Will Recent Legal Changes that make social enterprise for registered charities easier in Canada be enough?

Social enterprise can be carried out in various forms – as a sole proprietor, partnership, cooperative, incorporated entity (either for profit, non-profit or charitable) to name a few of the possibilities.

There have been recent changes that will make it easier for social enterprises in Canada that are registered charities.  The first change relates to Ontario.  On December 15, 2009 the Ontario Government passed the Good Government Act, 2009 which resulted in the repeal of the Charitable Gifts Act (Ontario).  The Charitable Gifts Act had provided that an Ontario charity may not own more than 10 per cent of an interest in any business.  Ontario was the only province to have such a restriction and it applied to all charities.  Although there were workarounds with trusts etc. such a restriction in my view never made much sense and with “registered charities” having to comply with the “unrelated business” rules under the Income Tax Act there is a system in place to regulate charities’ involvement with business.  As a result of the Ontario changes a charity located in Ontario can now own more than 10% of a business.  Charitable organizations, but not public or private foundations, may own 100% of a “related business”.

The second change was by the Canadian federal government who announced disbursement quota reform in the 2010 Budget to remove the 80/20 expenditure requirement for Canadian registered charities.  This change will make it easier for donors and charities to more flexibly endow charities or create a reserve for either a foundation or a charitable organization. In the past, in general, if a person donated a million dollars to a charity and received an official donation receipt either the charity needed to have those funds subject to a ten year direction where the capital cannot be spent for ten years or the charity would need to spend by the end of the following year 80% of the million dollars or $800,000.  After the March Federal Budget there is now greater flexibility. A donor can donate money to the charity or foundation, and the charitable organization will only have to spend 3.5% of the average value of their reserves, endowments, investments, buildings owned by a charity but not used in charitable programs or administration to the extent the amounts are over the $100,000 mark. For foundations it is 3.5% of the amount over the $25,000 mark.  Charities and foundations however are not precluded from spending more than 3.5% and many will of course spend almost all of the funds on charitable activities, overhead etc. But this change does provide the donor and charity some flexibility to, for example, decide to spend 33% in the first year, 33% in the second year and the rest in the third year. 

This change will make it easier for charities to accumulate a reserve or have some investments.  There have been concerns that charities involved solely or largely with micro-finance would have difficulty meeting their DQ.  This change will make it easier for the micro finance charities to accumulate capital that is needed for loans and for other charities to accumulate resources that can be used to purchase equipment or buildings needed by the charity for charitable activities or invested in setting up a “related business”. 

These two recent changes will make it easier for registered charities that are involved in social enterprise.  However, do we need further legal changes to the legal environment in order for social enterprise to thrive?  Specifically do we need a social enterprise corporate statute in Canada as suggested by some?
Richard Bridge and Stacey Corriveau, for the BC Centre for Social Enterprise wrote a paper entitled “Legislative Innovations and Social Enterprise: Structural Lessons for Canada” (located at http://www.centreforsocialenterprise.com/f/Legislative_Innovations_and_Social_Enterprise_Structural_Lessons_for_Canada_Feb_2009.pdf) which argues for the adoption of a corporate act in Canada.  Their paper is well worth reading.  While having such a corporate structure in Canada may be advantageous, I would suggest that if it is anything like the UK Community Interest Companies (CIC) or the US L3C it may take a while to get this in Canada and I don’t think that it will have much of an impact on the social enterprise area even if it is passed and many social enterprises adopt it. 

This year we saw the passing of the Canada Not-for-Profit Corporations Act – which replaces the Canada Corporations Act.  That there is a new corporate non-profit statute is not surprising – what is surprising is that only in 2010 was it passed – a full 93 years after the Canada Corporations Act was introduced in 1917.  If to replace an existing act takes 93 years then how long will it take to set up a new corporate law regime specifically for social enterprise?  Also, if one sets aside the hyperbole by some surrounding this statue and how it is going to completely revolutionize for good or bad the non-profit sector, one realizes that it is an improvement – but having better corporate law will make the job of a federal non-profit easier in some cases (after the pain of conversion to the new statute) but only very slightly easier. 

Tonya Surman in a very interesting recent post notes:
“One of the things that I don’t feel has been adequately explored is the role that the nonprofit legal form plays in all of this. Certainly, charities have restrictions and given the tax benefit that they offer to donors, this makes sense. However, I have found the nonprofit legal form in Ontario to be flexible, to offer the marketing benefit, to be able to attract many types of grants and to enable us to deliver on our public benefit. It only costs $135 to create, you need 3 volunteer directors and you are good to go. Nonprofits can issue debt, can buy buildings, have a built in asset lock, can issue community bonds, can own an equity issuing for-profit and are required to deliver on their social mission. I wonder if the lack of a non-profit legal form of this nature in the US and UK was made them feel the need to create CIC and LLCs? Maybe we’re already sitting on the solution—using our existing Ontario non-profit legal form as the basis for social enterprise.”

You can read Tonya’s post at http://socialinnovation.ca/blog/community-enterprise-corp-for-ontario-response and also important are the comments by various individuals involved with social enterprise debating whether a new legal structure is necessary and what the real impediments to social enterprise are.

If CICs are brought to Canada they may be appropriate in the future for establishing a social enterprise but I think that a normal non-profit corporation provides many of the same benefits without having to have a new structure.  I have no problem with new corporate structures such as the UK Community Interest Companies (CIC) which, according to the CIC Regulator website, (located at http://www.cicregulator.gov.uk/) are a:
“new type of limited company designed specifically for those wishing to operate for the benefit of the community rather than for the benefit of the owners of the company. This means that a CIC cannot be formed or used solely for the personal gain of a particular person, or group of people.  CICs can be limited by shares, or by guarantee, and will have a statutory “Asset Lock” to prevent the assets and profits being distributed, except as permitted by legislation. This ensures the assets and profits are retained within the CIC for community purposes, or transferred to another asset-locked organisation, such as another CIC or charity.”

The main advantage of a CIC in the UK appears to be that your organization is designated as a CIC and therefore the public can easily recognize your organization as a social enterprise.  It is easier to pay board members of a CIC than with a charity which has restrictions on when board members can be paid.  You can issue shares in the CIC, which may be attractive to some.  There are some public benefit initiatives that do not fit within the definition of charity but can be included in the definition of a CIC.  CICs can pay dividends but there is a cap on the amount.  Clearly the CIC has greater freedom than a UK charity but it still cannot be politically motivated or serve a very restrictive group.  CICs are taxed as normal business entities – so they pay taxes unlike a Canadian non-profit.

Some have suggested that a new corporate structure for social enterprise in Canada should be considered to be a qualified donee.  I have a number of reservations about expanding the number of qualified donees to social enterprises, socially responsible or triple bottom line businesses.  There are some substantial benefits accorded to qualified donees like registered charities that, if extended to any organization that ostensibly has some small element of a social or environmental purpose, could result in almost every business in the country that receives professional advice claiming to be a social enterprise and we would have even greater difficulty paying for the important social, educational, health care and environmental programs that government supports.  While having more choice is generally considered to be a good thing – there are lots of flexibilities with the existing structures. 
Many organizations that carry on complicated operations have more than one legal entity to accomplish what they need.  Look at corporations that having holding companies, operating companies etc.  Some organizations have for-profit, non-profit and charitable arm – each achieves a different purpose and has the benefit of different rights and restrictions. 

A little bit of background on what charities can do.  Under the Income Tax Act (Canada), charitable organizations and public foundations can carry on “related business” that promotes their charitable objects.  An example would be a hospital cafeteria – providing food to patients and visitors.  They can also carry on other unrelated business activities, if “substantially all” (CRA says at least 90%) of the people involved in these activities are volunteers. Private foundations cannot carry on any business activities whatsoever.

So registered charities can carry on “related business” – either one that involves over 90% volunteers or one that is “linked and subordinate” to the charity’s objects.  A charity cannot carry on a business that is unrelated to its objects or becomes a dominant activity unless it is done 90% by volunteers.  Failure to follow these rules can result in penalties and deregistration. CRA has tackled this subject in CRA Policy Statement “What is a Related Business?” CPS-019 at http://www.cra-arc.gc.ca/chrts-gvng/chrts/plcy/cps/cps-019-eng.html

Many social enterprises fit within either the definition of related business or they may be substantially run by volunteers.
In my opinion the best way to carry out most social enterprises – with the greatest flexibility – is through using either a for-profit or non-profit corporation without registered charitable status.  While the for-profit has the greatest flexibility, a non-profit is tax exempt and may have greater credibility in certain circles.  Both the for-profit and non-profit corporation without charitable status provide great flexibility after launching a social enterprise if the business is to go in any one of a number of different directions. 

The disadvantages of using an entity that does not have charitable status include: you cannot receipt for donations, it is more difficult to obtain funds from other Canadian charities and you have less of the reputational benefits that come from being a registered charity.  If you want to be a charity and do a lot of fundraising then registered charity status is important but if you want to actually run a business you may be better off doing it as a for-profit or non-profit without charitable status and, if necessary, have an affiliated foundation/charity that can issue tax receipts and easily receive funding from foundations, etc.  The affiliated foundation can only transfer funds to the non-charity as part of a “structured arrangement” with “direction and control” and only fund certain described programs or activities that are charitable in nature.  My website http://www.globalphilanthropy.ca is largely geared towards helping Canadian charities that wish to work with non-qualified donees whether in Canada or outside of Canada and CRA’s recent consultation entitled “Consultation on the Proposed Guidance on Activities Outside of Canada for Canadian Registered Charities” focused on this issue and is located at http://www.cra-arc.gc.ca/chrts-gvng/chrts/plcy/cnslttns/ccrc-eng.html

Although some have argued that the legal restrictions in CPS-019 unduly restrict charities from conducting social enterprise – I would reiterate that in most cases social enterprises are more appropriately run as non-profits without charitable status.  Also, many charities are quite legally conducting social enterprise. 

The biggest impediment by far to having a thriving social enterprise sector in Canada is mindset.  Canadians are risk averse, while business is risky and social enterprise is sometimes even riskier and certainly more difficult.  If you are constantly told by very articulate people that there are tremendous legal impediments to social enterprise that need to be overcome in order to have a thriving social enterprise system then this just reinforces the notion that one just waits for all the perceived bumps to be removed before one gets going.  After the risk averse mindset the next biggest impediment is the skills necessary to run a social enterprise.  There are some very knowledgeable people in Canada with business and social enterprise skills but we need many more.  Just as with charities I find that good intentions (even when placed with lots of resources) do not necessarily result in a positive outcome, so with social enterprise good intentions even when well funded do not always create a successful social enterprise. 

Another impediment to have a thriving social enterprise sector is that registered charities do not understand the rules relating to conducting related business and some therefore have been avoiding this area.  Also many non-profits do not realize that charitable status has both benefits and restrictions.  Rather than eliminating the rules dealing with related business and replacing them with another set of rules as in the UK and US, which will create their own issues, it is better to continue the process of educating non-profits and charities as to their obligations.  Richard Bridge and Stacey Corriveau have been working hard at the educational process, in part with the support of the Canada Revenue Agency’s Charity Partnership and Outreach program.

I am sometimes told that a charity will not undertake a particular initiative because it is concerned that it may violate the rules relating to a “related business”.  Charities should remember that they can write to CRA, either on behalf of the charity or anonymously, and ask for CRA’s views on any activity.  It may take 3-6 months to get an answer but then at least you know what CRA’s view is on the matter. 

Furthermore, foundations often do not understand the flexibility they have in funding activities by non-profits that are not charities.  Many foundations insist that they will only fund programs conducted by qualified donees such as registered charities.  This often forces non-profits to obtain charitable status in order to be able to apply for foundation funding.  Obtaining charitable status may be completely inappropriate for a social enterprise.  Work should be done with foundations to encourage them to fund appropriate activities of non-qualified donees (non-charities) with all the necessary direction and control.

Irrespective of what happens with a new corporate structure as it is unlikely to happen in the next year or two and as Canada and social enterprise in Canada have changed over the last decade, it makes sense for those interested in social enterprise to have a respectful dialogue with Finance and CRA to examine and, if necessary, update requirements for charities wishing to be involved with social enterprise. 

Mark Blumberg is a lawyer at Blumberg Segal LLP in Toronto, Ontario.  He works in the area of non-profit and charity law.  He can be contacted at mark@blumbergs.ca or at 416-361-1982. To find out more about legal services that Blumbergs provides to Canadian charities and non-profits please visit www.canadiancharitylaw.ca or www.globalphilanthropy.ca