This article was originally published in Lawyer Monthly and can be accessed here.
From CIC to CIO – would your social enterprise clients be better off as charities?
When we advise clients who are trying to get a voluntary organisation off the ground, one of the first issues that we address is the choice of legal structure. There has been a growing demand for corporate structures in recent decades, often driven by a desire to offer more protection for the promoters against personal liability but sometimes on account of the advantages of being able to do business in the name of an organisation rather than through the promoters themselves.
Corporate charitable structures have been available for many years. Indeed, some of the oldest charities in England and Wales are corporations formed by Royal Charter, and it has long been possible to establish charitable companies and charitable registered societies. More recently, of course, the new CIO structure has been in use for over eight years and has proved to be extremely popular, combining the advantages of corporate status with a simpler regulatory regime than that which applies to charitable companies.
Where things tend to get more complicated is where a client has a non-commercial project but is not convinced that a charitable structure is appropriate. This situation may arise where the founder is, in essence, an entrepreneur who wishes to retain the ability to earn a living from the business while still exercising control over it at board level. In other cases, the client may have activities in mind that are simply not suited to the constraints that come with charitable status.
Readers will be aware of the community interest company (or CIC), a creature specially designed for social enterprises and introduced by the Companies (Audit, Investigations and Community Enterprise) Act 2004. In many respects a CIC is like a commercial company, with some refinements to make it suitable for businesses that want to do good for the community. While it must satisfy a “community interest test”, it can have aims far wider than those recognised as charitable and so the structure offers significant flexibility.
The directors of a CIC may be paid, and investors can receive a modest financial return, but it remains an asset-locked body and is subject to limits on dividends or interest that it can pay out, and its assets can only be distributed to charities or other asset-locked bodies. For these reasons, CICs are recognised as being appropriate for a wide range of voluntary sector bodies that deliver benefits to the community.
CICs are not, however, entitled to tax reliefs in the way that charities are. There is also a tendency among grant-making organisations to decline to support CICs specifically because they are not charities, which puts more onus on the grant-maker to take steps to ensure that a grant is applied for charitable purposes.
We have seen a number of instances where an initial decision to establish a CIC has been followed by a realisation that, in many respects, the organisation has been operating in the same way as a charity:
- the directors have not been paid;
- the CIC has not engaged in any commercial trading activities that would have been inconsistent with charitable status; and
- all its activities are in furtherance of purposes that are clearly charitable.
This can be accompanied by an awareness of the fiscal advantages enjoyed by charities, including eligibility for Gift Aid on donations, exemption from corporation tax and Stamp Duty Land Tax (SDLT) as well as mandatory relief from non-domestic rates. And it is not possible to be a CIC and a charitable company at the same time – the two are mutually exclusive.
Until 2018, a CIC wishing to switch to being a charity would have had to set up a new charitable entity, apply to the Charity Commission for its registration as a charity and then, usually at considerable expense, transfer the business of the CIC to the charity. This might involve having to secure the agreement of the CIC’s landlord, funders and contractors to the transfer; if there were employees in the CIC, the parties might also have to go through formal TUPE consultation procedures for the transfer of employees to the new entity.
In 2018, the legislation relating to CIOs was amended so that it was, for the first time, possible for a CIC to convert directly to being a CIO, in the same way that a charitable company could already convert. The key advantage here is that it is a genuine conversion, and there is no need for a new entity to be created and therefore no need for anything to be transferred. That certainly simplifies the legal aspects of converting, but it is still not a particularly fast or straightforward process.
The Charity Commission and the CIC Regulator need to be lined up to make the conversion happen smoothly, and we have experienced a few hiccups in this regard where the application to the Commission is reviewed by someone who is not familiar with the conversion mechanism. However, nearly three years down the line we are finding that the procedure is relatively painless and is certainly less complex than the pre-2018 options.
If you are advising any CICs who you think might want to consider charitable status, it is worth having a look at the Charity Commission’s step-by-step guidance on the conversion process at https://www.gov.uk/guidance/convert-a-community-interest-company-to-a-cio.