A new tax relief is available for people who lend money to charities. David Ainsworth asks if it will work for charities, and how it interacts with gift aid.

As of last month, we have a new tax relief for charities looking to borrow money – social investment tax relief.

There is a considerable difference of opinion in the charity sector, though, about whether this is a good thing.

In brief, SITR gives an investor the right to make an unsecured loan to a charity and claim 30 per cent tax relief on the value of the loan. They can also charge market rate interest. But they can’t get the capital back for three years.

A Charity Tax Group conference last week heard that the relief was of limited use. It is too small-scale, it rewards the rich more than the charity, it’s not much use, and it’s a tax avoider's charter.

Let’s look at these objections.

It’s too small-scale

The maximum size of the investment is currently around £290,000 over three years.

This is expected to rise once the government gets state aid approval, but for the moment, it's a major impediment.

SITR deals are going to be quite expensive to arrange, and it would be helpful if the early ones involved millions, not hundreds of thousands. But the government’s hands are tied. Let’s hope once the de minimis limit is lifted, the cap on how much can be invested is set at a sensible amount.

This is made worse because there's a cap on the size of the organisation which can use it. Big charities, who would be the most likely to use it, can't do so.

The charity most likely to use it now is one with an income of £1m or £2m, where the de minimis limit is unlikely to be a significant problem. A £290,000 loan is probably fairly significant for an organisation like this.

For an organisation to use it, it would have to have some way of generating revenue, too. It will have to be able to invest the money in something which pays back more than it costs.

So it’s the medium-sized service delivery charity which will find this most use in the short term.

It rewards the lender more than the charity

You have to say this looks like a valid objection. If you make 30 per cent profit up front, plus interest, that’s a pretty good deal for the lender, but not enticing for the borrower.

For the organisations taking this relief, the hope is that they can use this relief to persuade someone to make an interest free loan. After all, if a donor lends you £290,000, they can claim back £87,000 in tax relief. The least they can do is not charge you interest.

If this isn’t generous enough, though, I can’t see any reason why a loan can’t be accompanied by a gift. In fact, I think it makes more sense to pay interest and take a gift, because you get two sets of tax relief.

Here’s one possible scenario.

• A top-rate taxpayer lends a charity £200,000 at 10 per cent interest, all capital repayable at the end of a three year period. He collects £60,000 in tax relief from SITR.
• He then gives £80,000 to the charity under gift aid and collects £25,000 in higher rate tax relief. The charity collects £20,000 in gift aid.
• Over the next three years, the lender receives £60,000 in interest on his loan at £20,000 a year.
• In total, the lender puts £280,000 into the charity and receives back £345,000 - £200,000 on his loan, £60,000 in interest, and £85,000 in tax relief. He makes a profit of £65,000, so he’s better off than if he’d just used SITR.
• The charity receives £300,000 in loan, gift and tax relief, and repays £260,000 in loan and interest. It makes a profit of £40,000, and receives interest-free use of the money for three years. So it’s effectively borrowed money for three years at an interest rate of -13 per cent.

In fact, this gift-and-loan scenario seems such a good deal I wondered if it was illegal. It doesn’t seem to be, though. I asked HM Revenue & Customs and Big Society Capital, and they seemed to think it should be ok.

I say that with the caveat that this scenario hasn’t been given a lot of thought, so it might prove unworkable for reasons I haven’t yet encountered.

It’s difficult to use

John Hemming, chair of the CTG, told the conference that charities can’t issue share capital, and therefore couldn’t take long-term investment.

But I feel there has to be a way around this problem.

To take just one example, imagine you’re a charity and you want to win some big contracts, but you don’t have the cash. So you sell performance-related bonds.

You agree that you will pay interest on those bonds each year based on the increase in your contract income. If you make a packet, your lender reaps the rewards. If you make a loss, you pay back less than you borrowed. Private investors can buy as many as they like for £100 each and sell them on whenever they like.

Something similar to this has already been tried – the social loan agreed by HCT Group and a consortium of social lenders. But SITR would make this attractive to individual lenders, because they are 30 per cent up before they start. 

At the moment, the de minimis limit prevents this being an effective tool, because it’s complicated and needs to be done at scale to really work. But that limit, we hope, won’t be around forever.

It’s a tax avoider’s charter

I do have some reservations about whether this relief could be used to avoid tax. Using the gift-and-loan model I mentioned earlier it’s possible for a charity and a donor to both make a profit on the investment.

If the lender, not the charity, extracted all the profit, they could make a 50 per cent return at little risk. So this is something to be monitored carefully.

At present this is a potentially useful relief, for a limited section of the sector, with a number of potential problems that need to be ironed out.