social enterprises are constituted as CLGs, and of these, 59% are not registered as charities. 3. Overall, this means that around one-third of all social enterprises are CLGs, not registered as charities, which would not be eligible for the SITR as it is currently proposed. 4. In order to ensure that CLGs meet the definition of social enterprise, CLGs should demonstrate that they are driven by a social and/or environmental purpose. This evidence could be obtained by a review of the organisation s governing documents to ensure that a social and/or environmental mission is embedded in its constitution. 5. CLS s should similarly have to demonstrate that they meet the definition of a social enterprise, as evidenced by a social and/or environmental purpose; and in addition, they would need to prove that they are not applicable to EIS as well. 6. Trading subsidiaries may likely be interested in and require additional finance to expand their operations. The existing VCT scheme does not adequately provide for trading subsidiaries in that the investee organisation cannot be controlled by another organisation meaning that these trading subsidiaries are excluded. 10

11 7. If the definition is not made more inclusive of the additional above mentioned groups, the SITR will exclude many organisations that it is intended to support, and the potential economic and social benefit from it will be reduced. 11

12 Question 3 Is there an alternative definition of social enterprise that would more accurately reflect the types of organisation that should benefit from the relief, and would be workable in legislation? If so, please provide one. 1. As mentioned in the response to Question 2, the definition of social enterprise should be more inclusive, and cover the following organisational forms: Community Interest Companies (CIC). Community Benefit Societies (BenComs). Charitable Incorporated Organisations (CIO). Companies Limited by Guarantee (that are regulated by the Charity Commission). Companies Limited by Guarantee (that are not registered as charities). Companies Limited by Shares (CLS). 2. Should an actual definition of social enterprise be needed, the current and principal definition already used by government 8 forms the foundation of an alternative definition to the one proposed in this consultation: A social enterprise is a business with primarily social objectives whose surpluses are principally re-invested for that purpose or in the community rather than being driven by the need to maximise profit for shareholders and owners. 8 Definition first developed and published as an official definition for social enterprise in 2002 from the Social Enterprise Unit within the Department for Trade and Industry (now the department for Business, Innovation and Skills and the Social Enterprise Unit was integrated into the remit of what is now the Office for Civil Society). This definition is still widely used across government departments, including BIS, see 12

13 Question 4 Are there any particular advantages or disadvantages to making charities eligible for the relief? In particular, is there a risk that donations to charities will be displaced into investments and what would be the consequences of this? 1. Yes, there are clear advantages in making charities eligible for the relief and the risks of displacement of donations are unclear as yet. 2. Charities should be eligible for the relief because they are a major source of demand for social investment. Registered charities represented 32% of social investment recipients in a randomly selected sample in and at least 35% of organisations with greater than 25% trading identifying themselves as social enterprises (which is the group traditionally considered particularly interested in obtaining social investment) There is a potential risk that a tax relief for social investment will displace or cannibalise from the tax relief base designed to benefit charities, particularly in relation to Gift Aid. As people are not able to access both Gift Aid and SITR this may cause the level of philanthropic giving to decrease if people choose to invest as opposed to donate their money, as they previously would have done. 4. It is not possible however to ascertain with any certainty the extent to which this cannibalisation may occur before the reliefs run alongside one another. There is also some research which suggests that the motivations and mind-set driving those to engage in social investment will likely be different from those who engage in charitable giving Messaging and awareness-raising around the SITR will need to take into account these different mind-sets, philanthropy and social investing, in communications with potential investors. 9 See Growing the social investment market: landscape and economic impact, GHK, 2013 at See The People s Business, SEUK, Worthstone, The role of tax incentives in encouraging social investment, commissioned by Big Society Capital and City of London Corporation (2013). 13

14 Question 5 If charities are eligible for the relief, it will be necessary for specific anti-avoidance rules to ensure investments do not receive relief as both investments and donations, including the need to account for donations and investments separately. Do you foresee any practical problems with this? Are there any other specific avoidance risks that would arise from allowing charities to be investee organisations? 1. The same funds should not be able to attract Gift Aid and SITR. 2. It is worth noting that an investment can only be contemplated should the social enterprise have a business model that enables taking on repayable capital. Many charities prefer to separate out such activity into a wholly-owned trading subsidiary. 3. If wholly-owned trading subsidiaries are eligible for SITR then many charities may prefer to direct social investments into their trading subsidiaries for increased accountability and transparency reasons. This would aid the aim of accounting for donations and investments separately. 4. Charity parent companies therefore and also their wholly-owned trading subsidiaries should be made eligible for SITR. 14

15 Questions 6 and 7 Would a size requirement of up to 250 employees be appropriate for the social investment tax relief, or should a lower limit be introduced initially? What are the benefits and disadvantages of using gross assets or turnover to measure size, and what would the appropriate limits be? Please provide reasons and evidence. 1. No. Ideally no size limit should be imposed as the definition for eligibility for charities and social enterprises should hinge on the proof of a social purpose, not on the size of their business operations or stage of growth. 2. Social enterprises across the size spectrum are in need of investment with an estimated 39% of social enterprises stating access to finance as a barrier to sustainability and growth Number of employees is not an appropriate measure because it fails to account for the labourintensive nature of charities and social enterprises, 13 nor that much of their social impact is derived from employment of disadvantaged groups. For example, a limit on the number of employees would significantly restrict the ability of larger service organisations to participate, such as the public service spin-outs where at least 7 mutuals have greater than 1,000 employees and the average number of staff at all mutuals is Annual turnover is also an inappropriate measure of size because it is unrepresentative of an organisation s ability to raise finance. Turnover levels are likely to comprise a mix of different items, including grant funding, donations and trading income, much of which can be particularly volatile. Charities and social enterprises should not be penalised for being successful in achieving grants or trading income through their good management. 5. If a size limit must be placed on the relief, the amount of gross assets is the most appropriate measure to determine size of eligible organisation as it is the measure most closely related to the problem the SITR is trying to address: lack of assets available to secure against investment. 6. Many charities and social enterprises that should benefit from SITR cannot raise the right capital as they hold a small amount of assets even though they may have large numbers of employees 12 Social Enterprise UK, The People s Business: state of social enterprise survey 2013 (July 2013). 13 Compared to all SMEs, social enterprises tend to be larger in terms of employees: a fifth of social enterprises have between employees compared to 14% in SMEs generally, see Social Enterprise Barometer, BIS, February See Soft Finance, Hard Choices, BCG, 2013, at 5. 15

16 and significant annual turnover. A recent survey of health and social care spin-outs seeking working capital to service contracts shows that on average they hold assets of 124k, even though they have on average turnover of around 18m, and up to 2,000 employees. 15 A gross assets limit of 15m (consistent with EIS) should be used, and an initial grace period (for example, 3 years) for the size limit to take effect should be allowed in order to encourage larger charities and social enterprises that may be more able to use the SITR quickly to demonstrate the effect of the SITR. 15 See Spin-Out, Step-Up, SEUK, 2013, at

17 Question 8 Would it be appropriate to exclude particular activities from the social investment tax relief, in order to keep the tax relief well-targeted, or would the existing regulation of the qualifying organisations be sufficient? If the Government does introduce exclusions, should specific organisations be entitled to the social investment tax relief that are not currently able to access the venture capital reliefs, for example organisations delivering social care, or arts based organisations? Should any additional exclusions apply? Please give reasons. 1. No, it would not be appropriate to exclude particular activities. 2. The other venture capital schemes (EIS and VCT) have deliberately excluded activities to avoid purely speculative activities. The current proposal already provides a clear list of eligible charities and social enterprise organisations that precludes organisations that would undertake speculative activities. 3. Moreover, many charities and social enterprises expressly exist to deal in the excluded activities, for example: Financial activities, such as banking, insurance, money-lending, debt-factoring, hirepurchase financing or other financial activities: these are precisely the activities that Community Development Financial Institutions deal in to assist individuals experiencing financial exclusion (9% of social sector organisations are engaged in these activities); 16 Property development and leasing and letting assets: these are precisely the activities that community organisations, such as IPS (BenComs), deal in to exercise rights of community ownership under the Localism Act 2011 and to build community cohesion in deprived areas; and Operating or managing nursing homes, residential care homes or social care housing, or managing property used as a nursing home, residential care home or social housing: these are precisely the activities that health and social care charities deal in to improve the 16 According to a survey of social enterprises, see The people s business, SEUK, 2013, at p

18 lives of the elderly and infirm (10% of charities and social enterprises are engaged in these activities 17 and approximately one-third of all social care providers are charities). 4. Many charities and social enterprises are currently prevented from accessing current venture capital schemes (EIS and VCT) because of the above excluded activities, even if they have an equity structure. 5. These organisations may include CIC CLSs (which there are around 2,000), IPS (BenComs) with redeemable shares, and theoretically some charities. This means it is very important that the new tax relief can also be used by charities and social enterprises with equity structures in order to ensure that they could pursue many of these activities. 17 According to a survey of social enterprises, see The people s business, SEUK, 2013, at p

19 Question 9 Do you agree with these general principles governing the scope of the investment instrument as a means to ensure that the tax relief for social investments is well-targeted and focussed on appropriately high risk investments? 1. We agree with the following proposed general principles, that: The same investment does not also qualify for tax reliefs under SEIS or EIS. The original investment or principal is not secured against assets or subject to guarantee. The holders of the investment do not have preferential rights to assets on winding-up of the social enterprise, compared to other holders of the same type of investment. 2. We do not agree with the general principle, returns on the investment should be payable at a broadly commercial rate and on broadly commercial terms. It is extremely problematic as it will not ensure that the tax relief is well-targeted to appropriately high risk investments. 3. There are fundamental differences between the principles governing social investment and commercial investment and practical issues which would make this general principle unworkable. No floors or caps should be applied from the outset on the rate of return. 4. A full response to this specific issue is available in our response to question

20 Question 10 What would be the most appropriate way to ensure that tax relief is not provided for less risky debt investments? Do the summary criteria set out in Box 4.A achieve this aim? 1. Yes. 2. A set of summary criteria (such as in Box 4.A) is more effective than an exhaustive prescriptive list at capturing the variety of investments (other than less risky debt investments) emerging in the social investment market 18 that should be eligible in this tax relief. 18 These include: - Equity (e.g. Charity Bank, SettleHydro). - Quasi-equity (e.g. CTT revenue-participation agreements, Peterborough Social Impact Bond). - Performance-related debt (e.g. HCT group part-fixed, part-social loan). - Unsecured lending (e.g. Scope fixed coupon bond). 20

21 Question 11 Would a rule requiring investments not to be secured against assets or subject to guarantee ensure that the tax reliefs are well-targeted? Would this create any substantive difficulties for investors? 1. Yes. Security is an appropriate measure of the riskiness of capital, if it is defined appropriately. 2. Linking the tax relief to investments subject to guarantee however is more problematic. 3. Security is an appropriate measure for distinguishing the less risky from more risky investments. Clearly there is greater certainty of the recovery of original principal invested in the event of failure to repay when security is present. 4. The type of security that is less risky and should be outside the scope of the tax relief is residential and commercial property and land (together property assets ) because these offer by far the lowest level of risk and are already the most attractive security to investors. Investments secured by property assets are demonstrably less risky than other assets because they offer a greater likelihood of recovering the original amount invested. 5. Guarantees are not as appropriate as a tool for distinguishing the less risky investment products. Guarantees obviously increase the likelihood of recovering the principal investment (and reduce the risk of non-recovery) than holding no security whatsoever, however such investments remain substantially risker than harder property assets because: They are clearly more dependent on the credibility and continued good credit of the underlying guarantor, which can be more volatile than fixed assets. Enforcement action as against guarantors is particularly difficult and requires complicated and lengthy legal actions (particularly against individuals with serious consequences including eventually selling the guarantor s house). 6. If still necessary to exclude investments subject to guarantee, it may be possible to distinguish the guarantees that are useful at reducing risk from the less useful ones. 21

22 Question 12 Is it reasonable to require an investment return at a commercial rate, given the nature of the social investment market? If so, what would be the most appropriate way to ensure that any dividends or interest payments that form a return on the investment are paid at a broadly commercial rate? How can the Government best limit opportunities for manipulation on returns? 1. No. 2. A commercial investment is viewed within a profit maximisation context only, whereas a social investment is viewed from the point of view of maximising both social and financial returns. 3. The blend of financial and social return can also differ significantly from deal to deal, depending on numerous separate factors, both from the point of view of the investee (such as the sector they work in or the beneficiary group they are supporting) and of the investor (risk may be shared by differently motivated investors with different risk-return expectations, greater risk may be ventured in new markets and / or innovative approaches). 4. A commercial rate of return could also go against the nature of how social investment operates between an investor and an investee and how they choose to define return based on the expectation of social and financial return, and alongside that, how they calculate risk into the return. 5. For example, it is for the social investor to decide whether the potentially lower return offered by a social investment instrument relative to a commercial one is attractive given the social impact created, and whether this satisfies their perspective of the level of risk involved. 6. Given the nascent stage of development in the social investment market, clear and robust information about the rates of return and risk are still evolving. 19 It is also unclear which commercial rates of return from a mainstream financial market could alternatively be applied. Further, a workable definition should also incorporate risk-adjusted return to properly account for the perspective of the investor. 19 A only minor difference in expected returns is provided between secured lending, unsecured lending and equity products in the most recent market survey, which contrasts with the obvious return differentials evidenced in mainstream financial markets indicates that the market has not yet established clear pricing trends. See Growing the social investment market: landscape and economic impact, GHK, 2013, at p

23 Question 13 Would it be appropriate to allow redeemable shares, or an equivalent for debt-like investments, after the minimum period for investment had been reached? 1. Yes. Redemption and the equivalent for debt-like investments should be permitted after the minimum investment period. 2. Most traditional financial products (save for pure equity) allow for some measure of redemption of the investment product after a time. For example, regular interest-bearing loans have set maturity dates whereby the outstanding principal and interest becomes payable. Investors will likely expect this format for many types of investment products that are not equity. 3. Existing social investment products with redemption periods include the Scope bond, which is repayable in full after three years, and even revenue participation agreements, that may require redemption after a fixed time period. 20 This redemption period also offers investees the chance to know when they will be finally free and clear of debt. 4. Amortizing loans, which repay both interest and a proportion of principal investment prior to the maturity date, should also be considered within the scope of the tax relief. HMT would need to decide how much outstanding capital would be permitted at the end of the minimum investment period. 5. In relation to IPSs, withdrawable shares should also be permitted to be redeemed or withdrawn after the minimum investment period at par value, in keeping with their current experience of using them to raise community investment capital. The requirement for a maximum investment of 20,000 per individual investor and the investor s ability to only retrieve par value would help ensure that the investor still bears the sufficient risks in the investment. 20 See 23

24 Question 14 Would the criteria overall result in any damaging, distortive or unintended consequences in the field of private investment into social enterprise? Please give examples where investments would be supported, or where difficulties might arise. 1. No, as long as the criterion is able to take into account that social investment has different (social as well as financial) return expectations to commercial investment. 2. We agree with the summary criteria for the SITR investment instrument in general terms, and as noted in the response to Question 12, have a concern around the definition of commercial rate of return. 24

25 Question 15 Would a tax relief allowing investments of a maximum of 200,000 per investee organisation over three years be successful in generating additional social investment? If so, what types and sizes of social enterprise would be likely to benefit? 1. Yes in and of itself, but a limit of 200,000 per investee (or approximately 150,000) misses a huge opportunity. 2. Such a limit would mean that the tax relief has only limited effect in stimulating social investment: Recent research provides that the average investment size in the social investment market is 264,000, in excess of the 150, Further, the average sizes of the most risk-taking products, quasi-equity and equity, were substantially higher at 242,500 and 162,000 emphasising the need to set a higher investment limit. Most government contracts that charities and social enterprises will be seeking to compete for will require working capital funding likely to be greater than this cap; potential million pound contracts arising out of the forthcoming 500m justice reforms would require substantial working capital funding. More bespoke social investment products that need to be developed in the social investment market require a much greater level of investment size to make the economics work, given the extra effort and resources required to develop them. Interviews with mainstream financial institutions suggest that the market failure for lending to social sector organisations exists for amounts up to 5m of investment, and a total absence of mainstream finance for investment amounts below 2m Further, it is unclear that a 150,000 investment limit would be adequate to attract existing and mainstream intermediaries to engage in this tax relief. Intermediaries will be required to develop products, funds and find investors for the tax funds, much like Octopus, MMC and Oxford Capital Partners operate in the EIS market. Initial feedback from existing EIS fund managers and market 21 See Growing the social investment market: Landscape and economic impact, GHK, 2013, p From interviews with mainstream banks, as provided in Internal Report for BSC on State of Secured Lending Market, Management Consultant,

26 participants suggests that 150,000 limit is much too low to attract the interest of professional EIS fund managers and advisers that may need to charge substantial costs to arrange and promote any offer (and such cost amounts would be too great a proportion of the investment to be feasible). Evidence about the take-up of EIS funds suggest that at least 50% of the total volume of investments made through the EIS is for amounts of investments into companies of greater than 1m We understand that this investment limit has been designed by HMT to comply with the European Commission limit for de minimis state aid and therefore enable speedy implementation of the tax relief within the Finance Bill We agree with the need to capitalise on the current momentum in the social investment market. However, we have two specific considerations about how this investment limit can be applied within the context of State Aid regulations. 5. Firstly, the calculation of the state aid would ideally be made on a different basis for debt products to quasi-equity and equity products. 24 From our reading of the relevant Commission Regulations and discussions with stakeholders, 25 it may be possible for the de minimis amount in respect of quasiequity and equity products to be calculated as the total capital injected, whereas the de minimis amount in respect of debt could refer to a calculation about the difference between the actual interest rate charged and the market interest rate multiplied by the principal amount of the debt. If this distinction is possible, it would have a material effect on the amount of unsecured lending that could be permitted under this tax relief Even if this de minimis calculation is possible, it is still important to set a higher level of maximum investment per organisation of 5m (to be comparable with EIS). Whilst we appreciate that such an investment limit increase remains subject to the approval of the European Commission, we believe that a public commitment to seeking approval to increase the investment limit would have a productive effect on the development of the tax relief for intermediaries as well as generate greater attention about the relief in the social sector. 23 EIS1 tables from HMRC. 24 Assuming that plain debt products are included within the remit of the relief, as provided in our responses in Part B and Part C. 25 This includes Commission Regulation (EC) No 1998/2006 of 15 December 2006 on the application of Articles 87 and 88 of the Treaty to de minimis aid Article 4 and the consultation on the draft regulation at Article 4(2)(b) ( Loans ) and 4(4) ( Risk finance ) on the application of section 107 and 108 of the Treaty and Functioning of the European Union to de minimis aid. 26 For example, a 5% difference between the reference rate and actual rate could mean that a social sector organisation could obtain 3m of unsecured loans instead of the current 150,000 limit. 26

27 Question 16 Is a cap of 1 million of investments per investor per year the right amount? 1. Yes. 2. There is however a discrepancy between the proposed 1m cap for investors and 200,000 cap for investees. We foresee that this will create administrative burdens for investors who will have to invest in five or more separate social enterprises in order to take maximum advantage of the SITR. 27

28 Question 17 Should the EIS conditions on how and when the money raised by the investment must be used also apply to the social investment tax relief? 1. The EIS conditions that relate to the terms of the investment (such as the length of the relief) would apply to the SITR. 2. The EIS conditions that refer to restriction of certain sectors (as noted in the response on Question 8) would not apply to the SITR. 28

29 Questions 18, 19 and 20 Is the double cap, (aggregate cap at 35 per cent and dividend cap maximum 20 per cent) on distribution by CIC limited by shares too burdensome and does it therefore discourage investment or setting up such a CIC? How and why? If there were to be a change to the caps, should one or both of the caps be removed or increased? Please give reasons and explain how this should be done. Would this change allow adequate protection of community assets? What would be the effect of changing or removing the peg to the initial paid up value of shares? Would this affect the statutory asset lock and the protection of community assets? If so, please say why. How should the value of shares be determined by the market, by inflation, by a specified percentage? 1. The current CIC dividend caps and pegs to initial paid up value of shares are burdensome and discouraging investment. To address this, pegs to the initial paid up value of shares should be removed and the aggregate dividend cap should be raised to 49%. 2. Community Interest Companies have been attracting increasing interest with a 20% increase in the number of CICs on the public register over 2012/2013 from the previous year. We also understand that many large public and private sector commissioners (such as the NHS) are favouring the CIC form as an easy way of distinguishing organisations that they can contract with. 27 However, these trends belie some conflicting experiences about the use of CICs limited by shares in particular: CIC limited by shares comprise less than 25% of overall amount of CIC, suggesting they may be being underused. Lack of funding was the most common reason that CICs stated for their dissolution (25% cited this) often still relatively quickly after establishment 28 prior to 21 months when they are required to submit their first community interest report. Interestingly, only 0.5% suggested they dissolved because of a failure to be awarded contracts that they were expecting. 27 According to the feedback from the workshop held at BSC relating to identifying social purpose businesses. 28 Many CICs dissolved prior to 21 months when they are required to submit their first community interest report. 29

30 Feedback from key stakeholders including social entrepreneurs suggested that the CIC model, particularly the dividend caps, remains confusing and unattractive for organisations keen for substantial growth The peg to initial paid up value of the shares exists not just in the dividend cap, but also in the event of redemption of shares and wind-up of the CIC. This peg remains a significant barrier to encouraging greater investment in CICs limited by shares: For investors, the current pegs are unattractive because it means the price of shares is effectively always set at the initial investment amount providing for no capital growth over time. Further, even though sales to third parties are permitted by the CIC regulations, it is extremely unlikely that any third party investor will purchase shares (certainly not for any value above the initial paid value) that have this restriction embedded. For entrepreneurs that found CICs limited by shares with the hope of growing scale and social impact, the current pegs severely impede their ability to share in the growth of the CICs (or sweat equity ). Entrepreneurs effectively cannot sell shares back to the CIC (through redemption) or to a third party investor at any premium. The social investment tax relief will not be able to be as effectively used as possible under the current form of CIC limited by shares. The incentivising of long-term patient capital in the tax relief is inconsistent with a CIC structure that effectively prohibits investors obtaining any capital gain. 4. Removing the pegs to paid up value of shares therefore provides greater flexibility and significantly better access to capital and use of CICs limited by shares within the new tax relief. 5. The aggregate cap on dividends should remain to safeguard community assets however it should be increased to 49% of all distributable profits accumulated over time. 30 This altered structure would be beneficial because: It is simpler to understand for entrepreneurs and investors (one dividend cap). It provides flexibility for CICs to design the capital structure to attract a wider variety of investors (for example, a different share class could be used to attract a particular investor class). 29 All data in this paragraph from Annual Report 2012/2013, Regulator of Community Interest Companies, CIC Regulator. 30 Currently section provides an ability to carry forward unused dividend capacity from year to year up to five years, see the Information and Guidance Notes, Office of the Regulator of Community Interest Companies, March

31 Setting such a dividend cap structure would also be broadly consistent with current approaches to ensure that the social mission of private companies invested in. By way of example, BSC has published a Governance Agreement 31 that mandates that all investees that are private companies must ensure that surpluses are principally used to achieve social objectives (as) the pay-out of cumulative profit after tax to shareholders will be capped at 50% over time. SEUK also suggests that the majority of the surplus is re-invested in the social enterprise Removing the pegs to initial paid up value of shares will provide greater flexibility and significantly better access to capital and ensures that CICs limited by shares can effectively utilise the new tax relief. Protection of community assets would be maintained by the requirements flowing from the existing legal duties imposed on directors to adhere to the community objects of the company, as well as the existing requirements to produce community interest reports. If concerns still exist about the protection of community assets, enhanced reporting of community interest could be required for CICs that obtain significant amounts of external equity investment (for example, investment amounts higher than 1m) Another option that could be investigated would be to ensure that each CIC has a golden share that has no economic value but has control of the CIC s community objects. This golden share would help prevent a change of the social mission in the case of a new equity owner. Of course, at all times, dividend payments will remain subject to the existing restrictions on unlawful distributions and directors duties under English corporate law meaning that appropriate restrictions on abuse of these regulations will continue to exist. 8. We do note that a question could be raised about whether the changes to the caps on redemption of shares, repurchase of shares and winding-up of the CIC would fundamentally change the nature of the asset lock. If this was a significant concern to the CIC regulator, one idea to address this issue is to ensure that private investors would be able to share in any appreciation in value of the CIC in the same proportion as with dividends. That is, private investors should be able to receive up to 49% of dividends from CICs (as in our current proposal) and also up to 49% of the capital gains from the CICs (arising on redemption, repurchase or wind-up). 31 See the BSC website: 32 See SEUK s membership badge criteria at 33 This concept was referred to by UnLtd at and has been discussed in the context of a roundtable hosted by BSC and UnLtd in early August. 31

32 9. This approach would ensure that investors could receive some benefit from the appreciation of the value of the CIC (and if less than 49% of shares are issued to private investors, their full entitlement to that appreciation) whilst the community, including other investors that are asset-locked bodies within the meaning of the CIC regulations 34 and the CIC itself, would continue to receive the majority of the appreciation of value of the capital gain. Sales of shares by private investors (even if wholly owned by private investors) would continue to be allowed however the shares sold would retain the same rights on redemption, repurchase and wind-up. 10. Whilst we understand there is limited evidence about the views of key CIC stakeholders for such reforms, the responses from a survey of CICs conducted in early 2013, A Fair Share: 2012 Review of the CIC Dividend Caps are encouraging. It provides that the most common suggestion for reform to the CIC regulation from CIC CLSs and key stakeholders was to have one unified cap of 49% These reforms could produce a very attractive model of investment for social investors, entrepreneurs and the community. If these suggested reforms are undertaken, we expect an increase in both the number of new social organisations constituting themselves as CICs, particularly mutual spin-outs and social impact bonds (see Part D (III) below) and the number of existing social organisations constituted as (non-charitable) CLS and CLGs to transfer to the CIC form. The anticipated increase in investment into CICs would also mean that many CICs may now be a larger size as well. To properly implement these reforms, we would also support an increase in the resources available to the CIC Regulator to ensure that it can effectively regulate and raise awareness of the CIC model throughout the UK. 34 As described in section of the Information and Guidance Notes, Office of the Regulator of Community Interest Companies, March See A Fair Share: 2012 Review of the CIC Dividend Caps, CIC Association CIC, January