Harnessing social investment tax relief to transform public services

Stone King’s response to the Treasury’s Consultation on Social Investment Tax Relief

HM Treasury has recently closed its consultation on social investment tax relief (SITR).

At Stone King we view SITR as an incentive that has the potential to unlock a valuable source of capital for charities and social enterprises, so they can develop and realise much needed social projects that may not otherwise be possible. We believe this consultation is an invaluable opportunity to improve SITR so that more areas of social policy can benefit from private investment.

We worked with Big Society Capital on their response to the consultation but also submitted our own, which we share below.

In our response we highlight some of the key areas for opportunity, such as eliminating the seven year age limit for organisations receiving investment, as well as explain why the current model (built upon EIS, the Enterprise Investment Scheme) does not quite fit for this sector.

Where we believe most impact can be made, however, is by taking ‘residential care provision’ off the list of excluded activities. This is an area in critical need but one which could also generate investment, acting as the basis for genuine change.

Summary

We believe that SITR has been under-utilised up to this point because it was not initially designed in a bespoke way for the sector to which it applies. Having worked with charity and social enterprise clients who have either tried to use SITR or wished to but did not meet the criteria, it is clear that there are numerable projects which could move forwards if the criteria were updated. This opportunity should not be missed.

Residential accommodation and wrap-around services for vulnerable groups: the need for SITR and the opportunity for society

In our work with charities, social enterprises and local authorities, we have seen a number of examples of public services which are currently:

  • provided at very high cost to the public purse (both directly and through knock-on access to other life-long services),
  • in a state of crisis in terms of demand versus available budget,
  • and in need of an alternative approach to funding.

Property is often key. For example, where accommodation is provided together with wrap-around services for looked after children and young adults; accommodation for homeless individuals; specialist accommodation for those with disabilities; hospices; rehabilitation schemes for ex-prisoners; and refuge accommodation for victims of domestic violence.

Time and again this is demonstrable proof that a stable, secure home with tailored support services halts the downward spiral for these vulnerable people. The social impact for individuals and wider society is clear and the economic advantages must not be underestimated, as reduced demand for ongoing or more extensive support means a significant reduction in demand on the public purse.

There is a considerable capital cost incurred in acquiring the necessary housing and other suitable property. Currently, properties are typically being provided by private landlords on expensive short term tenancies which are costly for the authorities and unlikely to provide longer term stability for the residents.

Social enterprises and charities could significantly improve this situation if they were able to provide accommodation and services in ways which align with their social or charitable purposes, benefitting vulnerable residents, reducing cost to the local authority and re-investing their profits in those social purposes. A common barrier, however, is the need for substantial capital investment.

The wider opportunity of SITR to facilitate improved provision of services, particularly public services and social benefit is a consideration which was not contemplated in the initial creation of the tax relief, but at this stage it should be specifically considered, even as far as being an objective of the relief. This is particularly relevant in relation to the provision of residential care accommodation in various forms.

The availability of SITR would provide a tipping point to encourage and facilitate individuals to invest in social enterprises and charities that provide these accommodation-based solutions. Whilst the tangible assets of the social enterprise would provide investors with a degree of reassurance, their investment would be subordinated to all the liabilities of the social enterprise or charity in which they had invested and their financial return would be capped at the outset. This is inherent in the nature of the social enterprise or charity which effectively prohibit investors from benefitting from potential increases in property value. For the investment receiving entities, this would strengthen their capital bases upon which to expand and improve services in ways which provide continuity and are central to the residents’ social outcomes.

Such investments could also be an opportunity to design more innovative financing solutions, using SITR investment to act as leverage for other types of investment and geared borrowing, allowing improved and sustainable solutions for areas of social policy which are in crisis. This has the potential to deliver real significant social impact and considerable savings to the public purse.

Why was this excluded in the first place?

Provision of a tax relief for investors is intended to encourage investment in sectors and industries which are high or higher risk. Using a similar basis to EIS, it has therefore been viewed that certain activities should be excluded from benefit as they are lower risk in terms of investment, or potentially at higher risk of being abused. As a result of these concerns, the provision of residential care accommodation, which is key to many social enterprises and charities, was deemed an excluded activity for the purposes of SITR.

As we have mentioned above, the urgent need for accommodation linked to the delivery of improved targeted support services, coupled with the increasing pressure on local authority resources can be described as an area of ‘market failure’ which is in need of support, some of which could be provided through tax relief.

Moreover, the risk of abuse, which was initially a cause for concern born from the experience of EIS, does not translate to the use of SITR because of the structure of receiving entities, as explained below.

Why is the perceived risk of abuse significantly mitigated within a social enterprise or charity?

SITR-qualifying investments can only be made into asset locked entities. This automatically limits the return that may be achieved by investors even if the entity were to be hugely financially successful. An asset lock means that the assets of the entity must be applied for the benefit of the entity’s social or charitable purposes instead of for private benefit.

For charities, in terms of capital, the asset lock means:

  • Charities cannot take equity and cannot issue dividends (except in extremely rare circumstances where any return must be to another similar and asset locked charity);
  • “Investment” in a charity must therefore be by way of a loan and, to qualify for SITR, must be unsecured and subordinated to other creditors;
  • On a solvent winding up the charity must transfer its surplus assets to another charity with the same or similar charitable purposes;
  • Charities may only sell their assets to another asset locked entity, or for full value and if the latter then the proceeds of sale must be applied for their charitable purposes;
  • De facto, investors cannot benefit from any capital gains e.g. by increase in the value of property.

In terms of income, for charities the asset lock means:

  • Charities must not pay more than a commercial rate of return on any loan made to them;
  • There is a limit on the return on investment which a charity can pay to an investor. This is set at the time of investment and is specified in the documents reviewed by HMRC as part of the advance assurance process so HMRC can see at the outset what is being offered.

For community interest companies (CICs), in terms of capital, the asset lock means:

  • On a solvent winding up the CIC must transfer its surplus assets to a similar asset-locked body after payment of liabilities.
  • CICs limited by shares may only return to their shareholders the amount of the subscription monies paid to the CIC for those shares. So if a share has been subscribed for £1, the holder of it may only ever receive a return of capital from the CIC of £1 for that share.
  • CICs limited by guarantee do not have share capital and can only raise money by way of debt. To qualify for SITR any such debt must be unsecured and subordinated.
  • De facto, investors cannot benefit from any capital gains e.g. by increase in the value of the property.

In terms of income, for CICs the asset lock means:

  • CICs can only pay out a maximum of 35% of their distributable reserves as dividends. And, as with other companies, the directors may not make any dividend until they have taken into account the working capital and other financial needs of the CIC. Thus the income return to any equity investment is limited.
  • CICs must not pay more than a commercial rate of return on any loan made to them;
  • Furthermore the rate of return on SITR qualifying debt offered by a CIC to investors is set at the time of investment and is specified in the documents reviewed by HMRC as part of the advance assurance process so HMRC can see at the outset what is being offered.

These features therefore prevent potential abuse or disproportionate personal gain to the investor.

As such, the opportunity for abusive practices is extremely limited. The re-consideration of excluded activities, particularly in this area, to take account of the nature of asset locked structures, the protection this provides and the nuance this requires (as opposed to the application and risks of EIS) is paramount in order to unlock the real potential of SITR as a catalyst for social improvement and a much-needed line of support for an increasing vulnerable population across the age ranges.

Final summary

We believe that SITR has been under-utilised up to this point because it was not initially designed in a bespoke way for the sector to which it applies. Having worked with charity and social enterprise clients who have either tried to use SITR or have been interested but have not met the criteria, it is clear that there are numerable projects which could move forwards should the criteria be updated in the ways discussed. The opportunity to create real impact is especially clear with regards to the application of SITR investment to areas of public social policy and residential accommodation. Whilst we understand HMRC’s legitimate concerns around this area, we believe that more nuanced and innovative criteria can be developed which addresses these concerns whilst also enabling what could be a transformative access to finance. This opportunity should not be missed.

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