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Community investment tax relief

Category Technical Articles
AuthorTechnical Department
25 per cent relief – but over five years! David Bertram considers the rules for accreditation, qualifying investments, conditions for relief and how to claim CITC tax relief: Article published in the August 2002 issue of Tax Adviser. David Bertram is a Director of Clayfield Professional Guidance Ltd.
The Community Investment Tax Credit (CITC) scheme aims to encourage private investment in businesses and social enterprises in disadvantaged communities The scheme gives tax relief to individuals and companies investing in accredited Community Development Finance Institutions (CDFIs) which use investors’ funds to finance small businesses and social enterprises working in, or otherwise for, disadvantaged communities.

Eligibility for tax relief

An investor (who may be an individual or a company) making an investment in a body is eligible for relief for investment if the body is accredited as a CDFI under Finance Act 2002 (FA 2002), Sch. 16, para. 4–7 at the time the investment is made, the investment is a qualifying investment (see FA 2002, Sch. 16, para. 8–13), and the general conditions set out in FA 2002, Sch. 16, para. 14–18 are satisfied.
(FA 2002, Sch. 16, para. 1).

Meaning of investment

An investment in a CDFI is made when a person makes a loan (whether secured or unsecured) to the CDFI. However, this does not apply where a CDFI uses overdraft facilities provided by him. Where a loan agreement authorises a CDFI to draw down amounts of the loan over a period of time, it is treated as made when the first amount is drawn down. There is also an investment where an issue of securities of or shares in the CDFI, for which he has subscribed, is made to him.
(FA 2002, Sch. 16, para. 2)

Meaning of ‘the five year period’

The rules of the CITC scheme require that certain conditions are met throughout ‘the five year period’. This is the period of five years beginning with the ‘the investment date’.
(FA 2002, Sch. 16, para. 3)

Application and criteria for acceptance

Applications for accreditation as a CDFI must show that the CDFI’s principal objective is to provide (directly or indirectly) finance, or finance and access to business advice, for enterprises for disadvantaged communities. It must also satisfy such other criteria as may be specified in Treasury regulations, which may be made by reference to material published by the Secretary of State, Department of Trade and Industry (DTI). Where the Secretary of State DTI accredits a CDFI he must specify that the body is accredited as a ‘retail’ CDFI (as contrasted with a ‘wholesale’ CDFI). Thus there is a distinction between CDFIs whose purpose is to finance other, usually smaller, CDFIs, and those CDFIs who invest directly in disadvantaged areas.
(FA 2002, Sch. 16, para. 4)

Terms and conditions of accreditation

An accreditation under the CITC scheme may also be conditional upon compliance with requirements set by regulations, including requirements relating to the provision of information. The Secretary of State DTI delegates his functions under the CITC scheme to the Small Business Investment Taskforce (SBIT), assisted by the Small Business Service. The SBIT is a non-departmental public body, one of whose purposes is to advise on various funding issues for businesses.
(FA 2002, Sch. 16, para. 5, 6)

Period of accreditation

The accreditation period is three years beginning on the day specified in the accreditation. If a CDFI is already accredited, and is seeking a new accreditation, the new accreditation runs from when the body’s current accreditation expires, unless the new accreditation specifies that the existing accreditation be treated as expiring immediately before the grant of the new accreditation. One reason why a CDFI might seek a new accreditation before the end of an existing period of accreditation could be where the CDFI raises the maximum permitted amount of investment (see FA 2002, Sch .16, para. 21 below) and wishes to raise more before the end of the existing accreditation period.
(FA 2002, Sch. 16, para. 7)

Conditions to be satisfied in relation to loans

The are three conditions to be satisfied before a loan can be a qualifying investment:

(1) either:

  • the CDFI receives from the investor, on the investment date, the full amount of the loan; or
  • if the loan agreement authorises the CDFI to draw down amounts of the loan over a period of time, the end of that period is not later than 18 months after the investment date.

(2) the loan must not carry any present or future right to be converted into or exchanged for a loan which is, or securities, shares, or other rights which are, redeemable within the five year period.

(3) the loan must not be made on terms that allow any person to require repayment:

  • during the first two years of the five year period of any of the loan capital advanced in those two years;
  • during the third year of the five year period of more than 25 per cent of the loan capital outstanding at the end of those two years;
  • before the end of the fourth year of the five year period of more than 50 per cent of that loan capital; or
  • before the end of the five year period of more than 75 per cent of that loan capital.

Any requirement which arises because of a failure by a CDFI to fulfil any obligation of the loan agreement is disregarded if that obligation is imposed by reason only of the commercial risks to which the investor is exposed as lender under that agreement, and is no more likely to be breached than any obligation that might reasonably have been agreed for the loan in the absence of the CITC scheme.
(FA 2002, Sch. 16, para. 9)

Conditions to be satisfied in relation to securities

Two conditions must satisfied in relation to securities:

(1) the securities must be subscribed for wholly in cash, and be fully paid for on the investment date: and
(2) the securities must not carry any present or future right to be redeemed within the five year period, or any present or future right to be converted into or exchanged for a loan which is, or securities, shares or other rights which are, redeemable within the five year period.
(FA 2002, Sch. 16, para. 10)

Conditions to be satisfied in relation to shares

The two conditions which must be satisfied in relation to securities are:

(1) the shares must be subscribed for wholly in cash, and must be fully paid for on the investment date, and there should be no undertaking to pay cash to the CDFI at a future date in connection with the issue of the shares; and
(2) the shares must not carry any present or future right to be redeemed within the five year period, or any present or future right to be converted into or exchanged for a loan which is, or securities, shares or other rights which are, redeemable within the five year period.
(FA 2002, Sch. 16, para. 11)

Tax relief certificates

An investor needs a tax certificate because no claim to CITC tax relief may be made without one. In relation to an accreditation period, a retail CDFI (see FA 2001, Sch .16, para. 4) must not issue tax relief certificates for investments made in the CDFI in that period with an aggregate value exceeding £10m, or in any other case, issue tax relief certificates for investments made in that period with an aggregate value exceeding £20m. If a tax relief certificate does not meet these requirements it is invalid. A CDFI that issues a tax relief certificate which is made fraudulently or negligently is liable to a penalty not exceeding £3000.
(FA 2002, Sch. 16, para. 12)

Pre-arranged protection against risks

Any arrangements under which an investment is made must not include any arrangements to provide partial or complete protection for the investor against what would otherwise be the risks attached to making the investment. This means that protection by way of any insurance, indemnity or guarantee or otherwise may be invalid. This does not, however, invalidate arrangements for the provision, for the investor, of protection against such risks as might reasonably be expected to be provided for commercial reasons if the investment were made in the course of a business of banking such as the charging of a property as security for a loan.
(FA 2002, Sch. 16, para. 13)

No control of CDFI by investor

Neither the investor (nor any person connected with him (see TA 1988 s 839)) can control the CDFI at any time during the five year period.
(FA 2002, Sch. 16, para. 14)

Beneficial ownership

The investor must be the sole beneficial owner of the investment when it is made. Subject to rules dealing with nominees and bare trustees (see FA 2002, Sch. 16, para. 44) individuals and companies investing in an accredited CDFI must do so in their own capacity, and not in their capacity as a trustee or partner. Where the investment consists of a loan, the person beneficially entitled to repayment of the loan is treated as the beneficial owner of the loan.
(FA 2002, Sch. 16, para. 15)

Investor must not be accredited

The investor must not, itself, be accredited as a CDFI on the investment date. This is to ensure that where an accredited ‘wholesale’ CDFI invests in another accredited CDFI, tax relief is obtained only on the first investment.
(FA 2002, Sch. 16, para. 16)

No acquisition of share in partnership

Where a CDFI is a partnership, the investment must not comprise any amount of capital contributed by the investor on becoming a member of the partnership. Here, the amount of capital contributed by an investor on becoming a member of a partnership includes any amount which purports to be provided by him by way of loan capital, and is accounted for as partners’ capital in the accounts of the partnership. A member of a CDFI which is a partnership may still be able to obtain tax relief on a loan made to the partnership if the other rules of the scheme are satisfied.
(FA 2002, Sch. 16, para. 17)

No tax avoidance purpose

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 the avoidance of tax.
(FA 2002, Sch. 16, para. 18)

Individual investors

Where an individual investor makes a claim the relief takes the form of a reduction in the amount of his income tax liability for that tax year. For each relevant year this reduction is the smaller of five per cent of the CITC invested amount for the year, or the amount which reduces his income tax liability for the year to nil.

The ‘relevant’ years are the tax year in which the CITC investment date falls, and each of the four subsequent tax years.

This entitlement to make a claim for relief is subject to the following restrictions:

(1) where the claim relates to loans (see FA 2002, Sch. 16, para. 22), no claim can be made after a disposal, or excessive repayments or receipts of value);
(2) where the claim relates to securities or shares (see FA 2002, para. 23), no claim can be made after a disposal or excessive receipts of value); and
(3) no claim can be made after loss of accreditation by the CDFI (see FA 2001, Sch. 16, para. 24).

In determining the amount of income tax to which the investor would otherwise be liable were it not for CITC scheme relief, no account is taken of:

(1) any personal reliefs or allowances under Income and Corporation Taxes Act 1988 (ICTA1988), s. 256–278 or for qualifying maintenance payment (per ICTA 1988, s. 347B);
(2) any interest paid on a loan to purchase a life annuity (per ICTA 1988, s. 353(1A) and 365);
(3) any reduction of liability to tax under any double tax arrangements (under ICTA 1988, s. 788), or as a credit by way of unilateral relief (per ICTA 1988, s. 790(1)); or
(4) any tax at the basic rate on so much of that person’s income as is income, the
income tax on which, he is entitled to charge against any other person or to deduct, retain or satisfy out of any payment.

It is important to note that the effect of this paragraph together with FA 2002, Sch. 17, para. 2–4 (CITCs – consequential amendments) is that income tax relief under the CITC is given after taking account of any relief obtained under the Enterprise Investment Scheme (ICTA 1988, s. 289A), any relief obtained under the Venture Capital Trust Scheme (ICTA 1988, Sch. 15B), but before deducting any other reliefs which are given in terms of tax, and so as to leave sufficient tax in charge to cover any Gift Aid payments (FA 1990, s. 25).
(FA 2002, Sch. 16, para. 19)

Company investors

Where a company investor makes a claim relating to a loan, securities or shares for a relevant accounting period, the relief takes the form of a reduction in the amount of its corporation tax liability for that accounting period. For each relevant accounting period this reduction is the smaller of five per cent of the invested amount for the period, or the amount which reduces the company investor’s tax liability for the year to nil. The ‘relevant’ accounting periods are the accounting period in which the CITC investment date falls, and each of the accounting periods in which the subsequent four anniversaries of that date fall.

This entitlement to make a claim for relief is subject to the following restrictions:

(1) where the claim relates to loans (see FA 2002, Sch. 16, para. 22), no claim can be made after a disposal, or excessive repayments or receipts of value);
(2) where the claim relates to securities or shares (see FA 2002, Sch. 16, para. 23), no claim can be made after a disposal or excessive receipts of value);
(3) no claim can be made after loss of accreditation by the CDFI (see FA 2002, Sch. 16, para. 24); and
(4) no claim can be made if the company investor is an accredited CDFI (see FA 2002, Sch. 16, para. 25).

CITC scheme tax relief is deducted from a company investor’s liability to corporation tax after taking account of any marginal small companies' relief (ICTA 1988, s. 13(2) or s. 13AA(2)) and investment relief obtained under the Corporate Venturing Scheme (FA 2000, Sch. 15, pt. V), and before deducting any double taxation relief.
(FA 2002, Sch. 16, para. 20)

Determination of ‘invested amount’

Where the investment is a loan, the invested amount is:

(1) for the tax year or accounting period in which the investment date falls, it is the average capital balance for the first year of the five year period;
(2) for the tax year or accounting period in which the first anniversary of the investment date falls, it is the average capital balance for the second year of the five year period; and
(3) for the third, fourth and fifth tax year or accounting period it is the average capital balance for the period of one year beginning with the anniversary of the investment date falling in the tax year or accounting period concerned. Alternatively, if is less, it is the average capital balance for the period of six months beginning eighteen months after the investment date.

Here, the average capital balance of the loan for a period is the mean of the daily balances of capital outstanding during the period.

For securities or shares, the invested amount for a tax year or accounting period is the amount subscribed by the investor for the securities or shares.
(FA 2002, Sch. 16, para. 21)

Loans: no claim after disposal or excessive repayments or receipts of value

No claim can be made for a tax year or accounting period, where the investment consists of a loan, if, before the qualifying date, the investor disposes of the whole or any part of the loan (disregarding any repayment of the loan), the loan is completely repaid, or the loan repayments made exceed the permitted balance. The qualifying date is the anniversary of the investment date next occurring after the end of that year or period.
(FA 2002, Sch. 16, para. 22)

Securities or shares: no claim after disposal or excessive receipts of value

Where the investment consists of securities or shares, a claim made for a tax year or accounting period must relate only to those securities or shares held by the investor, as sole beneficial owner, continuously throughout the period beginning when the investment is made, and ending immediately before the qualifying date relating to the tax year or accounting period. No claim for relief may be made for a tax year or accounting period if, before the qualifying date for that year or period, receipts of value in the five year period exceed the permitted limits for the investment or any part of it (see FA 2002, para. 32(1)(a)–(d)). The qualifying date for a tax year or accounting period is the anniversary of the investment date next occurring after the end of that year or period. This is the same definition as for loans in FA 2002, Sch. 16, para. 22.
(FA 2002, Sch. 16, para. 23)

Loss of accreditation by the CDFI

Where a CFDI ceases to be accredited from a ‘relevant’ time within the five year period, no claim for relief can be made by the investor for the relevant tax year or accounting period, or for any later tax year or accounting period. The relevant tax year or accounting period is:

(1) where the relevant time falls within the first year of the five year period, the tax year or accounting period in which the investment date fell; and
(2) in any other case, the year or period in which the last anniversary of that date fell before the relevant time (or, if the relevant time itself falls on an anniversary of the investment date, the year or period in which that anniversary falls). (FA 2002, Sch. 16, para. 24)

Accreditation of the investor

An equivalent rule to FA 2002, Sch. 16, para. 24 is concerned with accreditation of the investor company (rather than of the CDFI in which the investment is made). However, it applies with effect from the time which the investor company becomes accredited, rather than the time the CDFI loses its accreditation.

Where a company investor becomes accredited with effect from ‘the relevant time’ within the five year period, no claim for relief relating to the investment may be made by the company investor for the relevant accounting period or any later period. The relevant accounting period is:

(1) where the relevant time falls within the first year of the five year period, the accounting period in which the investment date fell; and
(2) in any other case, the period in which fell the last anniversary of that date before the relevant time (or, if the relevant time itself falls on an anniversary of the investment date, the period in which that anniversary falls).
(FA 2002, Sch. 16, para. 25)

Attribution

Attribution is a concept used where it is necessary to reduce or withdraw tax relief, where there is a part disposal of an investment of shares or securities. For company investors, the relief attributable to any loan, securities or shares an accounting period is the reduction made in the company investor’s liability to corporation tax for that period that is attributed to that loan, or those securities or shares.

Where an investor’s liability to income tax or corporation tax is reduced for a tax year or accounting period, then:

(1) where the reduction is obtained for one loan, or securities or shares comprised in one issue, the amount of the tax reduction is attributed to that loan or those securities or shares; and
(2) where the reduction is obtained for a loan or loans, securities or shares
comprised in two or more investments, the reduction is apportioned between the loan or loans, securities or shares in each of the investments pro rata to the invested amounts for the loan or loans, securities or shares for the year or period and is attributed to that loan or those loans, securities or shares accordingly.

Where an amount of a reduction of income tax or corporation tax is attributed to any
securities in the same issue, a proportionate part of that reduction is attributed to each security. Likewise, where a reduction of income tax or corporation tax is attributed to any shares in the same issue, a pro rata part of that reduction is attributed to each of those shares.

A follow through rule applies where corresponding bonus shares are issued to an investor for any ‘original shares’ comprised in the investment that have been continuously held by the investor, as sole beneficial owner, from the time they were issued until the issue of the bonus shares. After the issue of the bonus shares, the CITC tax relief scheme applies as if the original issue had included the bonus shares, and the bonus shares had been held by the investor, as sole beneficial owner, continuously from the time the original shares were issued until the bonus shares were issued.

If any relief attributable to a loan or any securities or shares has to be withdrawn (see FA 2002, Sch. 16, para. 27–39), the relief attributable to that loan or each of those securities or shares is reduced to zero. Also, where any relief attributable to any securities or shares has to be reduced (see FA 2002, Sch. 16, para. 27–39) by any amount, the relief attributable to each of those securities or shares is reduced by a proportionate part of that amount).
(FA 2002, Sch. 16, para. 26)

The circumstances in which relief is withdrawn will be considered in a future article.

Technical Department
020 7235 9381

August 2002 by

 

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