Scale

There are many good people doing good work on excellent projects in the #socent sector, but most are operating on a limited scale. As a charities tax specialist working in an accounting firm my influence on social enterprise will always be small, especially when consistently working with small social enterprises. I enjoy and am inspired by the few social entrepreneurs I have encountered and mentored, but they have a long way to go.

There are many arguments for small-is-good and locally based solutions and I don’t intend to go into them here; suffice it to say that my aims for my life are to operate on a large scale.

My aim is to be the Finance Director for a multinational renewable energy company/co-operative. Or a locally-owned regional utilities company (thanks to both Tim Smit and Welsh Water at previous Voice conferences for that inspiration). Or to operate a co-operative train operating franchise.

To become that person I (and the sector) need some more skill.

Skill

In my experience there is simply not enough commercial business knowledge in the #socent sector (this is clearly a general statement and I know there are many people with commercial business experience, but they are still not enough of them). At the same time, social enterprise is being encouraged to go after bigger contracts on a larger scale, through consortia if necessary. The sector whines about Serco, BT and the others always getting the contracts but it conveniently forgets that one of the reasons this happens is their experience & knowledge at delivering the objectives the Government wants, which the commissioner can rely on.

(Next time your charity is complaining about a contract appearing to go to one of the entrenched big players, ask yourself why you’re still buying audit services from the Big 4 accounting firms and not trying someone like me who actually cares.)

There are huge public-service orientated contracts and services being delivered by anonymous multinational corporations and to compete with these organisations the social enterprise sector needs to have the skills & experience to know how to operate in those markets. I have significant accounting and tax knowledge built up from my time in a Top 10 accounting firm but I do not have the practical experience that I need to run a renewable energy company finance department. I do not have experience of raising £2B on the capital markets to invest in water mains and sewers (like Welsh Water did).

There is only one place I will get this experience and that is by working in the industry I am trying to emulate.

Sleeper Agent

I am becoming a sleeper agent. I am going to work for Moody International and I will spend my days thinking up clever ways to reduce their tax charge and make them more money. In the short term one could argue this is against my ethical principles, but I am taking the long term view.

In 5 or 10 or 15 years time I will have the commercial sector contacts & expertise to go to the capital markets with an ethical friend or two and raise our first £1B to tender for an upcoming community-owned train operating franchise.

I will always be a friend of social enterprise and I will change the world. Just not today.

Alastair Irvine @InspirateCIC

http://uk.linkedin.com/pub/alastair-irvine/17/55b/431

Level Playing Field

I have to say I agree with Phil. It seems obvious to me that CICs are more similar to charities (both have a regulated social mission, both are allowed to trade, both have their assets are locked into being used for the social mission) than they are SMEs (no asset lock, no social mission, very little regulation).

Tax Reliefs

Personally I think there should be a complete overhaul of the tax system in the UK so take into account social mission as well as profit, preferably attempting to measure the social performance in the process (Social Value Tax Credits – outlined in previous posts).

However, it did occur to me that it would be so incredibly simple to extend the charity tax reliefs to CICs. I would not propose a blanket relief from tax for CICs (even charities do not enjoy this) but simply apply the same rules to CICs such as

• Primary Purpose Trading exempt from tax
• Other minor trading income exempt from tax
• Investment or Property income exempt from tax

I honestly cannot see why this should not be done. However, despite the talk in the election about the Big Society I think it will be a long time before such reliefs are extended to CICs.

Being Practical

The alternative to a long-term lobbying plan is to simply get on with it and there ways and means that CICs can get out of paying tax. The easiest way is to donate the profits to a charity that supports similar aims to yourselves. The downside of this is that the money is no longer within your control and you don’t build up reserves to get you through future tough times.

These fears can be eased by setting up a charity under your control with suitably wide social objectives that allow it to support the business in the future. The charity could then grant the money back to you (for you to do nice things with), or it could loan it back to you, or it could contract with you to deliver a service for it. Any of which could get you through the trobuled waters. This does involve regulatory burden, dobule the number of meetings you attend and might be closer sniffed over by the regulators, but there’s nothing wrong with it (just make sure you get the VAT right, and be careful over the timing of the donation).

I know it shouldn’t be this way. But sometimes it is quicker to go round than through.

My concept of Social Value Tax Credits did include a possible repayment of tax, limited by reference to the total PAYE and NI paid (reflecting existing legislation with R&D credits). However, it would be much better and more efficient if organisations that create social value did not have to pay the NI in the first place. Such a scheme would not attempt to measure the efficiency or performance of any particular social enterprise, but that might actually be a good thing.

Social Firms

I learn from my friends at Social Firms UK  that they have considered the possibility of this very concept – some sort of waiver of Employer’s National Insurance contributions for businesses that employ disabled or disadvantaged people. This seems to me to be a very easy idea to implement and regulate – and many permutations exist:-

• Any business that employs at least 25% disabled or disadvantaged people doesn’t have to pay Employer’s NI on their salary
• Any business that employs at least 25% disabled or disadvantaged people doesn’t have to pay Employer’s NI on any salaries (that would prick up the ears of many businesses)
• Any business that employs at least 25% disabled or disadvantaged people doesn’t have to pay Employer’s NI on their salary and can keep the Income Tax deducted on the disabled or disadvantaged persons salary under PAYE too (this is not the place to discuss the Income Tax rates applicable to disabled or disadvantaged people)

No doubt some businesses will try to take advantage of the rules and exploit them. Its not difficult to think of a scheme where the idea of dropping all NI contributions incentivises businesses that employ disabled people but do not actually expect them to do any work. This is a partial victory I suppose (as they now have an income) but this is clearly a long way from ideal. This is why I favour only offering reductions to employers on the disabled or disadvantaged persons wages only and not across the board (although see below for wider socent impact).

Such reductions would also deeply incentivise all businesses to consider becoming Social Firms (those with at least 25% disabled or disadvantaged employees), or at least employing significantly larger numbers of such people. Especially if there were two thresholds; perhaps

• Businesses with >10% of their workforce disabled or disadvantaged stop paying Employer’s NI
• Businesses with >25% of their workforce disabled or disadvantaged also keep the PAYE Income Tax?

As with Social Value Tax Credits, social enterprises at the front line doing good work are being directly funded by Government in a reletively regulatory-hassle free way.

Discrimination

On the one hand, we wish disabled people to be treated equally with everybody else. On the other hand, Social Firms UK has data which suggests that it does cost more to run a social firm than a ‘normal’ business and that these businesses need financial support.

The ethics of this debate are also for another place. I believe that anything that encourages the employment of disabled or disadvantaged people has to be a good thing.

Wider Social Enterprise Sector

The above idea compensates businesses for employing disabled or disadvantaged people, an important but simplistic social aim. There are also many other social enterprise models with wider-ranging environmental or social aims that this would not cover. What might be done?

Any attempt to broaden the scheme would entail someone making a decision about whether or not that organisation in question is a social enterprise or not. This would require a definition of what a social enterprise is and whilst one or two exist, these do not have complete support in all quarters. This is not to say that this is a dead end, if a definition was set by Government then arguable similar NI or PAYE reliefs could be applied to qualifying enterprises.

All the above needs more thought. As usual do contact me if you’re interested in fleshing things out. alastairirvine@inspirate.org or follow me @InspirateCIC. I think I might consider VAT next. Zero-rating anyone?

Which is exactly what the conference is about – how to move beyond business as usual and broaden the range of social enterprise into the wider community. Social Value Tax Credits may just be one answer to that problem – SVTCs would give real incentives to all businesses to do social good. Financial tax incentives are something old-school business understands; the airy-fairy notion of responsibility is something they mostly still struggle with.

So far in this blog I have considered the basic concept of the tax credits and also whether or not SROI is actually robust enough to be used for these purposes. I have since decided  it probably isn’t robust enough, we will probably need an expenditure-based credit rather than an impact-based one. Which raises some interesting points.

Use The Existing Structure

Relief from direct taxes is (broadly) already available to businesses; companies can take it as a deduction from taxable profits (relief for individuals is more complicated but very similar). All social enterprises could structure themselves so as to make use of this tax relief – any social business could set up a sister charity, which actually does the good work. This does involve considerable regulatory burden and costs (which quite possibly could eliminate the tax relief you are getting) but it is possible.

Cut Out Waste

The setting up of a sister charity does involve cost and hassle. I think there is a strong argument to be said for eliminating the need to give the money to a registered charity (especially for registered social enterprises). Relief for expenditure incurred directly by a social business on social good should attract tax relief at the moment; although it might be claimed by HMRC to not be deductible I would argue strongly that such expenditure forms part of the trade and so should be deductible. The correct status of such expenditure largely untested at present.

It follows, therefore, that the elimination of the need for a charity becomes stronger when enhanced deductions are available for such expenditure.

Enhance The Tax Relief On Donations

I think the existing relief should probably be taken one stage further – the amount of donations made to charities or registered social enterprises should be enhanced beyond the original donation (i.e. twice the amount donated is deducted from taxable profits) and to compensate society for loss of tax revenue, the rate of direct taxes should be increased by an ‘appropriate’ amount.

In many ways, such a system would merely reflect efficient economic reality – instead of needlessly funnelling the money through the tax system, through central government and into the charity’s hands to do good with, we’re cutting out the middle men.

Enhance Relief on all Social Cause Spending

Ideally, I would like to take the enhanced relief even further and bring in expenditure-based Social Value Tax Credits. All expenditure on social aims by any businesses should attract some sort of enhanced tax relief. Donations to charities would be eligible for tax relief at (say) 125% of the amount donated; whilst direct expenditure on social aims (by either businesses or the now-taxable charities) would attract 150% repayable tax relief. Suddenly charities are being performanced managed in way they never were before and all business has a real incentive to act in a socially responsible way.

Potential problems include defining which expenditure is for social aims and which isn’t (exactly what was that employee doing, for example). This also doesn’t include any measure of the efficiency of the expenditure (the impact) but to do so requires measuring the impact, which as we’ve established is inherently judgmental.

I need to think longer about the potential drawbacks of an expenditure-based relief and how best it could be implemented. I have also recently been asked about potential National Insurance based incentives to do good (hire disabled or disadvantaged people) and I will write about such possibilities in future.

As usual, any questions just ask @InspirateCIC or via the website inspirate.org. See you at #Voice10!

Last time I explained the basic concept of Social Value Tax Credits; a mechanism which recognises the social benefit delivered by all organisations, gives them tax deductions for this social benefit, and also finances social enterprises and charities. This time I am going to explore one of the potential issues – measuring the social value.

Social Return on Investment

SROI is a methodology for measuring the social impact an organisation (or project or department) has on the world around it. The basic formula is

Social Return = Social Impact - (Attribution + Drop-Off + Deadwieght)

To measure the Social Impact you take the following steps:

1. Work out what impact your organisation has (the Outcomes on your Impact Map)
2. Decide what you will measure to record impact (the Indicators of a change in an Outcome)
3. Measure the Indicators (how much it changed by)
4. Calculate a financial Proxy as the value of a change in an Outcome
5. Multiply your Proxies by your Indicators
6. Deduct the Deadweight (an estimation of what would have happened anyway)
7. Deduct the Attribution (what happened because of the actions of others)
8. Extrapolate this value out for the expected time of impact
9. Deduct the Drop-Off (an estimate of the reduced impact of your actions over time)
10. Add the lot together
11. [Optional] divide the result by the costs of running the organisation for that year

This methodology is extremely sensitive to the assumptions made within it. The only known number is the measurement of each Indicator; the rest are all estimates (however well-calculated or sound the logic they are based upon). For example:

• What is the best Financial Proxy for better health:
  • What you would pay for Health Insurance; or
  • What it costs the NHS to keep each citizen alive?
• How long does the enhanced self-esteem of becoming employed actually last?
  • 3 months
  • Until fired
  • Forever ?
• Who is mainly responsible for an increase in recycling in an area
  • The local authority;
  • The local recycling project;
  • Central Government’s ad campaign;
  • Some Celeb in the media?

This subjectivity does make SROI not ideal for use in Social Value Tax Credits, as conceivably an organisation could make claims for someone else’s good work.

The solution to the subjectivity (in my opinion) is to significantly reduce the amount of credit available. If we reduce the Tax Credit claimable / £ of Social Good created, this will go some way towards rectifying the situation. As and when better models are developed for measuring the social impact of an organisation then the amount of credit given could be increased to recognise the more sound the calculation.

Perhaps we could even go as far as someone making an assessment of how sound the calculation was done, giving it a score, and this feeding into the amount of Tax Credit available? Or will this simply add another subjective measure to an already complicated calculation?

Measuring Social “Cost”

A methodology that would be far less open to subjectivity and probably be more comfortable for Government would be to allow a Tax Credit based on the amount an organisation spends on creating social good (rather then the amount of social good it creates). This is in line with the current R&D Tax Credit (upon which this Social Value Tax Credit is based) and also follows existing practice; in that company’s can usually claim a deduction of any donations made to charities.

The problem here is that using cost doesn’t take into account the effectiveness of the organisation in creating social good, perversely it benefits those who are inefficient at doing so. There is also still some subjectivity as you would have to decide why an expense was incurred – for the “business” or for the “social good”.

Summary

Social Return on Investment is not perfect, but it is a recognised methodology for measuring the social impact an organisation creates. It could be used as a basis for the calculation of the amount of Social Value Tax Credit available to an organisation, but the inherent subjectivity should be taken into account when the financial benefits of the Tax Credit is being decided upon.

Any questions or comments gladly welcome, especially on Social Accounting (which I know little about).

I will now introduce my idea for Social Value Tax Credits (“SVTC”); the basic theory behind them and possible areas of impact / details that need further consideration at a later stage. I am writing this in layman’s terms as much as possible but inevitably there will be some “tax-speak”. If there’s something you don’t understand, tweet me @InspirateCIC

The Basic Concept

The underlying principle of this proposal is to build into UK tax legislation allowance for and recognition of the non-financial performance and impact of any business entity. The idea is to measure the social impact of an organisation and introduce specific legislation that allows the financial equivalent of this impact to be deductible from the taxable profits of the business. To whit:

Taxable Profits = Profits Before Tax – Financial Equivalent of Social Value Created

I strongly believe that these SVTC should be claimable by all taxable entities, to avoid any favouritism or protectionist allegations. I also believe that all businesses deliver some social value (and I am not alone in holding this belief), meaning that all businesses can and should be eligible to make a claim for SVTC. Some effects of this and the subsequent required changes are:-

• All businesses (including large plcs) would suddenly have significantly lower taxable profits and so to compensate for this and protect tax revenue the Mainstream Corporation Tax Rate would have to be significantly increased
• Charities will loose their tax exemptions; instead they will become taxable on their surpluses (the same as a profit-making business) but with the intention that their SVTC would eliminate their taxable profit

With these changes the financial effect for both business and charities has been minimal, their tax liabilities should remain roughly what they were before. However – the tax system now includes financial incentive to create social value as well as financial value. This is crucial in the wake of the current recession, to align the aims of capitalism with society’s aims for happiness and quality of life.

Social Enterprises will also be eligible to make claims for SVTC (of course) meaning that any who make profits will be given credit for the social value they create and pay a lower tax bill on their financial profits. However, many social enterprises (and social firms in particular) do not make profit so their SVTC will simply increase their losses carried forward for future relief against profits. This is where the repayable element of the SVTC comes in.

Following the precendent set by the existing Research & Development Tax Credit Claim, organisations would be able to surrender their SVTC to the Government in exchange for a repayment of their PAYE and NI liabilities for the period. The R&D claim supports loss-making companies by giving governmental financial support to encourage their activities. SVTC will do the same thing, by providing financial support to social enterprises to encourage and support them with creating further social value in the future:

Tax Refund Due = SVTC % Rate  * (Social Value Created – Profits Before Tax)

The actual formula would be more complex and have certain safeguards and restrictions built into it, but this is the essential idea.

Areas for Consideration

• Profit making busineses will relish the idea of getting a tax deduction for the social value they create and inevitably will aim to exploit this credit to the full. Are any of the current measures of social value creation (such as Social Return on Investment ["SROI"] ) robust enough to stand up to this exploitation?
• Will SVTC encourage the creation of social value, or merely the exploitation of these credits?
• As Social Value is so difficult to measure, should a tax credit based on the costs of the organisation’s social activities be introduced? Would this be more robust against exploitation?
• The implementation of SVTC would be intended to be fiscally neutral for business as a whole, but inevitably some businesses will fare better than others. Arms Dealers may find themselves facing a tax bill, Tescos might not. What pitfalls should we be aware of ? How much social value does an investment bank actually create anyway?
• HM Revenue & Customs will suddenly become the Judge and Jury over the amount of social value created by an organisation – is this a good thing? It would be a significant change in culture and widening of scope for them.
• Unless charities create more social value than the financial resources they consume, they will suddenly be facing a tax bill. On the plus side this will push them to ensure they are actually creating social value and so encourage better performance, on the down side I expect they will resist these changes tooth and nail.
• Social enterprises will now enjoy direct financial support from Government for the social value they create, do they have the capability to make use of this?
• Should Individuals also be given SVTC to take into account any volunteering or social value they create?
• Should the credits also be available to those who are self-employed or in a business partnership of some kind?
• SROI is a long process to accomplish – will SVTC be worth the regulatory burden?

Summary

If society wishes organisations and Government to work together to build happiness and quality of life as well as financial growth, we need to incentivise and measure the social value they create. Tools such as SROI give us good but not infallible measures of social value creation, what is currently completely lacking is an real incentive for old-school capitalist organisations to create social value.

SVTC will give a deduction from taxable profits for the social value an organisation creates. The credits will be refundable, meaning a tax refund can be claimed to assist with the costs of running the organisation.

Social Value Tax Credits give business reason to create social value, in terms old-school capitalists understand – tax savings. The credits will also incentivise charities to perform better and create more social value. The refundable element of the SVTC will support social enterprises on an on-going long-term basis.

Please let me know your initial thoughts on Social Value Tax Credits, either by commenting here (or on one of the forums I’m using) or tweeting @InspirateCIC or emailing me on alastairirvine@inspirate.org

Future editions of this blog will concern the areas of consideration above, respond to feedback received on the concept and develop the idea into something workable. I will also comment on some of the other ideas concerning tax support for social enterprises as they emerge.

Where We Are Now

When it comes to your tax status, being a social enterprise is completely irrelevant. HM Revenue & Customs will not have a clue what that means, it is not a status. The first key to tax relief is your legal form, as social enterprises can take on a variety of these and still do nice things.

Charities

Whether a company or a trust, if you are a registered Charity broadly your income will be exempt from direct taxation (income or corporation taxes) unless you:-

• Do something naughty,
• Trade outside your authorised limits (subject to certain exemptions) or
• Start dealing in land (more common than you might think)

Charities can also claim Gift Aid on money (or sometimes goods) donated to them by tax-paying individuals. A useful guide to charity taxation is published by HMRC here.

Companies

If you are a company (regardless of whether you are Limited by Shares or By Guarantee and being a Community Interest Company is also currently irrelevant) you basically suffer corporation tax on your income unless you manage to convince HMRC that you either

• Do not trade with a view to making a profit (which, if this is the case, would ask me to question whether or not you actually are a social enterprise as social enterprises should be about More Than Profit not Not For Profit)
• Only trade with your members (mutual trading)

Both these scenarios are extremely rare, but I have advised on both so do get in touch if you think they might apply to you

As a trading company, social enterprises are eligible for Enterprise Investment Scheme relief (or, more accurately, people wishing to support a new social enterprise company should be able to claim Enterprise Investment Scheme relief on the amount invested) but cannot claim Gift Aid on any money given to the company like a charity can.

Sole Traders or Partnerships

It is unlikely but possible that a social enterprise is legally a sole trader (a one-man band doing nice things), or a partnership (lots of people doing nice things together) or even a Limited Liability Partnership (lots of people doing nice things but with restricted financial risk). The individuals involved in all these variations are subject to normal Income Tax rules – any nice things they do are essentially ignored unless they make a financial donation to charity.

Clever Structures

It is fairly easy tax planning to set up a more complex structure involving both a charity and a trading company, to take advantage of the benefits of both, but this leads to double regulation nightmares and the associated fees. There is an argument to say that it should not be necessary for a social enterprise to structure in this costly manner and as such it is only of interest to organisations of a certain size.

There is precedent within Corporation Tax for HM Treasury to introduce legislation where tax can be easily avoided (albeit in a time consuming manner) so that the same tax avoidance can be achieved through the legislation without paying the solicitors, so this is an area that will be kept under review for future blogs.

Other Taxes

The above only really concerns direct taxation (tax on profits) but there are, of course, other taxes that are applicable to the Third Sector. Both Charities and Companies pay Employer’s National Insurance on any amounts paid to Employees, for example. Both are subject to VAT, although there are special rules for charities.

Consideration of other taxes will be considered in due course, for now I wish to concentrate on the tax on profits of social enterprises and tax relief to encourage investment.

Next time I will introduce the concept of Social Value Tax Credits, explain the basics of how they might work, who they could apply to and invite feedback on the basic idea before going on to examine specific areas of their implementation.

DISCLAIMER: All the above is an extremely simplistic view on a wide variety of tax issues, take proper advice, preferably from me

This year there has been some discussion about whether or not the UK tax system should be amended to support social enterprises. Eddie Finch of Buzzacotts recently wrote an article on the subject and the Social Enterprise Coalition also recognises the possibility of tax reform as does the Scottish Social Enterprise Coalition. I have also been pushing hard for social enterprises to make use of existing tax reliefs to encourage investment here and here.

The question is – what form (if any) should tax relief for social enterprise take?

To have a hope of answering this question we first need to understand where we are now, the base line from which we wish to move. That will be the subject of my next blog.

Future blog entries will introduce the concept of Social Value Tax Credits, examine the benefits of such a scheme (both for social enterprise but also wider capitalism and society), examine the pitfalls for certain social enterprises and charities and invite comments on how such problem areas could be avoided.

We will also examine other tax reliefs or areas of concern of interest to social enterprises as and when they come up.

We now also have a blog which we will be mainly using to encourage debate and engage in consultation concerning how the tax system can or should be amended to reflect the good work that social enterprises carry out and encourage their further growth.