6. Share interest and the use of profit or surplus
Profitability is central to the long-term financial sustainability of all enterprises.
It enables enterprises to build free reserves, finance the cost of capital, provide returns to shareholders, and support beneficiaries. Sustained losses will erode shareholder capital and eventually threaten the survival of the enterprise as a going concern.
The purpose and use of profit in a society is very different from that of a private or public limited company. In a private enterprise the purpose is to maximise the wealth of shareholders by generating profits and capital gains. This is not the case for societies.
Section 2(3) of the Co-operative and Community Benefit Societies Act 2014 states that a “co-operative society does not include a society that carries on, or intends to carry on, business with the object of making profits mainly for the payment of interest, dividends or bonuses on money invested or deposited with, or lent to, the society or any other person.”
Section 2(2)(ii) defines the purpose of a community benefit society as “being, or is intended to be, conducted for the benefit of the community”.
The payment of interest on share capital held in a society is regarded as a discretionary operating expense, and not as a distribution of profit.
A society should exercise caution in how it determines share interest rates, setting it at the lowest rate sufficient to attract the capital it requires, and making it clear to members that this rate will only be paid if it is affordable to the society.
Charitable community benefit societies are not-for-private-profit organisations, subject also to charity law, and have a different approach to the application of surpluses.
This is set out in the Statement of Recommended Practice (SORP), jointly produced by the charity Commission and the Scottish Charity Regulator, which provides recommendations on the accounting and reporting standards that apply to charities.
Surplus income over expenditure is regarded as a future resource for charitable activities, which should not be distributed for other purposes. Interest paid to shareholders in a charitable community benefit society is an allowable expense, subject to the provisions described in Section 6.5.
Section 14(12) of the Co-operative and Community Benefit Societies Act 2014 requires all societies to have rules stating “the way in which the society’s profits are to be applied” (see Section 3.2.12). Co-operative societies model rules usually include the powers to pay members a dividend drawn from profits, in proportion to the members’ transactions with the co-operative; an option not available to community benefit societies.
All societies usually have rules that allow the society to invest some of the profit in the development of the society, and to use some for the benefit of the broader community.
Community benefit societies and charitable community benefit societies must use their surpluses to pursue community benefits or charitable objects.
This can be achieved by reinvesting in the society, spending surpluses on charitable or community benefit activities (internal delivery), or donating surpluses to other community organisations or charities with the same or similar objects (external delivery).
Examples of internal delivery include where a community energy society, engaged in the trade of electricity generation, decides to employ a person to provide energy saving advice to the local community. Such expenditure is a legitimate operating expense for the society, if it is in pursuit of its objects, and should be offset against trading surpluses.
Where a society uses external delivery mechanisms for community or charitable benefit, it should endeavour to do so in a tax efficient way, ensuring that donations are gift aided wherever possible.
As a matter of good practice, a society should annually report to members how much of its trading surplus is being used for community or charitable benefit through internal and external delivery mechanisms.
Societies should also make provisions for the future withdrawal of share capital, by using surpluses to build cash reserves (see Section 2.3). These reserves should be sufficient to honour the terms of withdrawal stated in the rules of the society (see Section 3.2.9).
The Co-operative and Community Benefit Societies Act 2014 does not address the circumstances under which interest can be paid on share capital. However, the FCA would not normally regard the payment of interest on share capital as a profit distribution.
UK accounting standards and HMRC also treat the interest payable on non-transferable, withdrawable share capital as a pre-profit business operating expense. Interest paid on share capital in a society is a deductible business expense before any liability to corporation tax.
The following sub-sections provide further guidance on how each of the three main types of society should use and distribute profits, preceded by a sub-section on the general principles applying to interest paid on share capital.