The view that a community interest company should be the default choice for a charity’s trading subsidiary was given a significant boost last week, says Rachel Holmes.

I know one person who’s been asking this question for a while and, over the last year or so, I’ve had conversations with several other experts about whether the CIC should be the vehicle of choice for trading subsidiaries.  Nevertheless, it’s not been a pressing issue and although in my view there are advantages to using a CIC, they haven’t been so overwhelming as to make it a complete no-brainer.  However, the argument was given a significant boost this week, with confirmation by the Treasury that the forthcoming social investment tax relief will be available for investments in charities, CICs and community benefit societies, but not to charity trading subsidiaries per se. 

The aim of this article is not to present a watertight, evidence-backed case for using a CIC rather than a regular company limited by shares (a CLS).  It is a matter of opinion and, in places, unavoidably speculative.  The aim, rather, is to get charity trustees and their advisers thinking about whether the longstanding tradition of using a CLS for trading subsidiaries ought to be reconsidered.  

Will trading subsidiaries always qualify as CICs?

To qualify for CIC status, a company must (among other things) pass the “community interest test”, meaning that “a reasonable person might consider that its activities are being carried on for the benefit of the community”, according to the Companies (Audit, Investigations and Community Enterprise) Act 2004.  

This test should not present a high hurdle for subsidiaries that have been created to carry out charitable activities that the parent charity wants to ring-fence, or activities that, while community-focused, do not fall comfortably within the parent’s objects.  However, even trading subsidiaries whose activities are little different from those of commercial companies will likely pass the test if, at the end of each year, they pass their profits to their parent charity.  The community interest test is an activities test, and the activity of raising funds for an organisation exclusively pursuing public benefit purposes ought to pass it without too much trouble.

Keeping it in the family

As a vehicle whose assets are devoted to benefiting the community, the CIC is a closer cousin to charity than the CLS.  This may not be much of an advantage, but it could enhance public trust and goodwill towards the subsidiary, as well as offering greater brand coherence.

Access to finance

Back when CICs were a new and unfamiliar creature, they may have had a harder time persuading banks to lend to them than to tried and trusted CLSs, but is that the case now?  Is the situation still so much tougher for CICs (if indeed it ever was) that this is would count as a reason to choose a CLS instead?
In terms of attracting other investment, the CIC seems to offer a clear advantage.  Any wholly-owned trading subsidiary that intends remaining as such will not be looking for equity investors, but may nevertheless seek to benefit from capital injections from sources outside the banking sector, in the form of loans and bonds etc.  Although CICs are restricted in the rate of return they can offer on performance-related loans, the cap (which is to be raised from 10 per cent to 20 per cent) seems sufficiently generous so as not to deter commercially-minded investors, and there is no prescribed interest cap for other types of loan.  More importantly, however, a CLS is likely to struggle to attract philanthropic funders, who have generally been more open to the idea of putting money into CICs, on the basis that CICs are committed to benefiting the community and are regulated to ensure that they fulfil this commitment.  With the addition of the social investment tax relief, CICs will pull ahead of CLSs in terms of the deal they can offer to investors from both worlds.

CICs established under Schedule 3 of the Community Interest Company Regulations 2005 (as amended) can also pay dividends to equity investors. A subsidiary with social purposes of its own may spin off from the parent at some point to pursue its mission independently.  If it does, its ability to attract new investors could be key to its long-term sustainability. Again, a CLS with a robust business plan and good financial prospects may successfully attract commercial investors, but have difficulty convincing charities and other not-for-profit funders to get involved. Although there is a cap on the amount that a CIC can distribute in dividends, the cap will soon change so that, provided no more than 35 per cent of profits are distributed, there will be no limit to the amount that an individual investor can be paid in dividends. So the cap ought not to deter commercial investors, but – together with the other elements of the CIC asset lock – reassure philanthropic investors that their funds will be protected from carpetbaggers.  And, of course, the social investment tax relief will be an extra draw, available to CICs but not CLSs.

Charity trustees may argue that they have no intention for their trading subsidiary to go looking for investors or to do anything other than trade to raise funds for the charity, so – for them – the potential advantages of CIC status are hypothetical.  This may be true, but situations change, and what the CIC offers is greater flexibility to adapt to new circumstances.  

There are significant unknowns at this stage.  What is the general attitude of charitable and philanthropic funders towards CICs that have power to pay dividends?  Will that attitude change with the removal of the individual dividend share cap?  What effect will the power to make mixed-purpose investments have on the ability of differently-constituted subsidiaries to pull in funds from different sectors?  The answers to these questions will affect the comparative benefits of CICs and CLSs but, at the moment, there does not seem to be a downside to establishing a trading subsidiary as a CIC.  So is it time for charity trustees and their professional advisers to start considering the CIC as the default option?

Rachel Holmes is an independent charity law consultant