Community Interest Company (Amendment) Regulations 2014

Monday 21st July 2014 Grand Committee

Motion to Consider

16:36

Moved by

[Baroness Neville-Rolfe]

That the Grand Committee do consider the Community Interest Company (Amendment) Regulations 2014.

Relevant document: 5th Report from the Joint Committee on Statutory Instruments

[Baroness Neville-Rolfe (Con)]

My Lords, the Government believe that it is important to encourage the growth of what, for brevity, I will call CICs limited by shares. We want to attract social entrepreneurs who seek a vehicle for social enterprise but also require some return on their investment. CICs limited by shares are the way to do that and are one of this country’s most successful forms of social enterprise. The existing regulations contain unnecessary restrictions that limit dividend payment. At the moment, a director with a single share with a par value of £1 will receive a maximum of only 20p dividend payment, regardless of the level of profit made, or if the actual value of the shares has risen to £100. It is our intention, with these amendment regulations, to make it easier for investors to share in the success of a CIC.

The purpose of these regulations is to remove the share dividend cap—a statutory restriction on the amount of dividend that the directors of a community interest company may pay investors. CICs were introduced by statute in 2005, creating a new type of company for social purpose. The CIC is increasingly the model of choice for many social entrepreneurs, and since the legislation came into force, more than 9,300 social entrepreneurs or social enterprises have chosen to register as community interest companies, and numbers continue to grow year on year.

The CIC is a unique form of company. A CIC must be set up to benefit a particular community, and cannot be used solely to make a profit. CICs carry out a wide range of activities, but they take in sectors such as health and social care, including NHS spin-out social enterprises, environmental business support, addressing cultural needs and running community cafes and centres. At the core of every CIC is its community benefit.

One of the key characteristics of a CIC is its asset lock. The asset lock applies to all CIC models and requires the company to use its assets to achieve its objectives in the interests of the community. Two forms of CIC predominate: there is the company limited by guarantee, where there is no private gain; and the company limited by shares, where there are limits on the amount of profit that can be distributed in share dividends to shareholders. These limits are one aspect of the asset lock.

In 2010, changes were made to the legislation to simplify the application of the asset lock with regard to share dividend caps. These measures simplified the process of applying and managing the caps, but in 2012 a review of these changes by the CIC Association, an independent support organisation for CICs, together with the regulator of community interest companies, revealed that further action was needed, as the caps remained a barrier to investment and to taking up the share model.

There are currently two separate caps on the amount of dividend that the directors of the CIC can declare. The first limit is the share dividend cap, which prevents directors from declaring more than 20% of the paid-up value of a share. The second limit is the aggregate dividend cap, which prevents directors from declaring more than 35% of the profits of a CIC as dividends in any financial year.

These regulations today remove the share dividend cap completely, while retaining the aggregate share dividend cap. This change will make it simpler for CICs to declare dividend, encouraging investment in, and ultimately the growth of, CICs.

The changes we are making today have been fully consulted on and are supported. Last year a consultation was carried out jointly by the CIC regulator with HM Treasury, which was consulting on tax relief for social investment, where CICs are one of the specified models for investment. The joint consultation was a good example of collaboration between departments, and in both cases resulted in introducing new measures that would benefit CICs. The consultation showed that CICs found the so-called double cap confusing, difficult to work with and, frankly, unnecessary.

There is also evidence that the existence of the double cap put off founders of CICs from using a share model at all, instead creating a company limited by guarantee. This choice naturally inhibits the ability of a CIC to seek investment and to bring in share capital.

I hope to reassure noble Lords that the asset lock, which is a key feature of the CIC model, will not be compromised by these measures for the following reasons. First, CICs will still be able to distribute only 35% of their profits in share dividends, and the peg to the paid-up value of the shares will be retained in relation to redeeming or buying back shares by the company.

Secondly, the cap on performance-related interest will remain, although the regulator intends to increase this from 10% to 20% to encourage investment further, which can be done under her own powers.

Thirdly, CICs will continue to be required to report annually to the regulator on their activities and on the distribution of dividends.

The measure in these regulations, together with the changes to the performance interest rate being made by the CIC regulator, will, we hope, encourage growth in CICs. This is particularly desirable in light of the announcement by HM Treasury to introduce social investment tax relief in December 2013. These changes combined are expected to have a very positive impact on existing CICs, as well as encouraging social entrepreneurs to use this company form in new ventures.

These regulations will make it simpler for CICs to operate, and make them more accessible and attractive to investors while retaining the important elements of the asset lock and serving the needs of the community for which the CIC was established. I commend them to the committee.

[Lord Hodgson of Astley Abbotts (Con)]

I begin by adding my congratulations to my noble friend on her new role, and congratulate her on having so far descended the crest unscathed. Her officials certainly gave her—or parliamentary procedure gave her—a good mixture to begin with, starting off with IP, proceeding to employment regulations and now to company law.

I declare my long interests in the charitable world. As my noble friend Lord Wallace of Saltaire knows, I conducted the Government’s review of the Charities Act, and I have an interest in how CICs and the charitable sector work together. I do not oppose these regulations, but I would like just to draw attention to a potential danger. Then I have one specific question to which I would appreciate clarity from my noble friend.

We have a broad spectrum of organisations. We start at one end with limited companies, commercial companies, with which we are all familiar, and at the other end we have charities, which are severely and properly legally restricted. Everything has to be done by them for the public benefit. To fail to do so is breaking the law and opens the trustees to the full force of that law. Between those two extremes—limited companies at one end and charities at the other—there is an increasing number of corporate forms, one of which is the CIC. There are also community benefit societies—bencoms, as they are called—we had better have some new regulations for them; industrial provident societies; social enterprises that are not CICs; companies limited by guarantee that are not CICs; mutuals; charitable incorporated organisations; and CICs themselves.

16:45

I see the value in diversity. One does not want to be a one-club author. But we need to ensure that the public are clear about what all these organisations do, what their powers are and what they are permitted to do. Each of those organisations started out with a very clear differentiation in the law but sometimes those differences are being whittled away, on the grounds of utility, practicality and efficiency. This is one small whittling away. Does it really matter? Probably not but my concern is that we have this basic charity movement—165,000 registered charities doing wonderful things for our society and probably double that number if you take the unregistered ones—which is highly and hugely respected by the public.

The danger is that we create organisation forms that appear to the public to be charitable but are not entirely so. If there are scandals and difficulties, that may serve to undermine the trust that the public have in charities pure and simple, which remain the mainstream of our voluntary and social endeavour. Charities are already on the defensive due to, for example, the Cup Trust and the accusations of tax avoidance; the issue of executive salaries—what should the major charities pay their chief executives; and of course the even more vexed question of charitable aid going to extremist causes overseas.

I accept what my noble friend says, that the asset lock is critical, and certainly if she were to say that the asset lock will be changed, that would be a red signal as opposed to a yellow one, which I think we have this afternoon.

[The Deputy Chairman of Committees]

My Lords, I am sorry to interrupt the noble Lord but we have a Division. We shall resume in 10 minutes.

16:47

Sitting suspended for a Division in the House.

16:57

[The Deputy Chairman of Committees (Lord Geddes) (Con)]

The noble Lord, Lord Hodgson, was in full flow. Perhaps he would like to resume.

[Lord Hodgson of Astley Abbotts]

I thank the Lord Deputy Chairman. I was just concluding my first general concern about the regulations, which is that we are in danger of creating such a multiplicity of corporate forms that the public become concerned. As such, if we have scandal or difficulties in these intermediate categories, that may undermine the public trust in proper, full charities which are already under some pressure because of other issues such as executive salaries, aid to extremists and so on. I was saying to my noble friend that I very much hope that she will be robust in the maintenance of the asset lock, otherwise that would open up a significant whittling away. I hope that as the Government think about reforms in this area they will bear in mind the need to keep as clear a differentiation as possible and to explain it to the public. That is my general concern.

On my specific question, I turn to a point that my noble friend raised in her opening remarks about the change being made by the regulator to raise the performance rate of interest rate payable from 10% to 20%, which is in paragraph 8.3 of the Explanatory Memorandum. I understand from my noble friend’s remarks that this can be done by the regulator off her own bat. I seek an explanation of what this actually means. I understand what it says on the tin, but does that mean that it is inside the tin? If I understand it, it means that if I were to lend some money to a CIC and was able to arrange with the management that some performance-related criteria could be set—and I might seek that they be set in a way that was reasonably favourable to me—I could then get a 20% performance-related interest rate payable.

I may be completely wrong, in which case I am delighted to withdraw that view, but if I am right that does not seem to be a very happy state of affairs. A 20% rate of interest is high. The regulator should have control over the performance criteria that enable such a rate to be set, but it seems unlikely that that could happen without a high degree of bureaucracy. As the Minister knows, 20% in today’s markets is an extraordinarily high rate of interest, when the base rate is as it is. Indeed, it is nearly the APR that you are charged on overdue bounces on your credit card—about 22% or 23%—which everyone is saying is close to usury and that it is disgraceful that people should be charged such a rate.

17:00

It is strange to set this performance-related percentage in a vacuum. It would be much better if it were related to the Bank of England’s base rate, as then it would go up and down depending on interest rates. There have been times when rates have reached a level when a 20% performance-related rate would have been perfectly proper, but at current levels that is not the case. I understand that this is pretty specialised and specific. My noble friend may wish to write to Members of the Committee about it, but her officials may have managed to scribble a note that has made it absolutely clear that the whole thing is not as I thought it. If that is the case, I would be happy to withdraw my concern, which is that there is an opportunity here for malfeasance that could undermine general confidence in the sector.

[Lord Young of Norwood Green (Lab)]

My Lords, I thank the Minister for her introduction and the noble Lord, Lord Hodgson of Astley Abbotts, for his seminar on the variety of different organisations, which certainly educated me. He talked about destroying trust, but even now you regularly get bits of paper through your door, sometimes accompanied by a bag, from organisations purporting to be collecting clothes for charity. It is only when you read more carefully that you realise that there is not a registered charitable number associated with it. Even now the public have to be careful when they are contributing either in cash or kind.

We are not opposed to these changes, but we have some questions, to which I trust the noble Baroness will be able to respond. One justification for this move is to increase the number of CIC start-ups, but does the Minister have any estimate of the increase that will result? What merits are there in the Government’s proposal to remove the individual share cap while retaining the aggregate cap, versus the CIC Association’s proposal of linking the individual dividend cap to profits rather than paid-up share capital? Have I made that clear, or do I need to repeat it? I am looking at those behind you. What merits are there in the Government’s proposal to remove the individual share cap while retaining the aggregate cap, versus the CIC Association’s proposal to link the individual dividend cap to profits rather than paid-up share capital? That is your starter for five.

The Government aim to create more of a market in CIC shares through the removal of the dividend cap. However, the CIC regulator has said that that alone is not enough, and that it must be accompanied by clearer guidance and a campaign to educate stakeholders. What is being done to fulfil that objective? I am glad that the noble Lord, Lord Hodgson, raised the question of the performance-related interest rate, because I confess that I did not quite understand what that meant in practice.

On a final point, as a matter of interest, although the Minister may not have the figures: have there been any situations where a CIC company has failed—due to misconduct, shall we say—in any way? What has the track record of those companies been, now that we have 9,300 of them?

[Baroness Neville-Rolfe]

My Lords, I thank noble Lords for their valuable comments during this debate, and for their kind words on my first day on the Front Bench. These regulations introduce a welcome simplification and are important in enabling and encouraging the growth of CICs and making the model accessible to more social entrepreneurs. In response to the question asked by the noble Lord, Lord Young, we expect there to be an increase of between 10% to 20% within the first two years.

With their community benefit, CICs are an important part of the social enterprise landscape which have widespread support, and these regulations will ensure that CICs remain so. The measure will encourage a wider market for investment in a key and growing model of social enterprise that is accountable and transparent in its operation. I was glad that my noble friend Lord Hodgson of Astley Abbotts joined our debate today and was able to make a valuable contribution given his great expertise in the charitable area.

I will make a number of points. The steps we are taking are cautious, and indeed, as the noble Lord acknowledged, they are intended to preserve the vital asset lock. The change to the dividend cap has been 10 years in the making. As I said in my opening speech, that has been thoroughly consulted on and is supported by the CIC community. On the point on performance-related interest, this recognises the balance between risk and reward. The 20% is a maximum and is based on profit. At present, very few CICs pay performance-related interest at all. However, I will look at the points that he made and will perhaps write to him in the light of that.

I agree with both noble Lords that the public should be properly communicated with on the availability of different types of social enterprise entities. We need to explain the options clearly to citizens—and online options in that area can be very helpful and important. That will also be important in the debate we had previously on the new family-friendly policies. We will certainly consider how we can best make sure that those new arrangements and the whole range of social enterprise entity provisions are made publicly available.

The noble Lord, Lord Young, asked about the failure of CICs. The regulator has had a number of complaints about CICs, but that is a very small proportion in relation to the numbers on the register. All are investigated, and I will write to noble Lords with the exact numbers. On the campaign to educate stakeholders, I understand that not only does the regulator place priority on this matter, but it also works closely with umbrella organisations such as Social Enterprise UK, Social Enterprise Mark and the CIC Association to promote CICs. In my experience, that is often a very good way of ensuring wider dissemination of information in the market. I am grateful for the points raised in this debate and I commend these regulations to the House.

[Lord Young of Norwood Green]

Before the noble Baroness sits down, did she cover the rather complex question I asked in her response?

[Baroness Neville-Rolfe]

Perhaps this is the question that the noble Lord kindly repeated for me, twice. I fear that I still found—

[Lord Hodgson of Astley Abbotts]

Perhaps I may be of assistance to the Minister. There is a limit of 35% on the amount of total profits that can be distributed; therefore, how they are distributed among the shares does not matter. Presently, the individual share dividend cap is linked to par value. The par value of shares can vary enormously—you can have a pound par or a penny par. Therefore, 10% of that is an irrelevant figure. What is important is that they should not be able to pay out more than 35%. How it is paid out among the shares does not matter. The important thing is to make sure that not all the profits will be paid out. If the officials have not got that wrong, I will shut up.

[Baroness Neville-Rolfe]

I am grateful to my noble friend Lord Hodgson for coming to my aid. I will, with the officials, take a careful look at Hansard and perhaps indulge in the art of letter writing to clarify this important point after the debate.

Motion agreed.