T H I S W O R K S H O P I S A P R O J E C T O F
S I G N A T I O N A L / C A U S E W A Y ,
G E N E R O U S L Y S U P P O R T E D B Y T H E
O N T A R I O T R I L L I U M F O U N D A T I O N ,
A N D P R E S E N T E D B Y
T H E B C C E N T R E F O R S O C I A L E N T E R P R I S E
The Fine Print: Legal & Structural Considerations
for Social Enterprise
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What we’ll cover today:
Introductions
The Canadian social enterprise landscape
Legal structures commonly used by social enterprise
The ‘boundaries’ of those structures
International structural innovations
What’s next for Canada
The focus will be on community-based enterprises.
Questions are welcomed at any time.
Thanks to our local workshop host!
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Who’s in the room?
Charities? Non-profits? Co-operatives? Government? Consultants? Others?
Board members? Staff? Volunteers?
How many are operating social enterprises?
Are the enterprises operating as ‘projects of the parent’?
Or stand-alone legal entities?
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What is social enterprise?
Not a legal expression in Canada
No national or provincial social enterprise act or regulation that defines it or gives it legal form or structure
Not addressed in the federal Income Tax Act
…so for now, we create our own definitions, which emerge from the actual experiences of social enterprise practitioners.
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One working definition...
Social enterprises are, for the most part, businesses operated by the community sector to meet a need in the marketplace that the traditional market does not offer; and/or to provide training and employment opportunities for the marginalized; and/or to provide unencumbered income to community-based groups to achieve more of their social / environmental / cultural goals with greater self-determination.
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And another...
The definition proposed by Causeway is a solid one:
‘Social enterprise is defined as any organization or business that uses market-oriented production and sale of goods and/or services to pursue a public benefit mission.’
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How common is it?
Excluding hospitals, universities, and colleges, the voluntary sector earns 43% of its revenue from the sale of products, memberships, and fee-for-service activities. An additional 36% flows from grants and contributions, while only 11% comes from individual donors.
On Not Letting A Crisis Go To Waste: An innovation agenda for Canada’s community sector, by Tim Brodhead, J.W. McConnell Family
Foundation, 2010.
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Why and how?
2010 survey of community-based SE’s, BC and AB n=140
Primary purposes:• Mission-based – 43.4%• Employment development – 32.1%• Income generation for parent organization – 24.5%Legal structure (multiple responses):• Registered charity – 55.6%• Non-profit – 61.1%• Co-operative – 14.8%• For-profit – 20.4%
Strength, Size, Scope: A Survey of Social Enterprises in Alberta and British Columbia by Peter Hall profiles data from 140 of 295 social enterprises in both provinces gathered in the spring and summer of 2010.
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Social Finance Census 201011
46% of non-profits are now engaged in social enterprise activity
1/3 of those remaining plan to enter the field in the next 2 years
25% of the social enterprises now existing contribute to more than 50% of the parent’s operations
1 in 5 social enterprises have been operating for over 25 years
1 in 3 social enterprises has launched within the past 2 years of 196 Ontario non-profit orgs surveyed
Current structures available...
Legal structures commonly used by community-based social enterprises in Canada are:
Co-operatives
Non-profit societies
Charities
Corporations
(Joint ventures are not intended for ongoing business activities).
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Co-operatives14
Over 8,400 co-ops in Canada, with $209B in assets
152,000 people employed, total
87,000 employed in non-financial co-ops
32,000 employed in the agricultural sector
70,000 co-op members serve on their Boards
Non-financial co-ops gross $27.7B annually
7 co-ops are listed in the Canadian Top 500 companies list
From federal Co-operatives Secretariat website 03.26.11
Co-operatives15
Incorporated under provincial co-operative acts (s0metime under the federal act)
In most cases, net income is taxed at corporate rates
Differentiated by ‘one member, one vote’
Primarily driven to achieve member benefit
Can raise capital by issuing shares to members or outside investors
Can institute an asset lock upon dissolution
Co-operatives16
Key principles:
1. Voluntary and open membership;
2. Democratic member control;
3. Member economic participation;
4. Autonomy and independence;
5. Education, training, and information;
6. Co-operation among co-operatives;
7. Concern for community.
Co-operatives17
Can operate as:
1. Worker co-ops;
2. Marketing co-ops;
3. Consumer co-ops;
4. Multi-stakeholder co-ops;
5. Umbrella co-ops.
These are not different structures... just different modes of operating.
Co-operatives18
No limits on profit generation
Relies on a critical mass of engaged and capable members
Some choose the co-op structure due to the attraction of the ideology, not true engagement of members
Non-profit societies
Easy and inexpensive to set up
Light touch regulation and reporting
Range of allowable community activities
Tax exempt
Favourably viewed by the public
Cannot apply for grants from charitable organizations, foundations, etc.
Cannot issue tax deduction receipts for donations
Cannot sell investment shares
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Non-profit societies
Last year, Bill 65 was introduced to the Ontario Not-for-Profit Corporations Act
The update clarifies that not-for-profit corporations are allowed to engage in commercial activities where the revenues are reinvested in support of the corporation’s not-for-profit purposes.
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Non-profit societies
Section 149.1 of the federal Income Tax Act under ‘miscellaneous exemptions’...
‘Non-profit organizations
(l) a club, society or association that, in the opinion of the Minister, was not a charity within the meaning assigned by subsection 149.1(1) and that was organized and operated exclusively for social welfare, civic improvement, pleasure or recreation or for any other purpose except profit, no part of the income of which was payable to, or was otherwise available for the personal benefit of, any proprietor, member or shareholder thereof...’
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Non-profit societies
The federal Income Tax Act ‘trumps’ the Ontario Not-for-Profit Corporations Act...
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Non-profit societies
It is generally believed that the non-profit structure is a ‘safer’ haven for social enterprise operation, since there seem to be tighter limits on charities operating social enterprises.
Five CRA rulings and two pieces of case law (court decisions) suggest otherwise.
Key ruling: November 2009.
CRA estimates that 75% of non-profits are currently offside.
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Non-profit societies
Questions asked were...
Can a 149(1)(l) organization [i.e. a non-profit] earn a profit?
If the profit is intentional, but used to fund the activities of the organization, will the organization qualify for the 149(1)(l) exemption from tax?
(Short) answers: ‘only by mistake’ and ‘no’.
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Non-profit societies
Only exception – accumulating surpluses for future acquisition of capital assets for community benefit
Contracts with mark-ups prohibited
Definition of ‘profit’?
Consequence if audited – loss of tax exemption and retroactive taxation on profits to date
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Charities
Inexpensive to set up
More complicated application process
Purposes must fall under 4 charitable heads
Heavier regulation and reporting requirements
Tax exempt
Can apply for grants from charitable organizations, foundations, and more
Can issue tax deduction receipts for donations
Favourably viewed by the public
Cannot sell investment shares
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Charities – introduction
All charities are non-profit societies...
...Not all non-profit societies are charities!
4 charitable heads:
1. the relief of poverty
2. the advancement of education
3. the advancement of religion
4. other purposes that benefit the community in a way the courts have said are charitable
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Charities – allowable activities
3 important activities that are not ‘business’… Soliciting donations Selling donated goods (narrowly defined – not thrift
stores) Fees charged for charitable programs and services.
Factors: Fees set to defray costs of the program, not make
profit;Comparable services not available in the market;Fees set according to charitable - not market -
goals.
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Charities – Related Business
An enterprise must meet 90% volunteer rule, or be linked and subordinate to the charity’s purposes (‘related business’) in order to legally operate as a project within the charity.
Can benefit from charitable donations and grants.
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Charities – Unrelated Business
If the social enterprise does not meet one of these tests, then it must be hived off into a taxable corporation (‘unrelated business’).
The corporation can donate up to 75% of its profits to the charity.
The corporation then pays income tax on the remaining 25%.
Must be complete separation between the charity and the corporation.
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Charities – linkage tests
‘Linkage’ to the organization’s charitable purpose means that the business must meet one of the following tests. It must:
Be a usual and necessary concomitant of charitable programs (e.g. a hospital parking lot, a university bookstore); or
Be an offshoot of a charitable program (e.g. a church that records and sells choir recordings); or
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Charities – linkage tests (con’t)
Represent a use of excess capacity (e.g. charging for parking lot use during hours of closure, or renting out event tents when not being used by the charity); or
Involve the sale of items that promote the charity and its objects (e.g. calendars, T-shirts, etc.).
***Most charities assume that their social enterprise is a related business when it is not – must meet one of these four linkage definitions!
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Charities – subordination
‘Subordination’ to the organization’s charitable purpose means that the business must meet all of the following tests.
a) ‘Relative to the charity’s operations as a whole, the business activity receives a minor* portion of the charity’s attention and resources.’
*(‘minor’ is not defined)
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Charities – subordination (con’t)
b) ‘The business is integrated into the charity’s operations, rather than acting as a self-contained unit.’
c) ‘The organization’s charitable goals continue to dominate its decision-making.’
d) ‘The organization continues to operate for an exclusively charitable purpose by, among other things, permitting no element of private benefit to enter its operations.’
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Charities – training businesses
Training businesses are charitable:
‘classroom training occurs before or accompanies the on-the-job training;
the participants are employed in the business for a limited period of time;
the charity offers a job placement service to help graduates of the program find work in the labour force;
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Charities – training businesses (con’t)
the proportion of workers from the target population in relation to the total number of employees is no lower than 70%, but alternative ratios may be justifiable if considerable supervision is required; and
revenues derived from the business do not substantially or consistently surpass the break-even point.’
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Charities – social businesses
Social businesses are charitable:
‘the work is specifically structured to take into account the special needs of the workers;
the workforce is comprised entirely of people who are physically, mentally, or developmentally challenged, with the exception of a few persons with specialized skills required for operating the business;
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Charities – social businesses (con’t)
the workers are involved in decision-making for the organization and sit on its board to foster their sense of competence and control over their lives; and
income derived from the business may pay the workers' wages, but the organization is subsidized, usually by government grants.’
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Corporations
This is the structure recommended by CRA for charities operating unrelated business.
Costs as little as $350 to incorporate.
Can be owned by a charity, non-profit, or co-operative.
Not entitled to as many grants as community-based structures (mostly HR and innovation subsidy).
Can sell investment shares.
Subject to corporate tax on profits.
Can donate up to 75% of net profits to (any) charity.
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Corporations (con’t)
No limits on profits.
The essential objective recognized by corporate law and theory is the maximization of shareholder value.
The majority can vote to change this priority, but the decision can always be reversed by future shareholders.
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Some international examples
Legal structures created to support social enterprise in the US and the UK are:
Community Interest Companies or CIC’s (UK) –2005 / 2007
Low-Profit Limited Liability Companies or L3C’s (US) – 2008
Benefit Corporations (US) – 2010
This presentation is a broad overview –
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Community Interest Companies – UK
Introduced via legislative changes to:
The Companies Act 1985 (England, Scotland, Wales)
The Companies Order 1986 (Northern Ireland)
Operates like a traditional company, for example:
Separate legal entity
Can enter into contracts in its own right
Does not cease to exist when ownership changes
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Community Interest Companies – UK
The CIC is described as ‘a profit for community company’ that ‘combines the pursuit of a social purpose with commercial activities’.
Over 350 CIC’s were formed in 2005.
Over 4,800 CIC’s have formed to date.
Can be established for any purpose that benefits the community (of interest or geography).
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Community Interest Companies – UK
Simple and inexpensive to incorporate (requires Community Interest Statement to form)
Light touch regulation
Can be formed new or converted from an existing standard corporation
Those choosing the CIC structure are:
Individuals
Businesses
Community groups
Those operating community-based projects
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Community Interest Companies – UK
Corporate form was chosen partly because of familiarity to banks and other financiers
Can sell investment shares
Dividend cap (increased from 5% to 20% above the Bank of England’s base lending rate in 2010)
Interest cap (increased from 4% to 10% above the Bank of England’s base lending rate in 2010)
Asset lock upon dissolution
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Community Interest Companies – UK
Net profits are taxed at corporate rates
Must file annual Community Interest Report in addition to regular tax reporting
Founders can serve on the Board, and Directors can receive reasonable remuneration
Considering allowing investors an investment tax credit of 20%
Considering reducing the rate of investor taxation to a maximum of 20% on income received from the CIC (vs. 40%).
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Low-Profit Limited Liability Companies – US
Variant on the Limited Liability Company (LLC)
Introduced in Vermont
Despite the name, no caps on profits
Created to be an IRS-approved ‘container’ for receipt of program-related investments (PRI’s) – loans flowed from US foundations with the expectation of below-market or zero returns
Owners are called members, not shareholders
Operates under an operating agreement
Flow-through tax treatment
Opportunity for tranched investment
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Low-Profit Limited Liability Companies – US
L3C has now been passed into law in Vermont, Michigan, Utah, Wyoming, Illinois, New York, North Carolina, Maine, and Louisiana.
L3C is in process in Colorado, Georgia, Oregon, North Dakota, Tennessee, Arkansas, and Montana.
Will the IRS approve the L3C as a pre-approved ‘container’ for receipt of PRI’s?
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Benefit Corporations – US
Not to be confused with the B Corporation, which is not a special legal structure, but a certification system – purely voluntary, shareholders can reverse it, and there is no formal enforcement authority.
Benefit Corporations are expected by some to eclipse L3C’s.
Passed in Maryland in April 2010, with Vermont soon following.
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Benefit Corporations – US
Legal corporation with added features.
Community interest purpose is more difficult to change – 2/3 shareholder majority needed.
Directors are obliged to pursue the declared purposes.
Requirement to publish annual Benefit Report.
No interest or dividend cap.
No required asset lock.
Regular corporate income tax rates apply.
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Canadian innovations...
On October 20, 2010, the BC Ministry of Finance announced a province-wide consultation on the possible creation of a ‘Community Interest Company’, to be embedded within the existing BC Business Corporations Act.
Deadline for written feedback was December 1st.
Awaiting word from the Ministry.
If one province adopts, the others will likely follow.
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The CIC and non-profit societies
A non-profit society could become a CIC (transfer assets from the society) or own a CIC (society as sole shareholder)
If a non-profit society owns a CIC, it may endanger its tax exempt status
As a corporation, the CIC is intended for profit generation – profit is taxable at corporate rates (16.5% federal + 5.5% to 14% Ontario provincial)
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The CIC and charities
The CIC may be a more attractive corporate vehicle for charities operating unrelated business.
Could entrench community priorities into the structure.
Could donate up to 75% of the CIC profits back to the charity, as with regular corporations.
The interest and dividend caps would align with the goals of social financiers, leaving more resources within the CIC.
Asset lock would ensure that resources remain within the community pool upon dissolution.
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What provincial jurisdiction can do...
Create framework to enable:
Light touch regulation
Limits on interest and dividends paid out
Lock on assets upon dissolution
Wide definition of community interest
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What provincial jurisdiction can do...
Create framework to enable:
Ability to sell investment shares
Ability to create a structure that welcomes hybrid ownership (a corporation can do this)
Ability to remunerate Directors
Qualification for provincial investment tax credits (but asked within the BC consultation to assume that the CIC moves ahead without this)
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What provincial jurisdiction cannot do...
Create framework that features:
Ease of use as recipient for PRI’s
Status as a qualified donee
Reduced federal income tax rates / tax exemptions
Ability to issue donation receipts
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Possible concerns re: the CIC
What would the impact be on traditional npo’s / charities?
Will the CIC serve to attract new capital investment?
Can this new structure be considered without accompanying investment tax credits?
Brand fairness issue – will the CIC become the new ‘brand’ for social enterprise?
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