Community Investment Tax Credit

Companies and individuals with an interest in urban regeneration will wish to take advantage of this new tax credit. The relevant sections of the Finance Act 2002 (which came into force on 23 January 2003) relate to investments and claims made on or after 17 April 2002.

The Community Investment Tax Credit can be claimed by companies as well as individuals. The amount of relief is 5 per cent (annually, each year for five years) of the amount "invested" in a "CDFI" or Community Development Finance Institution. For companies, this amount is deducted from their taxable profit. The definition of CDFI extends to any institution that has as its principal objective the provision of finance, or access to business advice, for enterprises for disadvantaged communities and will encompass many charities. We set out below the requirements for qualifying investments and how to claim, together with some legal issues that will need to be considered.

What form must the investment take to benefit from the Community Investment Tax Relief?

The investment may be made in the form of loans, securities or shares, provided the investment, of whichever type, is held for at least five years. It must also be considered to be a "qualifying investment" and satisfy certain general requirements.

Loans

The conditions that must be satisfied by a loan are that:

• on the investment date, the CDFI receives the full amount of the loan or if it is made under a draw down facility, the CDFI is to receive the full amount of the loan within 18 months of the investment date;
• it is not capable of conversion or exchange into a loan, securities or shares which are redeemable within the five-year period; and
• no person can require:
  • any repayment of the amount advanced during the first two years of the five-year period;
  • repayment during the third year of more than 25 per cent of the total amount advanced;
  • repayment before the end of the fourth year of more than 50 per cent of that amount; or
  • repayment before the end of the fifth year of more than 75 per cent of that amount.

Where a loan agreement authorises the body to draw down amounts of the loan over a period of time, the loan is treated as made at the time when the first amount is drawn down and, to accord with the first condition, the full amount of the loan must be drawn down within 18 months of the investment date.

Securities and Shares

To qualify, securities and shares must be subscribed for wholly in cash, fully paid on the investment date, and be neither redeemable within the five-year period nor capable of conversion or exchange into a loan, securities or shares which are redeemable within that period.

The general requirements referred to above are that:

• an investor must not control the CDFI in which the investment is made. In broad terms, the test is whether the investor has the power to secure that the affairs of the CDFI are conducted in accordance with its wishes;
• the investor must be the sole beneficial owner of the investment when it is made and must not itself be accredited as a CDFI on the investment date; no tax relief is available on an amount used by the investor to acquire an interest in a CDFI which is a partnership; and
• the investment must not be made as part of a scheme or arrangement the main purpose of which, or one of the main purposes of which, is avoidance of tax.

Wholesale and Retail Accreditation

A distinction is drawn between "wholesale" and "retail" CDFIs - that is, between CDFIs whose objective is to finance other CDFIs, and those that lend directly to the enterprises in disadvantaged areas. The distinction is important as it imposes a financing limit on CDFIs.

A "retail" CDFI may issue tax relief certificates up to an aggregate value of £10 million during its accreditation period (three years), while the limit for any other accredited CDFI (a "wholesale" CDFI) is £20 million. Any certificate issued wholly or partly for amounts in excess of these limits is invalid, and there is a penalty (not exceeding £3000) for their fraudulent or negligent issue. The limits may be changed by Treasury order. It is, however, possible to apply for re-accreditation within the three-year period, in order that the CDFI may raise the limits on the issue of tax certificates and increase the size of the fund. But there is no guarantee that the re-accreditation will be successful.

Procedure

In order for the investors to claim the tax credit, the CDFI will have to issue a tax relief certificate. It seems prudent to begin the registration process as soon as possible, as it is unclear how long this will take. Applications for accreditation should be made to the Secretary of State for Trade and Industry.

Who can claim the tax relief?

Companies as well as individuals may claim this relief. Relief for companies is subject to receipt of a valid tax relief certificate. Relief may be claimed for the accounting period in which the investment is made, and for each of the accounting periods in which the four subsequent anniversaries of that date fall. The amount of the relief for a period is the smaller of:

• 5 per cent of the invested amount for the period; and
• the amount which reduces the investor's income tax liability for the year to nil.

Tax relief is deducted from the liability to corporation tax after taking account of any marginal small companies relief and investment relief obtained under the Corporate Venturing Scheme, and before deducting any double taxation relief.

For individuals the relief will take the form of a reduction in the amount of income tax liability for a tax year, and for each year is the smaller of:

• 5 per cent of the invested amount for the year;
• the amount which reduces the investor's income tax liability for the year to nil.

For example: an individual investor subscribes £10,000 for shares in a CDFI which are redeemable after seven years. The invested amount for each year will be £10,000 (the amount subscribed). Tax relief of £500 (5 per cent of £10,000) may be claimed for the tax year in which the shares are issued, and for each of the four subsequent tax years.

Some legal issues

Investment in a CDFI will involve other technical issues. In particular, CDFIs will need to ensure that they either comply with or are exempt from certain legal requirements. The following matters are likely to be relevant, but are not exhaustive.

Offers to the public

If the CDFI is a private limited company (as is likely if it is a charity), it will be prohibited under the Companies Act 1985 from offering shares or debt securities to the public. Certain limited offers are permissible - for example, where only a few investors are involved - and the offer may be exempt if the securities are not transferable (which, given the nature of the qualifying conditions for relief, might not be a disincentive).

In addition, under the Public Offers of Securities Regulations 1995 a prospectus is required to be published when shares or debt securities which are not to be listed on a recognised investment exchange are offered to the public for the first time. There are exemptions - for example, if the securities are offered to 50 or fewer persons in the UK, or are offered by a registered charity or are not transferable.

Financial promotion

Section 21 of the Financial Services and Markets Act 2000 provides that a person must not, in the course of business, communicate an invitation or inducement to engage in investment activity (such as buying or selling securities). Both the CDFI and the investors run the risk of breaching the prohibition. Breach is an offence and may lead to an agreement being unenforceable by the person in breach, and to his having to return any money or property he has received under the agreement and to compensate the counter-party for any loss. Invitations or inducements by any method of communication are caught, including e-mails, telephone calls, presentations and face-to-face meetings. The restriction does not apply to "authorised persons" under FSMA, or to communications approved by an authorised person, and there are various exemptions. Whether the exemptions apply will normally depend on the nature of the person receiving the relevant communications.

FSMA also prohibits the carrying on of regulated activities (such as accepting deposits or dealing in or arranging deals in investments) except by authorised persons. This will not normally be an issue for CDFIs and investors in view of the available exemptions - on deposit-taking, for example, debt securities with a maturity of one year or more do not qualify as deposits.

For further information, please contact:

Andrew Crawford
Corporate Partner
Telephone: +44 (0) 20 7367 2867
E-mail: [email protected]

Mark Nichols
Tax Partner
Telephone: +44 (0) 20 7367 2051
E-mail: [email protected]

Simon Howley
Corporate Professional Support Lawyer
Telephone: +44 (0) 20 7367 3566
E-mail: [email protected]