Social Investment Tax Relief Consultation Response

Social Investment Tax Relief Consultation Response
The Scottish Community Re-investment Trust (SCRT)
September 2014 

 

Background

 

1 The Scottish Community Re-investment Trust (SCRT) is a member led SCIO (Scottish charitable incorporated organisation) (SCO45093). Its principal purposes are:
to promote the third sector within Scotland for the benefit of the general public; and in particular:
1.1.1 to pool the collective financial assets of the third sector in Scotland in order to generate new forms of social banking and to provide, or assist with the provision of, financial products, support and advice, brokerage services and related support for the third sector in Scotland;
1.1.2 to promote the efficient and effective application of third sector resources, with a view to improving the collective long-term financial sustainability of third sector organisations within Scotland;
1.1.3 to take other steps to strengthen third sector organisations within Scotland, supporting them to address social, economic and ecological issues that disadvantage people and communities.

 

By harnessing the sector’s free reserves, together with the liquidity of likeminded investors and helping to improve the financial literacy of the sector, SCRT will work with partners to meet gaps in provision and encourage a greater financial maturity amongst third sector organisations.   

 

As part of the initial research into the appetite for such an intermediary, the SCRT Working Group canvassed opinions on both sides of the supply-demand spectrum and has undertaken research funded by Big Lottery specifically into the potential for crowd funding for third sector organisations in Scotland. These findings inform some of our responses below. 

 

The make-up of the third sector in Scotland is classically a pyramid with a substantial number of low or no income, volunteer run, user-led associations, often unincorporated and without charity status at the base and a few relatively large organisations (over £10m income) at the apex. This latter group account for a large slice of the sector’s income. There are an estimated 45,000 voluntary organisations, of which around 50% are registered as charities. Annual income in 2013 was £4.9 billion with expenditure of £4.7 bn. Housing (£1.46bn) and social care (£1.2bn) predominate. While two thirds of larger organisations were able to generate surpluses, these were generally very small with many large organisations unable to meet their reserves targets. Smaller organisations were unlikely to produce surpluses and had to dip into assets. Source: SCVO Third Sector statistics 2013. 

 

This fragile situation means that many Scottish third sector organisations have not been active in social finance or in the use of alternative financial instruments. 

 

This has been reflected in the slow development of a social finance market in Scotland. A number of social finance intermediaries operate in the country. Until the advent of SCRT, the principal Scottish domiciled players were Social Investment Scotland and four indigenous community development finance initiatives (CDFIs), one of them focused on Glasgow, one targeted on the Tayside region and two operating across Scotland. In addition at least a further five members of the Community Development Finance Association (CDFA), the membership body for CDFIs are institutions that operate across the whole of the UK including Scotland.

 

There has been a limited amount of interest in SIBs. We have therefore chosen not to respond to a number of the questions. Questions 24 and 26 have been answered in a personal capacity based upon direct crowd experience.  

 

Q1. We agree with the 5 criteria but would observe that these should be reflected in any tax measure, not just SITR. However:
• We would wish to see the ‘Affordability’ criterion (2) reflect social value or benefit as well as purely a financial calculation of affordability. 
• We question whether criterion 4 ‘sustainable and not open to abuse’ goes far enough. We would wish to encourage the future proofing of any relief but would argue that the relief should also not distort the social purpose of the enterprise. We also believe that abuse can be reduced by restricting the business model to social purpose and not permit private profit beyond that already allowed under, for example, CIC legislation.     

 

Q2.  Unlike England, EU structural funds have been available throughout Scotland in the Highlands and Islands Convergence Objective Programme area and the Lowlands and Uplands Regional Competitiveness and Employment Objective Programme Area. It is therefore likely that current de minimis support will be more widely spread across the third sector in Scotland than in England and, consequently, more of an issue for recipients of investment under SITR (and presumably CITR). We would argue strongly for a different treatment of current de minimis support in Scotland (and Wales and Northern Ireland) to that for England. 

 

SCRT’s research indicates very little evidence of need for the larger scale investments posited in the consultation paper. We recommend that the current limit of approximately £275,000 be uplifted to £500,000 with a future upper limit of £2 million in total tax advantaged investment. This will allow for an ecology of funding tapping into complementary tax advantaged streams. 

 

Q3.  The nature of the features of the SITR already impose limits on the operation of the tax relief. 

 

Not all third sector organisations or social enterprises are constituted as CICs, charities or Bencoms. Indeed, data from the EKOS, May 2014, mapping study of social enterprise in Scotland, indicates that 10% are unincorporated. As such, the relief is exclusive rather than inclusive. This also affects banking and other money lending activities, including crowd funding which may also include social enterprises that are not CICs, charities or Bencoms.  In Scotland there is growing community involvement in electricity generation – a significant potential market for SITR, but it is an excluded trading activity by virtue of the feed in tariffs, without any calculation of the overall tax advantage.  We believe that some of these design features will restrict the operation of a higher level of relief. 

 

Q4.  The consultation acknowledges that Scotland will be treated differently to England with a 3 hectare cut off for eligibility for direct subsidies under CAP. Agriculture and market gardening are important activities within the third sector in a number of ways: in the employment, often of marginalised workers, but also in developing sustainable local economies. In Scotland, there is also a significant and symbolic link between social justice and land ownership. Community Land Scotland has 47 member organisations who presently own some 500,000 acres that support 25,000 people. 

 

Community farms and market gardens, as well as crofts, have struggled to access finance from conventional sources. There is no agricultural mortgage corporation for social enterprise in the way that there has been for wider farming. Community farms therefore often rely upon community share issues on a best efforts basis, relying upon word of mouth marketing and goodwill. Many social entrepreneurs or communities wishing to expand or establish new business segments will not generate immediate cash flow. Often land may have lain fallow or have been used for alternative activities. The farmer will need to invest in soil rehabilitation, pasture establishment, fencing etc., all practices critical to long term success but which may not produce positive cash flows for 3 or more years. The farmer may not want to take on debt without the capacity to self-finance repayment. What is needed is patient capital. Typically, banks are constrained in their ability to provide the farmer with patient financing for improvements that don’t generate immediate cash flow. They are also limited to making loans that are based on collateral and credit history. Community financing through SIFIs or crowd funding can help to bridge this gap. The role of patient capital in sustainable agriculture can support the three-legged stool of sustainability, providing economic resources as well as environmental and social support. Money invested locally has a human face, amplifying the values of the community.  SITR can encourage such investment.  

 

Q5  Many community energy schemes are economically viable because the cost of capital is modest as investors balance limited financial return, say 4% or less, with ‘return’ through the tax system. The removal of such reliefs is likely to lead to two outcomes: one, lower numbers of investors unless the rate of financial return is increased, and two, greater recourse to long term bank debt to make up the shortfall. In both cases they may tip the scheme into being no longer viable. We believe that the removal of the reliefs may lead to a reduction in the number of communities developing schemes.   

 

Q6   As SIBs are not widespread in Scotland we have limited our response to the related questions. However, we are concerned that by expanding the range of SIBs eligible for SITR, the investor ‘tail’ may start wagging the provider ‘dog’, encouraging smaller organisations to engage in financing mechanisms they neither understand nor have the competence to undertake.  

 

Q7-11 No response 

 

Q12   While we have little objection per se to an intermediary social investment vehicle investing in equity and in unsecured debt that meet the criteria for SITR, particularly where the VCT has been established specifically to invest in social enterprises,  we are concerned that dividend and exit requirements may distort the underlying mission and purpose of the enterprise. There is a substantial philosophical question about whether any organisation established for public benefit can legally distribute income from its surplus for any purpose other than those contained in its objects. The Charity Commission is very clear that charities cannot pay dividends out of charitable funds although they can pay interest. This position would need to change through at least a tribunal decision. 

 

Q13-22 No response

 

Q23 For any organisation, whether an intermediary or not, the costs of listing, prospectus issuance and other regulatory matters must be taken into account relative to the amount of money being raised. It could therefore reduce take up at the smaller end.

 

Q24 The SCRT team consists of a number of individuals with an interest in the third sector  and as such the response to this question reflects the views of those individuals who choose to answer this question and not the views of SCRT.  

 

This will depend entirely on my investment strategy and my confidence in the intermediary. I believe different types of risk are at play between social and mainstream investments and would prefer to invest with a focussed intermediary rather than a hybrid. 

 

Q25 Crowd funding is a relatively recent phenomenon. SCRT research for Big Lottery found considerable latent interest in it amongst the third sector in Scotland. It is also clear that Scottish engagement lags the overall UK trend. The NESTA Crowd funding report estimated that some £200m had been raised across the UK in 2012. On a Barnett formula type split that would suggest some £16m within Scotland. However, the Glasgow Chamber of Commerce has identified less than £1m raised. In part this is because of lack of familiarity with the mechanism, lack of a Scotland specific intermediary, and a growing realisation that it is not just about making a 2minute video. It requires distribution networks and confidence to use these without fear of cannibalising existing channels.        

 

We believe it is difficult to estimate the amount of crowd funding that will be SITR efficient because:
• The market is a new one, and many third sector pitches have been in the perks or no financial return categories. 
• Its growth is partly a function of the low level of returns in the deposit market. If deposit rates rise there is no guarantee that money will continue to flow into crowd funding at the same rate.  However, it is evident that crowd funding is undertaken by large numbers of individuals and SITR might be one way of continuing to make crowd funding an attractive investment in social enterprises in the event of rising interest rates on deposits. 
• Many SITR investors are older and may therefore have limited surplus tax capacity.

 

Nevertheless, crowd funding has established itself as a part of the funding mix, especially at the start up and growth end of the market. This is likely to continue. Given the caveats above, and SCRT’s intention to be active in this market, we would expect crowd funding to continue to grow and to be used more widely in Scotland as familiarity and confidence increase. In the next 3 years we would anticipate that the third sector would raise no more than £15 million through SITR compliant crowd funding. However, if the design issues referred to in the consultation can be resolved it is possible that community farms, energy schemes and schools could be funded, at least in part, through crowd funding. This would have the potential to increase the overall amount raised under SITR. 

 

Q26  As with Q24, the SCRT team consists of a number of individuals with an interest in the third sector  and as such the response to this question reflects the views of those individuals who choose to answer this question and not the views of SCRT.  

 

As an investor I would be neutral about the investment channel. The project and its objectives would drive any decision, as well as any appetite I would have to share risk. 

 

I have invested in Crowd funding previously. Crowd funding allows me to choose exactly what I want to support; to assess directly the level of risk and decide what returns, if any, I am willing to accept.  This is important as I’m more likely to be very generous for social causes that I’m specifically interested in.  Under a VCT type arrangement I would be worried that my investment criteria was mediated by others in the scheme resulting in a fixation with the lowest common denominator of investment returns only.

 

Q27  As the name implies, the ‘crowd’ invest in crowd funding. Generally this means individuals with disposable income. In England some local authorities have supported crowd funding for economic and social purposes. The market has also been heavily retail investor focussed. It is unclear whether regulation will force change in this profile. The nature of small investments across a portfolio mitigates risk decisions but it is unclear how sophisticated investors in the crowd are. While social enterprises and the third sector will draw from a wide investment pool, we believe their core support will come from existing networks, be these current supporters, members, donors, customers or extended family and co-workers. Data from the Wharton Business School shows that 81% of contributors to Crowdfunding pitches are connected to people in the organisations at the first or second degree of separation.  However, If marketed correctly crowd funding enables the social enterprise to develop its outreach and brand awareness. 

 

Crowd funding by social enterprises appears to be less price sensitive and more about the overall social and environmental returns. Intuitively it is a democratic process that should lend itself naturally to social investment. However, its relative immaturity and that it has yet to operate in a rising interest market or where losses become more frequent or open to fraud, make it premature to determine just how important it will become. 

 

Q28  No response