SITR

Three easy ways to make the broken Social Investment Tax Relief work

By 10th July 2018 No Comments

Social Investment Tax Relief (SITR) has seen little take up from the bodies it was designed to assist – Kin Capital co-founder Tom Hopkins says this potentially important tax relief needs a governmental review now

SITR was designed to increase the access to reasonably-priced investment capital by range of eligible organisations which were struggling with established channels.

It is a tax incentive modelled on the better-known Enterprise Investment Scheme (EIS).

Unlike EIS, though, its aim is to generate a positive social return (or ‘impact’) as well as a positive financial return.

But it is failing.

SITR was launched in 2014 and was designed to increase the availability of capital to a range of eligible organisations that might struggle to raise finance at a reasonable cost through traditional methods; Community Interest Companies, Accredited Social Impact Contractors, Community Benefit Societies and Charities.

The key difference with EIS is any investment can be a structured as a loan (or equity) as opposed to as equity given the capital structures on the organisations above.

Another difference is the limits per organisation are lower – a qualifying social enterprise can only raise £1.5m over its lifetime, or only c. £300k if the entity has been operating for more than 7 years.

What has gone wrong?

All fair enough but the take up has been low – anecdotal evidence suggest around £2m was invested last tax year (2017/18), while the official amount for 2016/17 is 25 social enterprises received investment and £1.8 million of funds were raised.  Nothing to crow about, then.

Since SITR was launched, to end of 2016/17 tax year, only 50 social enterprises have raised funds of £5.1 million through the scheme.

Clearly this is disappointing for everyone involved in the social investment sector, at a time of spiralling interest from investors for social impact investment.

Currently investors don’t have many options for tax efficient social investment. There is of course Gift Aid but that is donating not investing. And the feedback from investors we have spoken is they like the fact SITR enables them to generate a modest financial return and a high social return.

So we believe demand from investors is not the problem – it is simply a supply issue and the government should look to loosen the restrictions on SITR to ensure more UK Venture Capital Scheme capital brings social as well as financial return.

Admittedly, following recent EIS and VCT rules changes, more capital will be invested into growth businesses, boosting UK Plc and creating jobs which is vicariously a certain level of social return.

But it you can’t argue that capital is helping vulnerable groups and it would be great to have one the UK Venture Capital Schemes delivering measurable social return outcomes to round off the positivity around these schemes.

What can be done to fix SITR?

SITR has substantial potential as a tool to offer enterprises and charities access to affordable social investment. However, it is the restrictions around accessibility of SITR which have hampered the ability for enterprises to make use of it.

Interestingly, one SITR Fund has changed the structure of their second fund to an EIS and SITR fund to give itself greater flexibility to deploy capital.

The critical failure of the SITR market is the fact that organisations who would benefit from it are deemed ineligible due to the restrictions of the legislation, particularly those changes introduced in the 2016 Autumn Statement

Some urgent and vital changes we at Kin would suggest are these:

  • Adjust SITR eligibility criteria so they are more attuned to the needs of social enterprises. This is our view is the easiest, most obvious and powerful of reforms that could be made.

So for instance, by allowing EIS qualifying companies to access SITR capital where there is a measurable social return outcome. These companies could apply to an appropriate regulator (e.g. the Community Interest Company regulator).

  • The government should re-allow refinancing of debt. Many social enterprises have a number of high-interest loans that could be replaced in part or fully by SITR loans.

This would reduce complexity, cost and cashflow constraints for such enterprises. Refinancing of existing debts was prohibited under the changes to SITR legislation in 2016 but would seem to be an excellent use case for SITR in reducing hurdles to social enterprise growth.

  • Revisit current care home investments restrictions. With an ageing population, the UK needs an expansion of high-quality care homes.

An accreditation scheme has been discussed by HMRC to allow SITR investment into only those care homes (and associated enterprises) that can be classified as social. In the interim, no SITR investment into care homes and associated enterprises has been possible. Kin Capital suggests HMRC launch this accreditation scheme, and/or review potential care home investments on case-by-case basis with the burden on the investee to prove social credentials in the interim.

Will anything happen?

The Government would argue three points above are not in the spirit of the SITR legislation but that is missing the point – SITR is in danger of dying before it gets started. A bit like renewable energy and EIS – investors, fund managers and investee companies need less, not more, restrictions, to help grow the market.

As long as there are genuine social outcomes being generated then who cares if an EIS company takes on unsecured SITR growth debt rather than EIS equity (and there are many reasons why it might prefer this route, eg less dilution)?

Pushing EIS and VCT capital to growth business is a good move by the government. But let’s make sure that a growing a capitalist country doesn’t forgot those who are less able.

And in times of stabilizing the UK balance sheet with various cuts, it the private sector that need to step in to perform vital services. And it is those companies which would benefit for looser SITR investment restrictions.

What is SITR?

SITR is a way in which social enterprises can raise funds by way of investment, and offer their investors tax relief. Designed to help fill the “funding gap” for social enterprises, the investment can be structured as equity or debt. The aim is to generate a positive social return (or ‘impact’) in addition to a positive financial return for investors.

The Tax Reliefs:

  • Income tax relief at 30% (with carry back)
  • Capital Gains Tax deferral – if a chargeable gain (made after 5 April 2014) is invested into an SITR qualifying investment
  • Tax free Capital Gains – gains made on disposal are free of capital gains tax
  • Loss relief against income and IHT exemption may also still apply if the SITR qualifying investment is structured as equity rather than debt

The Limits:

  • Individual investor limit of £1m per tax year (on top of the £1m EIS amount (£2m if Knowledge Intensive Business))
  • Any social enterprise can raise up to around £300k in any rolling three year period
  • However a social enterprise that has been trading for less than seven years can raise up to £1.5m over its lifetime

The Qualifying Social Enterprises:

  • Charities
  • Community Interest Companies
  • Community Benefit Societies
  • be a “prescribed” bencom (i.e. incorporate, in its rules, the asset lock)
  • Accredited Social Impact Contractor (typically a special purpose vehicle that will issue social impact bonds to raise finance for a particular project)
  • Any other body prescribed by the Treasury – so they have given themselves the flexibility to extend the scheme in the future to other or new types of social enterprises
  • Other than social impact contractors, these are all forms of organisation which are overseen by a regulator (other than HMRC), and are subject to asset locks and restrictions on paying out profits to members

Key Investment Structures:

Shares:

  • SITR shares cannot carry a right to a return which (either partly or wholly): is fixed or exceeds a “reasonable commercial” rate of return
  • On a winding up SITR shares cannot rank above any other shares

Debt:

  • Cannot be charged or secured on any assets
  • Rate of return cannot be greater than a “reasonable commercial” rate of return
  • On a winding up all monies due to the holders of SITR debt must: be subordinated to all other debts (other than, presumably, other SITR debts) or where the social enterprise has a share capital, rank equally with the lowest ranking class of share

You cannot have in place any arrangements for the investment to be redeemed, repaid, repurchased, replaced or otherwise disposed of within three years.

Case Studies

Ability Tech Community Interest Company (CIC)

Operating out of a factory in Bolton, Ability Tech sources components from all over the world, and designs and assembles electronic circuit boards on site according to client requirements. Yet while Ability Tec competes as an ordinary commercial organisation, it also operates with clear social-impact goals, with an inclusion and diversity focus of employing people with disabilities, including the managing director. The firm provides employment and satisfaction to individuals who may otherwise struggle at the margins of society. The employment policy brings concrete financial gain for the local community and reduces the cost of unemployment benefits. It also leads to an improvement in skills, better physical and mental health, and a reduced dependency on care providers. The SITR loan investment allowed the company to double the size of its workforce and continue its social mission.

FC United of Manchester (Co-operative and Community Benefit Society)

Moston in North Manchester is one of the most deprived areas of the UK. Income, employment, health, crime and education outcomes are in the bottom 10% when compared to the rest of the country. FC United of Manchester serves the community with projects including youth work, school holiday play schemes and adult education. Previously without a ground, the club used social investment to build a new stadium, enabling them to play home matches and provide a permanent base for their community outreach work. FC United of Manchester’s community work engages with approximately 2,000 people each year, developing the skills and enhancing the life chances of children, young people and vulnerable adults across North Manchester.

A version of this article was published in FT Adviser