Community Interest Company Regulations 2005

– in the House of Lords at 4:03 pm on 30th June 2005.

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Photo of Lord McKenzie of Luton Lord McKenzie of Luton Government Whip, Government Whip 4:03 pm, 30th June 2005

rose to move, That the draft regulations laid before the House on 1 March be approved [13th Report from the Joint Committee, Session 2004–05].

Photo of Lord McKenzie of Luton Lord McKenzie of Luton Government Whip, Government Whip

My Lords, the Community Interest Company Regulations are to be made under Part 2 of the Companies (Audit, Investigations and Community Enterprise) Act 2004. This House debated that Act thoroughly last year. Noble Lords on the Benches opposite agreed at Third Reading that the Bill had been significantly improved during its passage. I do not, therefore, propose to restate the case for community interest companies, but rather to concentrate on the regulations themselves.

Like the original proposals for community interest companies, these regulations have been subject to much consultation. Two drafts of the regulations were published while the Bill was under consideration and a formal consultation began in October 2004 for three months. The regulations now before us take account of the valuable comments made on the earlier drafts.

Part 1 of the regulations contains the usual provisions on citation, commencement and definitions. Part 2 deals with the community interest test and excluded companies. The regulator of community interest companies should not have to decide whether the activities of any political party benefit the community, so Regulations 3 and 6 exclude political parties from being or owning community interest companies. Nevertheless, community interest companies may campaign or lobby, just as some charities do, and that will be allowed provided that the campaigning or lobbying is ancillary to their activities to benefit the community.

Regulation 4 allows an employee-owned company to be a community interest company provided that its activities are intended to benefit the community. For example, it may have a policy of employing people who are long-term unemployed; or it may provide socially valuable goods or services at affordable prices to people who would otherwise not have access to them. Similarly, a company set up to benefit the employees of one employer, for example by providing childcare, could be a community interest company if it also provides childcare for the wider community.

Regulation 5 defines the term "section of the community" for the purposes of the community interest test. The definition is deliberately wide because we do not wish to constrain the potential activities of community interest companies.

Community interest companies must have certain provisions, mainly concerned with the asset lock, membership, governance and dividends, in their memoranda and articles. Those provisions are set out in Regulations 7 to 10 and Schedules 1 to 3.

Regulations 11 and 12 in Part 4 specify the additional documents to be supplied on the formation of, or conversion to, a community interest company. Regulations 13 to 16 make it a requirement for the regulator to approve changes to a community interest company's objects, and for companies to publicise proposed changes before they are made.

Regulations 17 to 25 deal with the cap on dividend payments, the distribution of any residual assets on winding up, and with share redemptions, buy-backs and capital reduction.

Following consultation we have decided on a double cap on dividends. The first cap is a limit expressed as a maximum percentage of the paid up value of a share which can be paid out each year. The regulations set this at bank base rate plus 5 per cent. Since a community interest company should not pay out too much of its profits in dividends, the regulations add a second cap, so that no more than 35 per cent of profits can be paid as dividends in a given year. The guidance notes on the regulations contain four worked examples showing how those caps will work in practice. The arrangement strikes a fair balance: it allows community interest companies which wish to raise capital by issuing shares to pay a reasonable rate of return but ensures that a substantial proportion of profits is retained in the business or used for the community benefit. The regulator will be able to change the dividend caps in the light of experience, after consulting and with the consent of the Secretary of State.

Regulations 26 to 29 deal with the community interest report which community interest companies will have to provide each year, to show how they have benefited the community, how much they have paid their directors, and whether they have transferred assets for the benefit of the community. The Regulator's office will check reports but their main value will be for those with an interest in a company: the employees or the community it is intended to benefit. They will be able to read the company's account of its activities and raise any concerns with the regulator who, under the 2004 Act, has powers to investigate where necessary. One way in which the regulator can intervene if he has serious concerns about the running of a community interest company is to appoint a manager under Section 47 of the 2004 Act. Regulations 30 to 33 make some provisions for such managers.

Regulations 34 and 35 make minor consequential amendments to the functions of the registrar of companies. Regulation 36 and Schedule 5 set out the fees for the regulator's main activities of approving the formation of, or conversion to, a community interest company and receipt of the annual community interest report. We have set each fee at £15. Finally, Regulations 37 to 42 set out some basic rules governing the hearing of cases by the appeal officer.

The Regulator of Community Companies, John Hanlon, was appointed, in accordance with the procedures of the Office of the Commissioner for Public Appointments, with effect from 1 April and he is producing extensive guidance for different types of community interest companies. These regulations represent the final step to implement community interest companies. There is already a queue of organisations wishing to form, or convert to, community interest company status and over 340 organisations have expressed interest in this type of company. It is clear, therefore, that the community interest company will meet a real demand. I beg to move.

Moved, That the draft regulations laid before the House on 1 March be approved [13th Report from the Joint Committee, Session 2004–05].—(Lord McKenzie of Luton.)

Photo of Lord Hodgson of Astley Abbotts Lord Hodgson of Astley Abbotts Spokespersons In the Lords, (Assisted By Shadow Law Officers), Spokespersons In the Lords, (Also Shadow Secretary of State for Scotland - Not In Shadow Cabinet)

My Lords, I am sure that the whole House is grateful to the noble Lord, Lord McKenzie of Luton, for his careful explanation of these detailed, technical regulations. I believe that this is the first time we have had the pleasure of taking part in a debate together since his recent elevation, on which I congratulate him.

For those of us who were involved in the passage of the parent Bill and approved the general principle of CICs, the arrival of these regulations is to be welcomed. I have read the record of the proceedings on these regulations in the other place and I shall endeavour not to repeat the points and questions raised there. I was glad to note from those proceedings, and to hear from the Minister, that a regulator of CICs has been appointed, that guidance forms and model articles of association are being prepared and that no fewer than 340 expressions of interest in becoming a CIC have been received.

During the Committee stage of the Bill here we were concerned that the financial costs of the CIC regulatory regime had been undercooked. The noble Lord, Lord Evans of Temple Guiting, will recall that. It would be helpful if the Minister could confirm to the House whether, in the light of experience so far gained, those original cost estimates are being met. In order not to lead him into temptation unnecessarily, I should tell him that paragraph 245 of the original Explanatory Notes to the Bill gives a total estimate of set-up costs in the range of £250,000 to £500,000. His colleague in the other place, Mr Alun Michael, said that set-up costs were now £515,000. So we are already some way above the top end of the range. Paragraph 244 of the Explanatory Notes states:

"We estimate the regulatory annual running costs at approximately £310,000".

Mr Michael said in the other place that the annual running costs are now £420,000. I can understand the difference between £500,000 and £515,000—after all, that is only 3 per cent. However, by my calculations the difference between £310,000 to £420,000 constitutes an increase of 35 per cent. It was, therefore, slightly strange that Mr Michael said:

"On the cost of the regulator the estimates in the regulatory impact assessment remain broadly correct".—[Official Report, Commons Second Standing Committee on Delegated Legislation, 21/6/05; col. 16.]

This Government can play a bit fast and loose with their accounting, but I do not think that an increase of 35 per cent could be described as broadly correct on any normal understanding of that word. Therefore, some clarification of what has been going on with the costs would be helpful.

I turn to two broad points. At Second Reading of the Companies Bill many noble Lords, myself included, wondered whether, desirable though the CIC model might be, it would not have been better to introduce it subsequent to, not in advance of, the long awaited Charities Bill. Clearly, there would be many points of overlap between the two pieces of legislation. Now the Charities Bill is progressing through your Lordships' House under the stewardship of the noble Baroness. Clause 32 of that Bill, and the associated Schedule 6, establish a new corporate format—a charitable incorporated organisation. That appears to duplicate the CIC concept. Will the noble Lord tell the House how CICs differ from CIOs other than that one is regulated by the Charity Commission and the other by the DTI, and that one may be a charity and the other may not? Are we not in danger of establishing expensive duplicative regulation?

This takes me to my second broad point—why cannot a CIC be a charity? We discussed this at some length in Committee on the Bill. For reasons that were not entirely clear, beyond a possible departmental turf war between the Home Office and the DTI, the noble Lord, Lord Sainsbury—who handled the Bill expertly for the Government—would not change his view. Now I read in paragraph 2, "Interpretation", that "asset-locked body" means:

"a community interest company, charity or Scottish charity".

Do the Government now admit that there is no fundamental reason why a CIC should not be a charity?

I have some more detailed questions. I note that Regulation 3 deals with the issue of political activities not being treated as being carried on for the benefit of the community. I do not seek to raise the difficult issue of the definition of political activity, which occupied much of the committee's time in the other place, but I am interested in what process the regulator will adopt to ensure compliance with the provision. It is easy to envisage circumstances in which a CIC is formed on a perfectly reasonable basis but over the years becomes more extreme in its approach. How will the regulator check that, and what sanctions does he have to improve performance? I note under Regulation 32 that he has the power to "remove a manager", but can he impose conditions on the CIC itself? In an extreme case, can a CIC be "de-CIC-ed", and if it can be, what happens to its assets? Does some sort of cy-pres rule apply?

Secondly, will the Minister explain the purpose of Regulation 5, "Section of the community"? I am not clear from the drafting whether it is permissive or restrictive in its intent or of the role it plays in Part 2 of the regulations.

Thirdly, Regulation 13 specifies actions that require the regulator's approval. I see no time limit within which the regulator must opine. There could be a concern that on a tricky point the regulator could take a long time to reach a decision, and that could seriously damage the operations of the CIC in question.

In Part 6, Regulation 17, "Declaration of dividends", I note in paragraph (1)(b) that the payment of a dividend requires the approval of "an ordinary or special resolution". The latter is an unusual provision. Dividend payments normally require only an ordinary resolution—a simple majority; not a special resolution—and a 75 per cent vote in favour. Is some special provision expected for dividend payments by CICs? If so, will the Minister explain it and the thinking behind it?

Under Regulation 17, will the Minister give an example of a case falling in Regulation 17(4)(b) that is not caught by the provisions of Regulation 17(4)(a)? I am sure that his officials regard that as a full toss of the leg stump and will be able to provide him with an easy answer, but if they cannot I will be perfectly happy if he can write to me with an example at a later date. I understand that it is quite a detailed question to raise in this way.

In raising these questions with the Government, it would be churlish if I did not congratulate them on the ingenious nature of Regulation 20 and the provision to allow a catch-up on unused dividend capacity. Equally, the Government have struck the right balance in Regulation 22 as to the interest rate cap of 4 per cent over the Bank of England base rate and the maximum level of dividend—35 per cent of distributable reserves—which the Minister referred to in his opening remarks.

I am slightly more uneasy about the share dividend cap being set at 5 per cent over the Bank of England base rate. The difference between an equity risk and a debt risk—the latter may well be secured on the assets of the CIC—should surely be reflected in a spread greater than 1 per cent. I appreciate that CICs are a special case, but the Minister might care to explain why the latter figure was chosen. For my part, a spread of 5 per cent between debt and equity might be more appropriate. So, for debt it is currently 4.75 per cent, plus 5 per cent, which is the 9.75 per cent figure that Mr Michael referred to for debt, with perhaps another 5 per cent for dividends on the equity, giving a maximum of 14.75 per cent.

Could the Minister clear up confusion in my mind regarding par value and paid-up value—subscribed capital—in relation to the operation of the cap? I was fully clear that the Government were not linking the cap to the par value of the share; indeed paragraph 22(5) seems to make that clear. The Minister used similar words in his opening remarks. However, the Minister in the other place—Mr Alun Michael—said:

"Since the base rate is currently 4.75 per cent, the maximum dividend for a £1 share is 9.75p in a year".—[Official Report, Commons Second Standing Committee on Delegated Legislation, 21/6/05; col. 6.]

I follow the arithmetic, but his choice of words indicates that he was talking about par value. Clarification would be welcome.

Finally, I turn to the position of Scotland, which was also discussed in Committee in the other place, but without much light being shed. Will the Minister take us through the position? In particular, will CICs be able to register at Scottish Companies House in Edinburgh? Are English CICs able to operate north of the Border?

As I said, we welcome the principles behind the CICs, so are pleased to see the regulations. Nevertheless, we are always anxious to eliminate duplication in regulations and minimise any regulatory burden. I look forward to hearing the Minister's response.

Photo of Lord Newby Lord Newby Spokesperson in the Lords, Treasury

My Lords, we on these Benches are also pleased to see the regulations. We welcome the establishment of the community interest companies. The Minister will be pleased to know that I shall not put him through such a rigorous viva as the noble Lord, Lord Hodgson, did. I have one question to raise and one point of clarification.

Regulation 11 requires any new community interest company to provide a community interest statement. Under the definitions, in that statement a company is required to indicate how it is proposed that its activities will benefit the community. I would welcome an assurance from the Minister that, in interpreting that requirement, the regulator will not require the company to set out a hugely detailed financial analysis of exactly how every activity that it might undertake will benefit various parts of the community. At the time that the company is established, a paragraph or two of broad explanation would suffice. Such a definition could lay itself open, under an over-rigorous and efficient regulator, to an onerous requirement on a new company to set out in greater detail than is required exactly how it would operate.

Photo of Lord McKenzie of Luton Lord McKenzie of Luton Government Whip, Government Whip

My Lords, I thank the noble Lords, Lord Hodgson and Lord Newby, for their welcome to the regulations, and for their questions, which I shall try to deal with as fully as I can.

I shall deal first with the question asked by the noble Lord, Lord Newby, which was about the role of the regulator in the statement. The objective is that the statement will not be unduly onerous; to make it so would defeat the thrust of the regulations and the legislation. It will be a matter for the regulator, in light of experience in each case. In some circumstances, a more rigorous expectation and examination may be required, but practice will doubtless lead us in the right direction on that. The provision is not intended to be restrictive and onerous in a manner that would preclude enterprises using that opportunity.

Let me see whether I can deal with the questions raised by the noble Lord, Lord Hodgson. The costs that he quoted from my right honourable friend in the other place—the set-up cost being £515,000, with annual running costs of around £420,000—are our current estimates. The Explanatory Note figures were estimated at the beginning of 2004 but the regulatory impact assessment—it was more recent, in October 2004—was closer. It is with those figures that the costs are broadly in line. I hope that that clarifies the matter.

The essential difference between a CIO and a CIC is that identified by the noble Lord—that one is a charity and one is not. A charity is subject to more rigorous regulation, and has the benefit of a tax exemption to go with it. The purpose of the regulations is to provide another vehicle—not a mandatory vehicle—for social enterprises and, in particular, for them to choose which they want.

Moving on to the question about the definition of the asset lock, the fact that one of the destinations of a distribution of assets from a CIC is a charity, as well as a CIC, is simply broadening the opportunities for the movement of assets from that enterprise. The fact that it is included in the definition does not seem to me to mean that we treat the two as being the same.

A question was asked about the role of the regulator in looking at political activity. Again, it is a matter for the regulator to take forward. At the end of the day, the regulator will have sanctions, including the appointment or removal of directors, the investment of property in the official property holder and, as a last resort, it could have the CIC wound up. So sanctions are there but, obviously, the objective of the process is for the regulator to engage along the way, if he thinks that the entity is strained beyond that which is incidental and reasonable.

Regarding territorial engagement, English CICs can operate in Scotland, like other English companies, and Scottish CICs can register at the Companies House office in Edinburgh. I hope that that deals with the point.

The noble Lord asked why payment of dividends required either an ordinary or a special resolution. It probably depends upon the nature of the shareholding in the entity. The key point is that it does not provide for interim dividends. It is important to ensure that the cap on dividends is effective.

The proposals before us, regarding spread on debt and equity, were based upon research and considerable discussions with the social enterprise sector and others to gauge what would be a reasonable spread in practice. In both instances, they try to strike that balance between recognising that capital should be available to those enterprises, without going all the way to generating the sort of returns that a normal profit-making company would wish to see. Regarding par versus paid up value, the cap applies to the paid up value of the shares, not the par value. That would often be the case, but it would depend upon premiums.

Regarding dividend resolutions, the model articles of association specify an ordinary resolution for declaring dividends and we expect that most would choose that. But if a company wants to specify a higher threshold, it will be able to do so.

I have tried to answer each of the questions. If I have missed any, I hope that the noble Lord would accept that I shall look at the record in Hansard and follow up in writing, but, if he wishes to come back on any point, I shall try to deal with it.

On Question, Motion agreed to.