Not-for-Profits Making Profits:Legal Structures for Social Enterprise
Presented by:
Margaret Mason and Michael Blatchford
January 19, 2011
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
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
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
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
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
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
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
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.
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
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
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
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]
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
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
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
Charities and Business Activities (cont.)
only charitable organizations and public foundations can carry on related businesses
private foundations are prohibited from doing so
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
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?
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
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
“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
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
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
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
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
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
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
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
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
Contact Information
Margaret Mason
604-641-4905
Michael Blatchford
604-641-4854
The information presented in these slides sets out general principles and issues only
and should not be used in place of specific legal advice.
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