Taxing questions on social investment

2 Sep 13

It’s good that the government wants to encourage more investment in social enterprises. But the plan to introduce a new tax relief raises some difficult questions for the chancellor, the taxman and social investors

At the last Budget the government launched a consultation on how to bring in tax relief for those investing in social investment. With the deadline of 6 September hurtling towards us, all sorts of people with a vested interest in securing a tax break will be finalising their submissions and dashing them into the Treasury while (legitimately) lobbying exercises are fine-tuned. I know what it is like from the other side as an ex-Treasury mandarin and adviser.

The government will have a lot to chew on. As far as I can see, it decided to announce the consultation because it wants to encourage social investment. There’s nothing wrong with that. Yet the classic arguments for a tax break that the Treasury likes – a real market failure – look a bit thin on the ground here.

The tax breaks being sought and explored are more or less equivalent to those available in venture capital, namely the Enterprise Investment Scheme that gives tax relief for investments in shares in qualifying companies, and for investing in Venture Capital Trusts that invest in smaller, high-risk companies. The argument here is that we want those who are taking risks on their investment to keep going and do more – because then at least some of the firms they support will grow to scale, producing wealth, jobs, and more tax revenue. The taxpayers’ shilling is therefore (supposedly) well spent.

It is not as clear-cut with social investment. Unless they are quasi-business type social enterprises, we would not expect to see enormous growth in individual social enterprises, nor are the investors likely to be taking massive risks in return for a (rare) but potentially enormous upside as is the model in venture capital. More to the point, we seem to be subsidising the investor to take a sub-market return because we think there’s a social benefit to doing so at both an individual not-for-profit level and for society and the economy as a whole.

The trouble is that the degree of social benefit varies greatly across social enterprises and charities, and experience to date suggests there is unlikely to be much effort going into measuring well the social benefit secured and holding it up against the tax foregone.
There may of course be a case for tax relief, at least for a while, since the sector feels risky to investors because it is new and below scale. If we believe we would be better off with a bigger social enterprise sector, then a tax break for a period could help achieve that.

Interestingly, the Treasury consultation paper talks about only giving a tax break where the social enterprises supported ‘are becoming commercial’ (para 4.8), which sounds odd given these are supposed to be explicitly non-for-profit organisations. This leads to a major headache for both the Treasury and HM Revenue & Customs in their responsibility to prevent such a tax break going to the ‘wrong’ organisations, ones that have simply restructured in order to qualify for the relief.

It is relatively easy to see lots of would-have-been firms turning themselves into social enterprises to jump through this loophole. Some barriers have already been put in place – they have to be Community Interest Companies (CICs), Community Benefit Societies (Bencoms) or charities. In addition, only those with fewer than 250 employees seem likely to benefit, raising interesting issues for larger charities with social enterprise arms that may have been looking at this option.

Finally, there is little said about the existing tax break in this area, namely Community Investment Tax Relief, which gives tax relief to investors who back businesses and other enterprises in less advantaged areas. Does this continue in the new regime or will HMRC take away with one hand what it gives with the other? And is this a decent swap for the sector?

The experience of social investment bank Big Society Capital and others suggests that getting the market to take off – and bring in new players rather than just getting existing ones to fund some social investment instead of grants – does require that the tax system is used to attract them in.

Whether that money therefore ’foregone’ will produce a flood of new money into social enterprises; whether it could be better be spent elsewhere in the not-for-profit sector; and whether tax breaks to encourage social investment just cannibalises funds that would otherwise have gone to grant funding, are things we will no doubt continue to debate.

This post first appeared on the New Philanthropy Capital Blog

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