Reform of Industrial & Provident Societies

Much has been made of the proposed reforms affecting the Credit Union movement in Northern Ireland (quite understandable given its size) but to date discussion has been relatively muted regarding reform of co-operatives and community benefit societies (which have a significant presence among the housing and agricultural sectors here). This is likely to change with the publication later in the year of a joint Treasury/DETI consultation on Industrial & Provident Society (IPS) reform.

Meanwhile, two pieces of legislation have been introduced to give effect to the reform of Industrial & Provident Societies in Britain. With any reforms in Northern Ireland likely to mirror those changes across the water it is worth taking a closer look at the two legislative documents.

1. Legislative Reform (Industrial & provident Societies and Credit Unions) Order 2010

Some of the key reforms include:

- An end to the minimum age restrictions for membership of a society.
- Reducing the age limit to become an officer to 16
- Removal of the £20,000 limit on any members maximum shareholding. The restriction has removed the limit for non-withdrawable shares. Withdrawable shares are still subject to the maximum limit.
- allowing a society to choose its own year end date
-facilitating the easier dissolution of societies by easing the voting requirements to dissolve.

2. Co-operative And Community Benefit Societies And Credit Unions Act 2010

Some of the key reforms include:

-renaming the previously titled Industrial & provident Society Acts to the Co-operative and Community Benefit Societies Acts (In effect a brand change).
- requiring all new Industrial & Provident Societies to be registered as either a co-operative or community benefit society.
- giving HM Treasury the power to apply to IPS, with appropriate modifications, company law on investigation of companies, company names and dissolution and restoration to the register.

The reforms in a Northern Ireland context:

The removal of the limit on non-withdrawable shares and the flexibility regarding year ends would be of benefit to any agricultural co-operative operating in Northern Ireland.

The removal of the limit would allow members of agricultural co-operatives to invest greater sums of money to expand the business and increase profitability. Agricultural Co-operatives would also be able to link their financial year end to the agricultural cycle which would make greater financial and commercial sense than the current arrangements.

With the name changes and increased Treasury powers to apply company law, the Government seeks to address concerns by bringing the Industrial & Provident Society format into the 21st century. It is hoped that these changes will add new vitality to a legal structure which has fallen in popularity in recent years.

Charities & Trading Subsidiaries Part 6

The final part of this series takes a look at the role of trustees in the everyday management and running of a trading subsidiary.

Part 6

Role of the Trustees

The trustee must scrutinise numerous funding and general financial/legal matters when a subsidiary is established (see parts 3 & 4). But their role also extends to the running of the subsidiary itself. The extent to which they should interfere in the management of the trading subsidiary is a delicate matter which can have repercussions.

It will be standard practice for the charity as majority/sole shareholder to appoint trustees of the charity to directorship positions within the trading subsidiary. This will allow the charity to monitor the activities of the trading subsidiary. Such persons will have two distinct responsibilities, both to the charity and the trading subsidiary. They will therefore have to be mindful of any conflicts of interest which arise from their dual mandate.

Whilst a monitoring role will be acceptable if undertaken with adequate safeguards the charity should not become actively involved in the management of the charity. The subsidiary board should be independent of the parent charity and the charity should not dictate instructions to the subsidiary. If it does adopt such an active management role then serious liability issues can arise for the charity if the trading subsidiary falls into financial difficulties.

Therefore those with a dual role should be in the minority on the subsidiary board and should heed the advice of non-conflicted board members when any possible conflict arises. Only by engaging such governance procedures will the difficulties associated with a conflict of interest be avoided.

Social Franchising

Two scenarios:

1. You are a charity/community organisation which seeks a more sustainable means of funding. You want to establish a business which will generate profits and/or achieve social objectives and reduce dependency on grants. There is one small problem though, you don't have a business idea and even if you did, you wouldn't know where to begin to make that idea a reality.

2. You are an established social enterprise with a proven profit making business and strong brand. You want to grow as a business and maximise the social benefits but you are unsure as to how you can carry this out.

A possible solution?

Social Franchising

Similar in many respects to ordinary commercial franchising, social franchising can deliver the outcomes required in the two scenarios.

But what is it?

In effect franchising is where two parties enter into a contractual agreement in which one party (the franchisor) will give the blue-print (business model) for its successful business to the 2nd party (franchisee) which will set up a copy of that same business with the ultimate aim that both sides make a profit. Social franchising simply follows this formula and throws in the added social dimension.

In conjunction with the blue print comes a substantial support package which the prospective franchisee will utilise. This will include staff training, technical support, help with marketing/promotion of the business and access to the general know how that the franchisor has developed over the years to make their business a success.

Such support may prove particularly appealing to a charitable/community organisation which is entering the commercial world for the first time and which would otherwise be daunted by the complexities of starting a business.

But what does the franchisor get in return?

Generally in any franchise agreement the franchisee will pay an initial fee to the franchisor for the business model. The franchisee will then pay a % of turnover each year to the franchisor in return for its continued support and access. The franchisee will also invest its own money in the initial start-up which reduces the financial risk for the franchisor.

Such an arrangement offers real advantages to both parties but is not without its drawbacks.

Although the franchisee will operate the business on a day to day basis the franchisor will still exercise significant control over operations. It may dictate how services/goods are sold and marketed. It will also be keen to ensure that all activities undertaken by the franchisee do nothing to bring the brand/business into disrepute. Such control may not sit well with some prospective franchisees who would chaff at such restrictions. This will also be labour intensive for the franchisor as they must assiduously work on maintaining quality and standards.

Franchising your business model could soon become a nightmare if the franchisee destroys the painstakingly created brand through mismanagement and your lack of oversight. Therefore the franchisor must be prepared to invest the time and effort into making the franchisees operation a success.

Social franchsing is something we are likely to hear more of in the future.

Community Interest Companies (CIC's)

Community interest companies (CICs) are limited companies with a number of additional features and regulations, created for those who want to conduct a business for the community benefit and not purely for private advantage. This is achieved by a community interest test and asset lock which ensures that the CIC is established for community purposes and the assets and profits are dedicated to those same goals.

The UK Governments stated objectives when drawing up this new legal model were to improve access to finance, create a strong new brand, provide protection from demutualisation (investors changing the aims and nature of the company) and preserve assets and profits for social purposes.

CICs will generally be structured as either a company limited by shares (CLS) or a company limited by Guarantee (CLG) although in practice the majority of CIC's register as the latter.

Setting up a CIC

When registering your company with Companies House, you will need to provide additional documents, including a community interest statement describing your social purpose. The CIC regulator will approve your application if your statement passes the community interest test - ie the business activities you intend to undertake will be carried out for the benefit of the community or a section of it. The test is whether a reasonable person could consider those activities to benefit the community.

Features of a CIC

CICs have to follow specific rules, including the following:

Asset lock

CICs must have an asset lock. This ensures that the company cannot generally transfer its profits or assets for less than their full market share. The exception being a transfer to another asset locked company such a charity or other CIC. It will also protect any remaining assets for the community if you dissolve the CIC. The lock is legally enshrined and cannot be removed under any circumstances.

Dividend Cap

If you set up your CIC as a company limited by shares, you will have the option of issuing shares that pay a capped dividend to investors. The cap is set by the CIC Regulator to protect the asset lock and strike a balance between encouraging people to invest in CIC's and the principle that the assets and the profits of a company should be devoted to the benefit of the community.

There are three elements to the Dividend Cap:

1. maximum dividend per share limits amount of dividend that can be paid on any given share. Currently the limit is a flat rate of 20% of the paid up value of the share.

2. The maximum aggregate dividend limits the total dividend declared in terms of the profits available for distribution. Currently, the limit is 35% of the distributable profits.

3. The ability to carry forward unused dividend capacity from year to year to a limited extent. Currently the limit is 5 years.

It should be noted that these caps set maximums. They should not be taken as in any way suggesting that those who invest in CICs are entitled to a particular rate of return on their investment.

Performance Related Cap

CIC will generally have the same borrowing powers as any other company. On rare occasions the situation will arise were the interest payable on debts or debentures is linked to the performance of the CIC (also known as quasi equity). The ability to pay uncapped interest in this fashion would circumvent the Dividend Cap.

Therefore a cap exists on the maximum interest payable. It has been set as 10& of the average amount of a CICs debt or sum outstanding under a debenture.

Accounting

Together with your annual accounts, you must present an annual community interest company report for public record. The report must show what the CIC has done during the year to pursue its pre-specified community interests.

Whilst take up of the CIC structure has been relatively muted in Northern Ireland the structure does appear to have struck a chord with many social entrepreneurs and is unquestionably a useful addition to the social enterprise sector.

For further information see the CIC Regulator website: http://www.cicregulator.gov.uk/

Credit Union Reform in Northern Ireland

The expansion of credit union powers is central to the proposed legislative reform in Northern Ireland. One of the more significant proposals put forth in the recently released joint Treasury/DETI consultation is the granting of investment powers which would allow credit union assets to be re-invested into community enterprises.

http://socialeconomylegal.blogspot.com/2010/04/credit-union-reform-in-northern-ireland.html

Credit Unions in the Republic of Ireland have had such powers for some time and have employed them to some effect, with the credit union movement now one of the biggest social finance providers in the state. Indeed the southern experience illustrates the relative merits of the proposed move in Northern Ireland

Aidan Stennett has compiled an insightful paper for the NI Assembly on the legislative framework underpinning these investment powers.

http://www.niassembly.gov.uk/io/research/2008/11608.pdf

This framework will undoubtedly provide a useful template for any legislative changes in Northern Ireland that may arise

Charities & Trading Subsidiaries Part 5

Part 5

Transferring the Subsidiaries Profits

There are a number of ways in which profits generated by the trading subsidiary may be transferred back to the parent charity. The path taken will have tax implications and this will often be the deciding factor in choosing the appropriate method.

The two main methods are as follows:

- Funds may paid in the form of a share dividend pursuant to the share capital acquired by the charity.

- Gift Aid may be used to transfer the money from the subsidiary to the charity.

The payment of a dividend to a Charity, whilst retaining a certain 'prestige' factor will often not be the optimum way of transferring money. Whilst a dividend is not taxable in the hands of the charity, it does not reduce the trading subsidiaries taxable profits. Thus the subsidiary would be liable to corporation tax.

The most common method of paying funds therefore is through the Gift Aid Scheme. Like the dividend, the Gift Aid payment will be exempt from tax in the hands of the charity, so long as the money is used for charitable purposes. However where the Gift Aid scheme differs is that the payments do reduce the subsidiaries taxable profits. n fact it is possible for a subsidiary to mitigate its entire tax liability through paying all of the companies profits to the charity under Gift Aid.

There is nothing underhand with this approach, it is a perfectly acceptable way in which to reduce the amount of tax owed by the trading subsidiary.

However, giving all of the profits to the charity under the Gift Aid scheme can cause some difficulties. A transfer of all the profits may leave the subsidiary with a lack of working capital, with the cash-flow problems that would entail. HMRC do give subsidiaries wholly owned by a charity some lee-way in this regard but it may be prudent in some instances for the subsidiary to retain some of its profits to meet working capital requirements. The charity would have to accept the ensuing tax liability for the amount of profits retained.

Charities & Trading Subsidiaries Part 4

As highlighted in part 3 of this series, a charity must adhere to the qualifying investment criteria if it wishes to avoid the potential tax penalties incurred by non-charitable expenditure. It cannot simply give a certain amount of money to a trading subsidiary as a goodwill gesture. Any investment must be commercially sound. This underlying requirement will therefore dictate the type of investment which a charity can make to the trading subsidiary.

Part 4

TYPES OF INVESTMENT

The two main types of investment are the acquisition of share capital and/or the provision of loans.

Share Capital

It may sometimes be prudent to subscribe only a nominal sum for the issue of share capital so as to satisfy company law. If a parent charity does subscribe a greater sum as a means of investment then that investment will be subject to risk if the trading subsidiary ultimately fails. This is because the repayment of share capital has a lower priority than the repayment of loans in the event of liquidation.

On the other hand the capitalisation of the subsidiary by loan carries its own risks. The provision of loans may expose the subsidiary to the risk of insolvency if it cannot repay its borrowings. It must be remembered that any loan by the charity must be on a commercial basis and offer commercial returns. the subsidiary would be obliged to pay a reasonable rate of interest in addition to the capital and this could cause some difficulties for a newly established subsidiary with marginal profit margins.

Therefore in this instance where profit margins are likely to be marginal it may be reasonable to pay more than the nominal amount for share capital.

Of course a trading subsidiary does not have to rely on the parent charity for sole funding. outside financiers can play a role in capitalising the enterprise. However, investment through the acquisition of shares is unlikely to prove attractive to such persons or organisations as they would be motivated by profit. This would sit uncomfortably with a trading subsidiary which gives all or most of it profits to the charity, leaving little or no dividend.

The charity could market the acquisition of shares to wealthy supporters who would be willing to invest and possibly fore go a commercial return.

Loans

HMRC guidance stresses the requirement that any loan from the charity to the trading subsidiary must be at arms-length and bear a commercial rate of interest with suitable repayment terms. It is highly unlikely that HMRC would tolerate a loan agreement with no rate of interest and a repayment schedule over a 1000 year time period!

The loan must also ordinarily be secured against any assets of the trading subsidiary. Where this is not possible, because the trading subsidiary has no assets, then HMRC will likely scrutinise the loan through an assessment of the business projections, cash-flow forecasts etc.

A trading subsidiary is of course under no obligation to obtain a loan from the charity. it may approach commercial entities in-order to acquire finance. This obviously puts the trustees of the charity at less risk as they wouldn't have to grapple with the many issues surrounding charitable investments as has been previously discussed.

However banks and other lenders may require guarantees/security from the charity itself as part of any loan agreement. This would expose, both the charities assets and the trustees themselves to risk if the subsidiary got into difficulty. Such commercial lenders may also stipulate repayment terms which would be in excess of what the charity would be obliged to charge under any loan agreement with the subsidiary.

Therefore loans from commercial lenders may not always be a viable option. Well-wishers and supporters of the charity could offer loans to the subsidiary on more favourable terms.

Charities & Trading Subsidiaries Part 3

Part 3

FINANCING A SUBSIDIARY

A trading subsidiary like any newly formed business will require starting capital in-order to finance its activities before a profit is ever realised. Given the nature of the relationship between the charity and trading subsidiary it is normal to assume that the charity may wish to invest monies into the subsidiary. There are special rules that apply when a charity wishes to invest funds in a trading subsidiary which must be adhered to.

Firstly any trustees wishing to invest should insure that they have the requisite power to do under the charities constitution.

Any investment made in the trading subsidiary must be deemed a 'qualifying investment' for HMRC purposes. if it does not qualify then HMRC will view the investment as 'non-charitable expenditure@. This can be defined as expenditure on things that are not for the charitable purposes as set out in the charity's governing documents or any investments and loans made by the charity which are not qualifying loans or investments as detailed by HMRC regulations.

Any non-charitable expenditure may result in the charity losing its tax exemption on all or part of its income or gains. the amount is taxable at the same amount of non-charitable expenditure.

For example: A charity receives gross gift aid income of £40,000. the charity would normally be entitled to tax relief of £40,000. If £30,000 was spent on charity grants and administration and £10,000 on a non-charitable loan then the charity would lose tax relief on the same amount of the £10,000 loan.

The list of qualifying investments does not include investments in or loans to subsidiary companies per se. there is provision however that a charity can make a claim to HMRC to treat such investments as qualifying.

To satisfy this provision the charity must show that it was made for charitable purposes and that it is for the benefit of the charity, and not to avoid tax.

In order to achieve this, the investment should be commercially sound and the charity should ensure that the investments are secure, carry a fair rate of return and in the case of loans, provide for recovery of the amount invested in due course.

The trustees must be able to justify financial support for a trading subsidiary as an appropriate investment of the charities resources. The Charity Commission for England & Wales has stipulated the following guidance for trustees when considering the investment of charities resources, both in general and in the particular context of a proposed investment in a trading subsidiary which is used to carry on a non-primary purpose trade.

- be certain that the investment is within the charities investment powers;

- exercise such care and skill in the investment process as is reasonable in the circumstances;

- have regard to the suitability to the charity of investments of the same kind as the particular investment which it is proposed to make;

- have regard to the suitability of the particular investment in question, as an investment of the kind which it seems appropriate to make;

- have regard to the need for diversification of investments, as appropriate to the circumstances of the charity; and

- ordinarily obtain and consider advice about the investment from a person reasonably believed by the trustees to be qualified to give it by his or her ability in and practical experience of financial and other matters; the advice needs to have regard to the suitability and diversification points mentioned above;

- the trustees must reasonably consider that it is in the charities interests to make the investment, after making a fair comparison of this form of investment with other forms of investment which might be selected;

- this fair comparison must involve an objective assessment of the trading subsidiaries business prospects;

- the trustees must be satisfied as to the financial viability of the trading subsidiary, based on its business plan, cash flow forecasts, profit projections, risk analysis and other available information; and

- the trustees must ordinarily take appropriate advice on the investment, and the financial viability of the trading subsidiary. What is appropriate will depend on the circumstances: the cost of taking the advice is a relevant factor, and the cost should be commensurate to the size of the proposed investment.

- pay attention to the length of time over which funds may be tied up in an investment in a trading subsidiary, since funds needed in the short to medium term may not be easily realised when invested in this way;

- consider, and take suitable advice on, the possibility of obtaining independent funding as an alternative to funding by the charity.

Public Procurement & Social enterprises

The NI Assembly recently published a Report on its Inquiry into Public Procurement in Northern Ireland:

http://www.niassembly.gov.uk/finance/2007mandate/reports/Report_19_08_09R.htm

The Committee for Finance & Personnel have made a number of recommendations which will be of interest to social enterprises engaged in the public procurement process.

Indeed the Committee states that implementation of the recommendations will achieve the objective of developing the social economy in Northern Ireland.

One of the more interesting recommendations is the support for the establishment of a public procurement brokerage service for social enterprises as advocated by the Ulster Community Investment Trust (Para 174).

As most social enterprises are small in scale it can be extremely difficult to break into the complex area of public procurement. The brokerage service seeks to address the key resource and knowledge limitations by offering professional support for the tendering of contracts. It is certainly a service that social enterprises should be watching out for in the year ahead.

Charities & Trading Subsidiaries Part 2

Part 2

WHAT IS A TRADING SUBSIDIARY?

It is an independent commercial body, quite distinct from the charity. Its legal structure will usually take the form of a non-charitable company limited by shares or a non-charitable company limited by guarantee.

Although the trading subsidiary does not enjoy the advantages of charitable status, it is not burdened with the stringent trading restrictions that a charity must comply with. It will therefore be able to undertake trading activities which the charity cannot.

WHY USE A TRADING SUBSIDIARY?

- trading subsidiaries offer greater flexibility and fashion the opportunity to generate greater sums of money for the charity.

- The trading subsidiary will be able to carry out non-primary purpose trading on a larger scale and obtain tax relief through the gift aid scheme. If a trading subsidiary gives all or part of its profits to the parent charity then it will not have to pay any tax on those profits. This can result in very significant savings for the charity through the reduction or elimination of tax liabilities. Where the non-primary purpose trading does involve a significant risk the Charity would have to establish a trading subsidiary if it wished to continue that form of trading.

- To protect the charities assets from the risk of trading. If the trading is carried out within the trading subsidiary then the risks associated with any losses will be ring-fenced within the subsidiary itself.

- To protect the trustees of a charity from personal risks & liabilities.

- The directors of a trading subsidiary may be paid for their work unlike their trustee counterparts. Therefore a more commercially savvy person may be attracted to run the business. It must be noted though that the establishment of a trading subsidiary should not be used as a backdoor method of paying charity trustees.

It is important to remember that it is not only where non-primary purpose trading is undertaken that a subsidiary may be established. A charity may set up a trading subsidiary for the purpose of primary purpose trading if it so wishes.

DISADVANTAGES OF SETTING UP A TRADING SUBSIDIARY

Where the establishment of a trading subsidiary is not essential the benefits enjoyed must be balanced with the drawbacks that such a move would entail.

The disadvantages may include:

- The tax benefits may not outweigh all the extra costs associated with setting up and running a subsidiary.

- The additional administrative burden of a legal entity, quite separate from the charity.

- Difficulties that can emerge concerning the financing of a subsidiary.

- Possible cash flow problems for the subsidiary if all of the profits are donated back to the parent charity.

- The possible conflicts of interest arising where trustees of charities sit on the board of the subsidiary as directors.

These potential drawbacks will not be relevant in every case but trustees must be careful to avoid having their positions compromised.

In Parts 3/4 I will take a look at the financing of a subsidiary. This is often a difficult proposition given the numerous constraints placed on charities but it is essential that trustees are alert to the potential pitfalls.

Charities & Trading Subsidiaries Part 1

Today sees the start of a 6-part series which considers the trading activities of charities and the role of non-charitable subsidiaries. This is a pertinent issue in today's climate as charities move towards sustainable funding models. In Northern Ireland where the various Grant monies have begun begin to dry up there will be an increased onus on local community and charity groups to utilise trading opportunities as a means of funding, as failure to do so could result in their very survival coming into doubt.

PART 1

TYPES OF TRADING CARRIED OUT WITHIN A CHARITY

Charities are allowed to trade by law provided that the trading falls within one of the following categories:

Primary Purpose Trading- covers trading which contributes directly to one or more of the objects of a charity as set out in its governing document. Also includes trading where the work is mainly carried out by beneficiaries of the charity (beneficial trading).

This form of trading is not subject to tax and is therefore an effective way of funding the charity.

Examples include: provision of education services by an educational charity or the charging by a hospital for health care services.

Work carried out be beneficiaries (beneficial trading) might include sale of furniture produced by those with learning difficulties.

Ancillary Trading- is not on its own primary purpose trading but is carried out as part (ancillary) of a primary purpose trade.

Examples include: a theatre charity established for the promotion of arts running a cafe bar which sells refreshments to those attending the performance or the provision of accommodation to the students by a University.

Again this form of trading is not subject to tax liabilities.

Non-Primary Purpose Trading- is a form of trading which does not contribute directly to one or more of the objects of a charity as set out in its governing document. A charity will be allowed to raise funds through the carrying on of a trade which is not primary purpose, but only if the trading involves 'no significant risk' to the resources of the charity.

There is however no tax exemption for non-primary purpose trading, subject to a small trading exemption.

Exemption for Small Trades

The exemption to tax is applied where total turnover from all non-primary purpose trading does not exceed the annual limit.

The annual limit is as follows: £5,000 or if turnover is greater than £5,000, 25% of charity's gross income, subject to an overall limit of £50,000

In Part 2 I will condsider the use of trading subsidiaries and their respective advantages and disadvantages.

Credit Union reform in Northern Ireland

The joint HM Treasury & DETI consultation document on the reform of credit unions has recently been published:

http://www.hm-treasury.gov.uk/d/consult_ni_credit_unions.pdf

The proposals for regulatory reform follow the review of the legislative framework which was published in July 2009:

http://www.hm-treasury.gov.uk/d/review_legislativeframework_creditunions080709.pdf

The Treasury has put forward the following preferred option for reform of the sector in Northern Ireland:

The regulatory functions would transfer from DETI to the Financial Services Authority (FSA) whilst the registration of credit unions would remain within the remit of the DETI. The legislative functions would remain with the Northern Ireland Assembly.

The transfer to the FSA would enable credit unions to access both the Financial Services Compenstion Scheme (FSCS) and the Financial Ombudsmen Service (FOS). This would offer greater protection to credit union members in the event of a collapse of their credit union.

The FSCS currently provides up to £50,000 protection of savings per member in the event of a collapse.

Regulation by the FSA would also enable access to U.K Government initiatives such as the Growth Fund and Child Trust Fund.


Whilst much of the discussion has rightly focused on the FSA debate another interesting aspect of the consultation process is the scrutiny of credit unions investing their assets in their local communities.

Question 4 of the consultation document queries whether credit unions in Northern Ireland should be given powers to re-invest assets into community development and community enterprises. Such a power would go beyond that envisaged for credit unions in Britain and offer the kind of community investment powers currently enjoyed by credit unions in the ROI.

The ability to re-invest credit union assets into community enterprises could prove to be a big boost for the social economy sector in general with increased investment the result. There are numerous examples of this already occuring in the ROI to good effect and there will undoubtedly be calls for credit unions in Northern ireland to be able to wield such investment powers.

The consultation period will end on the 24 May 2010.

A New Blog

I hope that this blog will be a useful tool and source of information for those people operating within the social economy sector in Northern Ireland and beyond.