Tomorrow looms the final deadline for submitting responses to HM Treasury’s consultation on a social investment tax relief (“SIR”). This is an important challenge to the social investment market and to the social investment and finance intermediaries (SIFIs) operating across our market.
HM Treasury’s consultation has modelled the structure and the resulting consultation questions on the existing tax reliefs to UK tax payers for investment into SMEs – the Enterprise Investment Scheme (EIS) and the Venture Capital Trust (VCT) frameworks. Treasury has commendably followed the recommendations of NESTA’s Financial Planners as Catalysts for Social Investment report (June 2012) to use well-known tax reliefs in order to “contextualise” the relief to private investors and to Independent Financial Advisers (IFAs), financial planners and private wealth managers already familiar with the commercial wrappers.
Few in our sector appreciate how advantageous an EIS tax relief can be – and how catalytic an identical SIR scheme could be.
Our response to the consultation has been driven by the principle that in order to truly engage private individuals on a large scale in investment into social enterprises, both the end investors and the distribution channel (their IFAs) need to feel that SIR is offering a fair deal. As such, SIR needs to offer the same tax benefits that EIS offers.
The tax benefits afforded to an EIS investor are considerable – and even more so in SEIS (Seed Enterprise Investment Scheme), where the upfront income tax relief is not 30% but 50%.
Important terms of the EIS tax wrapper are:
- The size of the relief available to the individual investor is up to £1,000,000 in any one tax year. This equates to a maximum hand-out by HMRC to the audacious investor of £300,000 per annum;
- The tax reliefs available to the individual investor are:
- Income tax relief at 30% (including the ‘carry back’ facility into the previous tax year);
- Tax free capital gains on investments;
- Full inheritance tax relief provided the investments have been held for two years and are held at time of death;
- Full capital gains tax (CGT) deferral on tax due on any other capital gains if gains are invested in EIS share; and
- Loss relief which can be taken as a deduction against income or as a capital loss.
Let’s work through what this means in terms of financial returns and downside protection for the private investor into social enterprise.
Assume our hypothetical investor Ms M. Pact would like to invest £100,000 into Children’s Support Services, a Social Impact Bond delivery company aiming to reduce the number of troubled adolescents going into residential care. She would immediately upon investment be able to receive 30% income tax relief in the tax year of investment. Her net cost of the investment is therefore £70,000.
Upon a successful sale of her investment in Children’s Support Services after the minimum three year holding period at, say, a modest 15% uplift, Ms M. Pact’s proceeds equal £115,000. The gross gain is £45,000. Ms M. Pact does not need to declare these gains on her tax return. On a £70,000 net investment, Ms M. Pact has received a gain of £45,000, or realised an internal rate of return (IRR) of 18% on her investment.
Had Ms M. Pact not been able to use the EIS wrapper, her gross gain would have equalled £15,000 and her net gain (applying a Capital Gains Tax of 28%) £10,800 (£15,000 less 28%*£15,000). This equates to an IRR of only 3%.
Equally, in terms of downside protection, the ability to achieve both income tax relief on the way in and loss relief on the way out of the investment makes an important difference to Ms M. Pact’s willingness to commit.
Her net cost of the investment remains £70,000. After the three year holding period, the value of the shares in Children’s Support Services has fallen to zero. Ms M. Pact, a 45% higher rate tax payer, can claim loss relief at 45% on the net cost of the investment, either against income tax or capital gains tax. The maximum downside on the investment equals £38,500 when subtracting the upfront income tax relief (£30,000 benefit) and the loss relief (45%*£70,000, or £31,500 benefit) from £100,000.
The need for a complete level playing field
The new relief is a great jewel handed to our market.
We believe we can make the most of the relief if it sets up social enterprise on a level playing field with purely commercial enterprises and both EIS investors and IFAs recognize the features of the tax relief. SIR should be made available at as identical terms as possible to the existing commercial regimes of EIS and VCT.
By Annika Tverin, Director at Social Finance