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Page 1: Not-For-Profits Making Profits

Not-for-Profits Making Profits:Legal Structures for Social Enterprise

Presented by:

Margaret Mason and Michael Blatchford

January 19, 2011

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Overview

what do we mean by “social enterprise”?

vehicles: for-profit corporation, not-for-profit corporation, charity

rules for for-profit corporations

rules for not-for-profit corporations

rules for charities

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What is Social Enterprise?

not a term of art

an entity that combines business-like activities with a social purpose

a not-for-profit that carries on activities to generate revenue

a business with social/cultural/environmental objectives

a program or venture that fulfills a social purpose

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What are the Possible Vehicles?

for-profit business corporation taxable

not-for-profit non-share corporation (society) tax-exempt in certain circumstances

charity non-share corporation (society) tax-exempt strict rules for business activities

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For-Profit Corporation

typically incorporated as a business corporation with shareholders

taxable

may be possible to operate in ways that reduce or eliminate tax payable

flexible ownership and minimal regulation

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For-Profit Corporation (cont’d)

profits/revenues may be used for social purposes if shareholders agree shareholders can be not-for-profits/charities

can operate with triple bottom line/sustainable principles

provides greatest flexibility in operations

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Not-for-Profit Corporation

typically incorporated as non-share corporation/society

members not shareholders

tax exempt if meet Income Tax Act definition of “non-profit organization”

current CRA position is problematic

not supported by case law

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Non-share vs. non-profit

provincial and federal legislation allows for the incorporation of non-share corporations a corporation without shares and without owners

the myth incorporation as a non-share corporation = tax

exempt status the reality

the organization must meet the definition of “non-profit” in the Income Tax Act to be tax exempt

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NPO Tax Exemption

to qualify for the tax exemption, the organization: cannot be a charity (or eligible for charitable

registration; must be organized and operated exclusively for

social welfare, civic improvement, pleasure, recreation or any other purpose except profit; and

cannot distribute income to members.

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What does this mean?

‘social welfare’ means – providing assistance to disadvantaged groups

‘civic Improvement’ includes – enhancement of value or qualify of community or civic life

‘pleasure or recreation’ – something fun!

‘any other purpose except profit’ – the catch all for organizations operated for other than commercial reasons

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CRA View - When can a non-profit earn a profit?

CRA Interpretation Bulletin IT-496R some earning of surplus revenue (i.e. profit) is

generally permitted as long as use of resources is reasonable

and as long as excess income is not greater

than reasonable needs of organization income from investments generally permitted

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The Law

revenue generated which is surplus to expenses is acceptable if utilized for the non-profit purposes of the organization Gulf Log Salvage Gull Bay LIUNA Canadian Bar Insurance Association BBM Canada

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Recent CRA Interpretations

a number of CRA technical interpretations issued in 2009 appear to apply a stricter definition of “non-profit” than found in case law profits must be “generally unanticipated” “where the organization intends…….to earn a

profit it will not be exempt…….even if it expects to use or actually uses the profit to support its not-for profit objectives” [emphasis added]

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Recent CRA Interpretations (cont’d)

profit must be ancillary and incidental to the purposes of the organization

cannot intentionally earn a profit to finance future capital projects

contracts where there is a “mark-up” will be considered to be intentionally profitable which could jeopardize tax exemption

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Non-profits: the bottom line

CRA appears to be applying a restrictive view of the definition

not supported by existing case law which provides that revenue surplus to expenses is acceptable if:

incidental to purposes not using social purpose as a cloak to avoid paying

tax reserves are reasonable in relation to needs

the CRA appears to have an audit initiative in this area

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Charities and Business Activities

charities can be non-share corporations, trusts or unincorporated association and in all cases the charity cannot distribute any of its assets to its members

charities can conduct business activities provided these activities constitute a “related business” as defined in the Income Tax Act

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Charities and Business Activities (cont.)

only charitable organizations and public foundations can carry on related businesses

private foundations are prohibited from doing so

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What is a Related Business?

1. is the activity within the scope of the charity’s purposes in its constitution if not, cannot conduct the activity without

amending constitution

2. is the activity a charitable activity? (charitable activity can generate revenue) if yes, it is a charitable activity and not a

business activity

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What is a Related Business? (cont.)

3. is the activity a business activity?

is there an intention to make a profit?

is there a potential to make a profit?

is it a commercial activity?

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What is a Related Business? (cont.)

4. if yes, is the business activity “related” to the charitable purposes of the organization?

if not, charity cannot perform activity

if yes, then charity can perform business activity within certain limitations

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Two Types of “related” business

a business that is substantially run (at least 90%) by volunteers; or

a business that is “linked and subordinate” to one or more of the charitable purposes of the charity

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“Linked and Subordinate”

the four types of "linkages" that CRA recognizes are as follows: “a usual and necessary concomitant

of charitable programs” hospital cafeteria or parking lot book store at a university

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Linked and Subordinate (cont.)

“an off-shoot of a charitable program”

sale of a popular church choir’s Christmas CD

“a use of excess capacity” university renting its dorms during

summer months

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Linked and Subordinate (cont.)

“the sale of items that promote the charity or its objects”

sale of coffee mugs and t-shirts bearing the charity’s name and logo

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Linked and Subordinate (cont.)

the factors which will be evidence that a business is subordinate are:

relative to the charity's operations as a whole, the business activity receives a minor portion of the charity's attention and resources

the business is integrated into the charity's operations rather than acting as a self-contained unit

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Linked and Subordinate (cont.)

the organization's charitable goals continue to dominate its decision-making

the organization continues to operate for an exclusively charitable purpose by, among other things, permitting no element of private benefit to enter into its operations

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An “unrelated” Business

charities that carry on an unrelated business risk their charitable registration

the “usual” solution is the creation of a wholly owned subsidiary corporation a for-profit corporation owned by the charity to

carry on the business activity which will donate proceeds ‘up’ to the parent charity

taxable, but minimized through donation credit

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Community Interest Corporations

‘hybrid’ vehicle proposed by BC Minister of Finance

not yet available would create a for-profit business with

entrenched social purposes may attract socially conscious investment

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Community Interest Corporations (cont.)

cap on shareholder dividends limited return to shareholders on dissolution potential for investment tax credit could be used as a subsidiary of a charity to

carry on an unrelated business

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Conclusion

charities have the least flexibility and the most restrictive rules

non-profits have traditionally failed to file required tax returns (even when tax exempt) and ignored requirements – this cannot continue

greatest flexibility and fewest restrictions in a business corporation while taxable, in many cases and certainly in start-

up phase, will not have taxable income

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Contact Information

Margaret Mason

604-641-4905

[email protected]

Michael Blatchford

604-641-4854

[email protected]

The information presented in these slides sets out general principles and issues only

and should not be used in place of specific legal advice.