BRIEFING PAPER Number 03426, 30 April 2014

Community Interest By Timothy Edmonds

Companies

Inside: 1. Social Enterprise 2. CICs 3. CICs in action. 4. The CIC Regulator

www.parliament.uk/commons-library | intranet.parliament.uk/commons-library | [email protected] | @commonslibrary Number 03426, 30 April 2014 2

Contents

Summary 3 1. Social Enterprise 4 2. CICs 5 2.1 Introduction & legal establishment 5 The Act 5 Consultation and Regulations. 8 3. CICs in action. 9 4. The CIC Regulator 10

Cover page image copyright: Rosendale Leisure Trust by Robert wade. Licensed by CC BY 2.0 / image cropped.

3 Community Interest Companies

Summary

This note outlines the function and main characteristics of Community Interest Companies (CICs). CICs are part of the growing social enterprise sector which covers a very broad range of activity across many sectors of life. Although they are not charities many CICs have strong ethical backgrounds or serve social needs and all are subject to controls on the distribution of profits and capital. It is a strongly growing sector with 12,500 approved CICs as at March 2014. Number 03426, 30 April 2014 4

1. Social Enterprise

The social enterprise sector is already well established in the UK. It is represented by the Social Enterprise Coalition (SEC) which has a considerable amount of material about the sector on its website at: http://www.socialenterprise.org.uk. SEC defines social enterprises as: Social enterprises are that trade in the market with a social purpose. They use tools and techniques to achieve social aims and include an incredibly wide range of organisations, for example co-operatives, development trusts, community enterprises, housing associations, social firms, and leisure trusts. 1 The examples given of well-known social enterprises include Welsh Water, Café Direct, The Big Issue, the Co-Operative Group and Loch Fyne Oysters. A report by the London Business School found that, in the UK:2 • 3.5% of the working age population are ‘actively involved in SEA start up effort and 2.8% manage a start-up. • SEA activity was highest in London and lowest in the East Midlands. SEA activity rates are higher in rural areas than urban areas. • The SEA rate is highest amongst the youngest age group (18-24) at 3.9% of the population • Women are far better represented in SEA than in traditional entrepreneurial activity. • 10.9% of Black Africans are social entrepreneurs’ three times higher than for the white population. • SEA has become more economically significant in recent years. The average SEA start up employs more people and has a higher turnover than the average mainstream start up. Furthermore, the clear trend is for work in this sector to be paid rather than voluntary. The social enterprise sector includes various business forms as mentioned above, the available types were added to by legislation which established CICS.

1 See website 2 London Business School, Social Monitor UK 2006 5 Community Interest Companies

2. CICs 2.1 Introduction & legal establishment The Act Community Interest Companies (CICs) were established by the Companies ( Investigations and Community Enterprise) Act 2004. The primary legislation has been given effect by two subsequent Regulations: The Community Interest Company (Amendment) Regulations 2009 (SI 2009/1942) The Community Interest Company Regulations 2005 (SI 2005/1788) The explanatory notes to the Bill set out what the original legislation hoped to achieve: Part 2 of the Bill establishes a new type of company, the community interest company, for use by social enterprises wishing to operate as companies. This Part of the Bill also establishes the Regulator of Community Interest Companies ("the Regulator"), whose role will be to maintain public confidence in the CIC model. The CIC is intended to be used by non-profit-distributing enterprises providing benefit to a community. Such businesses are presently active in areas such as childcare, social housing, leisure and community transport. Many of them already incorporate as companies, either as a company limited by guarantee ("CLG") or a company limited by shares ("CLS"). The special characteristics of the CIC are intended to make it a particularly suitable vehicle for some types of social enterprise - essentially, those that wish to work for community benefit within the relative freedom of the non-charitable company form, but with a clear assurance of non-profit-distribution status. Companies that are formed as, or become, CICs will continue to be subject to the general framework of company law. In particular, CICs and directors of CICs will have to comply with their obligations and duties under the Companies Acts and the common law, as modified by this Bill. The CIC will be a new variant of existing forms of company. It can take the form of a CLG or CLS, and existing companies limited by guarantee with a share capital will also be able to become a CIC. CICs will be registered as companies with the registrar of companies in the usual way, and will be subject to the usual regulatory constraints and powers associated with company status, including the oversight of the Department of Trade and Industry's Companies Investigation Branch. The distinguishing features of the CIC will be: in order to become a CIC, a company will have to satisfy a community interest test, confirming that it will pursue purposes beneficial to the community and will not serve an unduly restricted group of beneficiaries. The test is whether a reasonable person could consider the CIC's activities to benefit the community - it is therefore wider and simpler than the charitable test of public benefit; companies of a particular description may be excluded from CIC status by regulations; it is anticipated that political parties, companies controlled by political parties, and political campaigning organisations will be excluded in this way; CICs will not be able to have charitable status, even if their objects are entirely charitable. However, charities (and all other organisations except political parties) will be able to establish CICs as subsidiaries; each CIC will be required to produce an annual community interest company report containing key information relevant to CIC status. The report will be placed on the public register of companies; CICs will have an asset lock - that is, they will ordinarily be prohibited from distributing any profits they make to their members; Number 03426, 30 April 2014 6

however, it is intended that regulations will allow CICs that are limited by shares to issue dividend-paying "investor shares". The dividend payable on such shares will be subject to a cap; when a CIC is wound up, its residual assets will not be distributed to its members. Instead, they will pass to another suitable organisation that has restrictions on the distribution of its profits, for example another CIC or a charity; the Regulator will approve applications for CIC status, receive copies of the community interest company reports and police the requirements of CIC status, including compliance with the asset lock. He will have close links with the registrar of companies. The key role of the Regulator will be to maintain public confidence in the CIC model. He will aim to impose the minimum necessary regulatory burden on CICs, but will have powers to investigate abuses of CIC status and to take action where necessary, for instance to remove directors, freeze assets or apply to the courts for a CIC to be wound up. He will also set the cap on CIC dividends.3 More detail about the Bill and the debate on it can be found in Library Research Paper 04/62. During the Bill’s Second Reading, the Minister, Jacqui Smith, summarised the new company form: The community interest company will be a new and additional choice for social enterprises. It is not meant to replace other options such as charities, or the industrial and provident society, which is the form used by many co-operatives. Indeed, the Government are committed to modernising all legal options used by voluntary and community organisations and helping people to choose their most appropriate option. The special value of the community interest company is that it will offer the flexibility of the company form, yet be more suitable for many social enterprises than existing types of companies. Responses to consultations show that there is about 80 per cent. support for the idea of the community interest company, and it is supported by bodies including the Social Enterprise Coalition, the National Council for Voluntary Organisations and the Association of Charitable Foundations. Again, the community interest company is based on the idea of a bargain, and part 2 of the Bill creates the legislative basis for that balance. The people who run a community interest company will voluntarily accept certain constraints and a higher level of supervision and, in return, the company will acquire a status that signals to customers, investors, employees and bankers that the business is run for the benefit of the community, that its profits are wholly or largely applied for the benefit of the community, that its assets are protected for the benefit of the community and that it is subject to oversight from a regulator. The regulator will have the task of maintaining confidence in community interest companies and will also promote awareness of the potential of the new type of company.4 One of the main CIC-issues during the passage of the Bill was whether CICs should be allowed to have charitable status. During the committee stage of the Bill (especially in the Lords) there was debate over whether a CIC should be given the opportunity to become a charity. One argument was that there was no reason to deny charities what they would find most useful; charities already had a range of legal formats that they could adopt, another one would present no legal disadvantages; grant giving bodies find it easier to make grants to charities. Lord Phillips of Sudbury (Liberal Democrat) claimed that the Charity Law Association and the

3 Explanatory notes available on DTI website at: Companies (Audit, Investigations and Community Enterprise) Bill [HL] 4 HC Deb 7 September 2004, c636 7 Community Interest Companies

Social Enterprise Coalition both supported the principle5 that CICs should be able to be charities.6 Lord Glentoran (Conservative) illustrated his support by saying: As the noble Lord, Lord Phillips, has already pointed out, it is something of an anomaly for CICs to be denied charitable status. That is particularly so when subsection (3) of Clause 23 reads: "A community interest company established for charitable purposes— (a) is to be treated as not being a charity". That is almost a paradoxical statement.7 The Minister, Lord Sainsbury, went into great detail explaining the contrary view: In a nutshell, the provision on CICs and charitable status in Clause 23 is intended to ensure that there will be a clear distinction between this new type of company on the one hand, and charities on the other. I should emphasise that the CIC is not designed for use by charities, and it is not a part of the revision of the charity law which our colleagues in the Home Office are preparing. However, it is part of the same overall process of modernising the legal environment for the voluntary and social enterprise sectors. It will certainly not remove any of the existing options for charities, which will of course be updated and improved in the forthcoming draft charities Bill. The key point here is that the CIC has been designed as an alternative to charitable status. We expect that CICs will wish to use the freedom of company law to pursue a wide variety of purposes, some of which may be charitable, while others will not. CICs will certainly wish to trade and to behave as enterprises, in a way that is difficult for charities. They will have the freedom to pay their directors and to change the nature of their activities, subject to the requirements of this part of the Bill. […] We have concluded that a change of policy, to allow CICs to have charitable status, would not be of benefit to the charitable sector. Nor would it carry any benefit for social enterprises which are not charitable, who are the intended users of the CIC. However, it could adversely affect the value of the CIC to that latter group. It would also be likely to raise increased concerns about confusion between CICs and charities. That seems to me the nub of the argument—that in practice it is very difficult to see what the advantages of the amendment would be to charities. They have perfectly good forms in which to do what is needed, and it would require quite a distortion to the CIC form to make it charitable. Against that, one has to weigh the unpredictable, which is where confusion might come in. For those charities that wish to use the company form to incorporate—and the noble Lord, Lord Phillips, has said that there are many charities which welcome the certainty of company law—the CIC will offer no practical advantage over existing forms of company. The fact that it offers a statutory asset lock backed up by regulation will be of no value to charities, because charitable status already provides that. […] In practice, of course, a charity that wanted to use CIC status would face the prospect of meeting three new sets of requirements: first, the reporting and accounting requirements of being a company; secondly, the requirements of CIC status; and, finally, the charity regulation regime. The CIC proposals are designed to avoid unnecessary or overlapping regulation. But surely all these requirements, coupled with a lack of practical benefit to a charity from being a CIC, will deter any charity that might find the CIC brand of interest.8

5 In fact the SEC was silent on this point, see HL Deb 7 July 2004 c850 6 HL Deb 25 March 2004 c318GC 7 ibid c319GC 8 ibid c321-323GC Number 03426, 30 April 2014 8

Consultation and Regulations. The detailed Regulations governing the establishment and running of CICs were published in March 2005 and came into force in July 2005. An explanatory memorandum on the regulations can be found on the internet. The Department published a consultation paper prior to issuing the draft Regulations in October 2004. The responses to this document highlighted some of the more practical issues surrounding CICs functioning and regulation. The main issues under discussion were: • Deciding on the degree to which CICs should benefit a wider community than just their membership • How should the residual assets on the solvent winding up of a community interest company be distributed Various issues dealing with dividend bearing shares – • CICs have the option of structuring themselves as companies limited by shares, with the ability to issue “investor shares” that could pay a capped dividend to investors. What level of dividend cap should be set?

The issue of the dividend cap and the problems of reconciling the funding needs of CICs (and other social enterprises) is an ongoing matter.

A consultation was held on raising the dividend cap in 2013; it concluded that • the maximum dividend per share cap should be removed; • the maximum aggregate dividend cap should be retained at 35%; and • the maximum interest rate for performance related interest should be increased from 10% to 20%. Concurrent with the consultation, the Chancellor, in the 2013 Budget, announced the intention to provide tax reliefs for social enterprise investment. These are currently in the 2014 Finance Bill.

• The Possible “index linking” of dividend bearing shares to adjust their value for inflation in a solvent winding-up • Restricting the ability of investor shareholders to control community interest companies Lastly – • Issues surrounding the appeals (to the Regulator) The full consultation can be found here. The Community Interest Companies Regulations 2005 (SI 2005/1788) came into force on 1 July 2005. A series of simple leaflets covering the main issues and rules relating to CICs have been published on the BIS – CIC website here. 9 Community Interest Companies

3. CICs in action.

During the Second Reading debate of the Bill to introduce CICs, the then Minister admitted that she had no idea about how many CICs would be set up. In fact they have proved to be incredibly popular with a very diverse collection of interests and community groups. The main source of information about CICs can be found on the website of the CIC Regulator which can be found here. The Regulator’s office comes under the remit of the Department for Business, Innovation & Skills. There are currently about 9,000 registered and authorised CICs. A table showing the growth of CICs is shown below: Community Interest Company establishments 2005-14 Public Record Approved Dissolved Converted to Annual Cumulative a Charity Increase Jul 05 – Mar 06 208 0 0 208 208 Apr 06 – Mar 07 637 0 0 637 845 Apr 07 – Mar 08 814 35 3 776 1,621 Apr 08 – Mar 09 1,120 86 2 1,032 2,653 Apr 09 – Mar 10 1,296 372 5 919 3,572 Apr 10 – Mar 11 1,824 483 7 1,333 4,905 Apr 11 – Mar 12 2,087 590 11 1486 6,391 Apr 12 – Mar 13 2,055 765 11 1,279 7,670 Apr 13 – Mar 14 2,494 976 11 1,507 9,177 Total 12,535 3,307 50

Source: CIC Regulator Annual Report 2013-14 Number 03426, 30 April 2014 10

4. The CIC Regulator

CICs are subject to the authority of a Regulator whose powers derive from the Act. From the tine of the Regulator’s comments her office is positively involved in helping CICs become established as well as ensuring, for example, that the crucial ‘asset lock’ and restrictions on the distribution of profits are observed. During the Lords Committee stage the Minister, Lord Sainsbury, described the role of the office as having a ‘light touch’.9 The Regulator’s income comes primarily from fees charged for the incorporation and conversion of CICs. Currently the cost for applying to become a community interest company is £35 and to convert £25, of this £20 covers an element of the Registrar of Companies costs. The remaining £15 fee is transferred to the consolidated fund to cover an element of the Regulator’s costs. The office’s income does not meet its expenditure, by a wide margin and hence there is public sector subsidy. Full details of the work of the Regulator can be found in its latest Annual Report.

9 ibid c334GC

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