A new sustainable finance champion – demystifying the Community Investment Tax Relief (CITR) for institutional investors | Allen & Overy LLP

In 2003, the UK Government introduced the CITR scheme to provide private investors with a significant tax incentive to finance enterprises within disadvantaged communities through accredited CDFIs. Whilst a similar scheme is now well-established in the US, providing more than USD5.5 billion in funding since its inception, activity in this area in the UK has been limited but is slowly beginning to ramp up due to a recent change in UK law which increases the limits on the amounts accredited CDFIs can raise. The Council of the European Union is also looking at ways to support the development of the social economy sector in the EU.

In this article, we discuss the UK CITR scheme in more detail and aim to demystify CDFIs and the accreditation process, as well as discussing what counts as a qualifying investment and importantly, how investment into CDFIs may be maximised. We also discuss what steps the Council of the European Union has proposed to help incentivise social impact finance in the EU.

1. What is the CITR?

The current law relating to the CITR rules is contained in Part 7 Income Tax Act 2007 (for individual investors) or Part 7 Corporation Tax Act 2010 (for company investors) and the Community Investment Tax Relief (Accreditation of Community Development Finance Institutions) Regulations 2003 (the Regulations).

In essence, the CITR provides a tax incentive to investors (individuals or companies) who make “qualifying investments” (by way of loan, securities or share capital) in certain accredited intermediary organisations (CDFIs) which in turn invest (directly or indirectly) in enterprises and communities in under-funded areas. The tax incentive is a tax relief of up to 25% of the value of the investment in the CDFI which is spread over five years (5% each year) starting in the year the investment is made.

Put simply, an investor lending £100 across 5 years to an accredited CDFI would see their liability to corporation tax reduced by £25 which also helps to mitigate any credit risk for the investor. For investments made on or after 1 April 2013, unused excess relief can be carried forward and used in a later period within the five-year period. However, any unused excess relief at the end of the five-year period is lost.

The CITR scheme is jointly run by HMRC and the Department for Business and Trade (DBT). DBT is responsible for matters concerning the accreditation of CDFIs. HMRC gives effect to any relief to which the investor may be eligible and, if necessary, withdraws any relief no longer due.

2. What are accredited CDFIs and who can access them?

A CDFI is the vehicle through which investors are able to access the CITR. Enterprises which pursue the CDFI accreditation process will be expected to provide funding for a minimum of five years to small to medium-sized enterprises (SMEs) deemed unable to obtain funding from mainstream sources. CDFIs can take any legal form (including as UK securitisation companies).

A CDFI is accredited as being either “retail” or “wholesale”. Retail CDFIs are bodies whose principal objective is to provide finance directly to SMEs for their own purpose, whereas wholesale CDFIs are bodies whose principal objective is to provide finance to other CDFIs. Wholesale CDFIs may raise up to £100 million for CITR-eligible funding, while retail CDFIs may only raise £25 million of CITR-eligible funding in each three-year accreditation period. We discuss below ways in which this tax relief may be maximised.

The scheme is targeted to benefit SMEs either: (i) located within certain disadvantaged areas; (ii) located in communities disadvantaged by reference to certain metrics (e.g. income, employment and health); or (iii) owned and operated by, or intending to serve, individuals recognised as being disadvantaged based on certain criteria (e.g. ethnicity, gender and age).

3. The accreditation process

To be awarded accreditation, CDFIs must satisfy the following criteria:

• a long-term commitment to the investment;
• intend to provide finance to enterprises in or serving disadvantaged communities (broadly, that 75% of the assets directly or indirectly finance eligible SMEs);
• the finance will only be provided to those that have been unable to obtain funding from other sources;
• the finance will only be provided for eligible SMEs, as discussed above; and
• that the body must not invest directly or indirectly in residential property.

As part of the accreditation process, the body applying must provide detailed information about itself, including its current financial structure and evidence of its strategy to ensure that the investment raised under the CITR will be used to benefit disadvantaged groups.

4. Reporting obligations

Continued accreditation is dependent on continuous compliance with the CITR rules, which must be evidenced in an annual report. This report has to include various details about the CDFI including how much investment the CDFI has attracted as well as information on the loans and investments made by the CDFI. In addition, accredited CDFIs must agree for some of their details, including details of their business operations and the aim for which they were granted accreditation, to be published by the DBT. While no government agency continually monitors compliance during the period of the participation in the CITR scheme, CDFIs may be subject to random or targeted audits following participation in the scheme.

5. Qualifying Investments

It should be noted that only certain investments into accredited CDFIs which satisfy general conditions relating to the CITR scheme will qualify for relief under the scheme. The investment would need to be a “qualifying investment” for the purposes of the Regulations meaning that: (i) the loans, securities or shares made to or issued by the CDFI would need to satisfy certain requirements, for example, a loan must not carry any present or future rights that would allow it to be converted into, or exchanged for any loan, securities, shares or other rights that are redeemable within a period of five years beginning with the day the investment is made; (ii) the investor must receive a valid tax relief certificate from the CDFI; and (iii) there must not be any arrangements protecting the investor against risks relating to the investment. Other general conditions include a control requirement whereby relief is not available if the investor possesses or is entitled to acquire rights or powers that give that investor control of the CDFI.

6. Maximising investment

The UK CITR scheme is becoming a more attractive investment proposition. This has been helped by the departure of the UK from the EU, which means that the UK is no longer bound by the EU State Aid rules that limit the amount of funding that can be raised under these rules. EU state aid rules prescribe that no single beneficiary may receive aid exceeding EUR 200,000 over any three-year fiscal period, whereas the amount that can be raised by a UK CDFI is now £100 million and £25 million for wholesale CDFIs and retail CDFIs respectively.

There are also potential structuring options that may enable funding in excess of these limits to benefit from CITR. For example, one option would be to establish multiple wholesale CDFIs, each with its own £100 million limit, although, this could be challenging from an administrative and regulatory perspective. Alternatively, given that an accreditation has effect for a period of 3 years, an accredited CDFI may request that a new accreditation period starts even before the expiry of the existing period. This provision may be used by CDFIs who have already raised the maximum funds permitted under the terms of their existing accreditation and wish to raise more before the period of that accreditation expires.

7. The picture in the European Union

The EU is also looking to encourage investment in the social economy. In November 2023 the Council of the European Union adopted a recommendation on developing social economy framework conditions. The recommendation recognised the importance of taxation policy in fostering the social economy and in creating an equitable business environment. As such, one of the measures it recommends is for Member States to explore granting tax incentives to independent private investors who provide direct or indirect risk finance to eligible enterprises, although it remains to be seen whether this would still be constrained by the state aid limitations mentioned above. It further recommends that Member States should assess whether their current tax systems sufficiently encourage the development of the social economy and develop respective tax incentives. Examples proposed by the Council include corporate tax exemptions on profits retained by social economy entities and income tax incentives in the form of deductions or tax credits for private or institutional donors.

These developments may provide further opportunities for those looking to fund disadvantaged communities and should be monitored closely.