Last updated: May 13 2013

Social Impact Bonds – A New Investment Vehicle?

Recently, the federal and several provincial governments have announced their intention of introducing Social Impact Bonds.

While not strictly a bond – a debt instrument on which interest is paid by the borrower – the social impact bond is an investment vehicle which would allow both the individual and the institutional investor the opportunity to put their money to work to affect social change.

This arrangement, which was introduced in the UK a couple of years ago, is an arrangement between investors, government, a non-profit, and usually a third party to allow investors to fund non-profit projects and earn a return on their investment. The third party generally acts as a liaison between the parties to pool investment funds and flow returns from the government back to the investors.

Here’s how the arrangement works. An arrangement is drawn up amongst the parties whereby the investor’s capital is used to fund a non-profit project normally funded with government funds. The arrangement would include a set of criteria to determine success. If the success criteria are met, the government uses the money it saves because of those results to return the investor’s capital plus a financial return. If the success criteria are not met and the project saves no government money, then the government does not return the invested capital.

For example, say the project was to reduce homelessness. The criteria for success might be to get a specific number of homeless individuals into low-cost housing. The government would save money on policing costs and perhaps incarceration and emergency room costs as well. These savings would be used to pay back the invested capital and provide the return on investment to the investors.

In a recent call for concepts issued by the federal government, 154 submissions were received which included programs for at-risk youth, aboriginals, the unemployed, the disabled, and seniors.

From an income tax point of view, any return on the investment would be taxable income like any other form of investment income. Although never explicitly stated in any government publications, it is assumed that investment losses would be deemed capital in nature and investments in failed projects would result in a capital loss

This arrangement is a good thing for government because, unless the project succeeds and saves the money they would have otherwise spent, their cost is zero. It’s a good thing for non-profits because the capital provided by investors tends to be available over the life of the project, so they don’t have to re-apply for funding annually. But are social impact bonds a good thing for investors? If the projects are a success, the investors get to do social good as well as earn a return on their investment. If the project is not successful though, they may lose their entire investment without the income tax perks of charitable donations.

Read more in the HRSDC publication Harnessing the Power of Social Finance.