Social Enterprise In Canada

Presented by

The Legal Environment for Social Enterprise in CanadaPresented to Second Biennial Symposium

Law, Philanthropy and Social Enterprise: New Direction or Distraction?

September 21, 2011

Janice Y. Lederman

Presented by

The Legal Environment for Social Enterprise in Canada

Objectives

Janice Y. Lederman

Presented By:

• Understand the limitations of the charity and non-profit model

in relation to carrying on business activities

• Understand how the current legal environment impedes social enterprise

The Legal Environment for Social Enterprise in CanadaJanice Y. Lederman

Presented by


Why is it Important?

Janice Y. Lederman

Presented By:

• Social sector is seeking more effective tools for tackling

challenging social issues

• The system for funding as currently structured is not sustainable; new funding models are required

• Trend towards social enterprise is itself an innovation, aimed at creating sustainable, self-financing, solutions to intractable social issues


Presented by


Not the Sole Solution

Janice Y. Lederman

Presented By:

• Social enterprise:

– not a panacea for all that ails the social sector

– not an alternative to charities or non-profits

• Access to capital is a challenge across the spectrum of organizational forms


Presented by


Distinction Between Charities and Non-Profit Organizations

Janice Y. Lederman

Presented By:

• All charities are non-profits

• Not all non-profits are charities

• To be a charity, the entity must be registered as a charity under the Income Tax Act (Canada) (“ITA”)


Presented by


Organizational Forms

Janice Y. Lederman

Presented By:

• There are a number of different legal structures, and each

structure carries with it a basket of rules, including rights, obligations and liabilities

• The most common structures are:– sole proprietorships– partnerships (and limited partnerships)– cooperatives– corporations– joint ventures– trusts


Presented By:

• The corporation is the most common legal form

• A corporation is considered in law to be a legal person, separate from its shareholders

• There are two kinds of corporations in Canadian law: the share capital corporation and the non-share capital corporation


Presented By:

• In a share capital corporation, the Corporation issues shares in exchange for consideration, usually money

• There generally are no restrictions on the type of business that may be carried on

• Shareholders are the “owners” of the Corporation

• Ownership of shares gives holders the right to appoint directors, receive profits and receive the assets or remaining property when the corporation is wound up


Presented By:

• In a non-share capital corporation, there are no shares to be sold to raise money, and no “owners” as such

• The undertaking of the non-share capital corporation must be restricted to one of “patriotic, religious, philanthropy, charitable, educational, agricultural, scientific, literary, historical, artistic, social, professional, fraternal, sporting or athletic nature, or the like” (The Corporations Act (Manitoba))

• Members have the right to elect directors, and certain other rights, but have no right to participate in the profits


Presented By:

• The activity of the non-share capital corporation must be

carried on without pecuniary gain to members; and

• Any profits must be used to further the work of the non-share capital corporation


Presented By:

• Most for-profit businesses are established as share capital corporations or partnerships

• Most not-for-profits and charities are established as non-share capital corporations


Presented By:

• The partnership, and in particular the limited partnership, is often used in for-profit business activities because it offers great flexibility

• The relationship between the partners to a great extent is determined by contract; management powers, profits and losses are allocated by agreement between the partners

• The allocation of profits, losses, or management powers, need not be the same, and need not be proportionate to the amount invested


Presented By:

• The partnership form is not used by non-profits or charities in

Canada because the legal definition of partnership requires that the relationship be “for the purpose of carrying on a business in common with a view to earning profits”

• The U.S. has an organizational form known as the limited liability company (“LLC”), a hybrid of a corporation and a partnership which combines the advantages of both legal forms into one entity

• The U.S. has more recently established another version of the LLC called a low profit limited liability company (“L3C”)


Presented By:

• L3Cs were specifically designed to support program-related investments

by foundations

• The U.S. also has a structure called a Benefit Corporation (“B Corp”), which is a regular corporation with public benefit objectives. It can either be voluntary, by adopting a code and subjecting to review and certification, or several states have created enabling statutes

• The U.K. has an organizational form known as the community interest company (“CIC”), a corporation with some special features designed specifically for businesses that want to combine commercial activities with community benefit purposes

• Key special features of a CIC include a “Community Interest Test” and an “Asset-Lock”, but otherwise can operate as a company, pay salaries, raise debt or equity capital


Presented By:

• There currently is no equivalent in Canadian corporate or tax law to the LLC, L3C, B Corp or CIC structures (although B.C. has announced it will enable a CIC structure)


Presented by


Non-Profit Organizations

Janice Y. Lederman

Presented By:

• The undertaking of an non-share capital corporation must be restricted to one that is of patriotic, religious, philanthropic, charitable, educational, agricultural, scientific, literary, historical, artistic, social, professional, fraternal, sporting or athletic nature or the like

• Under corporate law, a non-share capital corporation may earn profits, but profits earned must be used to further the corporation’s undertaking and cannot be used to benefit its members


Presented By:

• However, if a non-share capital corporation wants tax exempt status under the Income Tax Act (Canada) (“ITA”), it must comply with the requirements of paragraph 149(1)(l) of the ITA which provides an exception from tax for non-profit corporations if:

– they are not charities

– they are organized and operated exclusively for any purpose except profit

– none of the income is available for the benefit of its members


Presented By:

• Thus in order to be eligible for tax exempt status under the ITA, a NPO may not have a profit making purpose

• Historically in Canada, the case law provided that a NPO could engage in profit-making activities and remain tax exempt if there was a causal relationship between the profit-making activities and its non-profit purposes


Presented By:

• In late 2009, and in 2010, CRA issued several technical

interpretations that took a more restrictive view than that of the earlier case law

• CRA’s current view is that a NPO will not qualify for tax exempt status where it intended to earn a profit


Presented by


Charities

Janice Y. Lederman

Presented By:

• To be considered a charity under the ITA, an organization

generally must:

– have as its purpose the pursuit of and the carrying out of activities that are considered charitable by the common law; and

– it must devote substantially all of its resources to charitable activities carried on by the organization itself


Presented By:

• At common law, an organization will only be considered charitable if:

– all of its purposes are exclusively and legally charitable; and

– the benefit is available to a sufficiently large section of the population so as to be considered a public benefit

• The CRA is of the view that charities may engage in a business activity if that activity is “directly related to and advances the goals of the charity”; if so, it is a “related business”


Presented By:

• The CRA considers a “related business” to be charitable activity, so there is no limit on the amount of related business that may be carried on by a charity

• On the other hand, if the business activity is not “directly related to or advance the goal of the charity”, then the activity is considered to be an “unrelated business” and the charity risks losing its charitable status if it carries on that activity


Presented By:

• Private foundations may not carry on any business activity

• There are two kinds of related business activities:

– businesses that are run substantially by volunteers; and

– businesses that are linked to a charities purpose and subordinate to that purpose


Presented By:

• A charity that carries on a business activity that does not fall within the CRA’s definition of a related business risks losing its charitable status

• What constitutes a linked and subordinate business?

– the fact that profits are directed to the charitable purpose is not a sufficient link

– business activities that are linked are “a usual and necessary concomitant of charitable programs”

– business activities that are subordinate to a charity’s purpose are those that remain subservient to the dominant charitable purpose


Presented by


Corporate Social Responsibility By For-Profit Business

Janice Y. Lederman

Presented By:

• Corporate social responsibility (“CSR”) reflects an early effort to promote socially beneficial activity by mainstream for-profit business corporations

• The legal debate around CSR focuses on the extent to which directors of a corporation may allow corporate assets to be used to serve the interests of stakeholders other than the shareholders

• Historically, directors of for-profit corporations had a legal obligation to maximize financial returns for their shareholders


Presented By:

• Case law in Canada and the U.S. has more recently settled the

fact that in making their decisions, directors may consider the interests of a broader group of stakeholders, even if it has some negative effect on the bottom line

• There is no “bright line” test as to the parameters of how far directors can go


Presented by


Social Enterprise

Janice Y. Lederman

Presented By:

• There is no legal definition of social enterprise in Canada, or

elsewhere

• The United Kingdom’s Prime Minister’s Strategy Report describes social enterprise as “organizations which, like mainstream businesses, trade in order to build long term sustainability but which operate for social purpose and use their profits to this end”


Presented By:

• The December 2010 Report of the Canadian Task Force on

Social Finance describes social enterprise as “any organization or business that uses market-oriented production and sale of goods and/or services to pursue a public benefit mission”

• These definitions are broad and cover many organizational forms and approaches


Presented By:


From Charities Aid Foundation (CAF) Venturesome Working Paper: September 2010 “Financing Big Society: Why Social Investment Matters” (2010)

Presented By:

• Proponents of corporate philanthropy and CSR generally accept that the corporation’s core function is to produce profits to benefit its shareholders

• Proponents of social enterprise see the corporation’s objectives as pursuing “multiple bottom line” or “blended value” results giving equal, and in some cases, paramount consideration to social and environmental outcomes


Presented By:

• There are a number of attributes of a typical social enterprise:

– they want a blend of social purpose and financial objectives

– they desire to bring business or market-based solutions and measurements of success to social problems

– they want to be operationally self-sustaining, rather than reliant on donations


Presented By:

– they want to grow their operations to scale

– they want to be seen to be doing good

– their managers see themselves primarily as business people

(Thomas Kelley, “Law and Choice of Entity on the Social Enterprise Frontier”, April, 2009; see also Nancy Roob and Jeffrey L. Bradach, “Scaling What Works” April, 2009)


Presented by


NPO’s and Business Activities

Janice Y. Lederman

Presented By:

• NPO’s (that are not charities) historically could engage in profit-making activity as long as such activity was ancillary to its non-profit purposes

• There is no destination test in Canadian law

• CRA has more recently taken a more restrictive position to provide that none of an NPO’s proposed purposes can be to earn a profit, even if the profit is used to further its non-profit purposes


Presented By:

• An NPO which carries on an activity intending to earn a profit

may be taxed by the CRA as a for-profit business

• Many NPO’s incorporate a share capital corporation to carry on the profit making activity; the for-profit business operates as a subsidiary of the NPO


Presented by


Charities and Business Activity

Janice Y. Lederman

Presented By:

• Charities may lawfully carry on related business activities without affecting their tax status

• There are two types of related business:

– those that are substantially run by volunteers; and

– those that are linked and subordinate to the charities purpose


Presented By:

• The fact that profits are directed to the charitable purpose is not a sufficient link

• Charities in Canada that wish to carry on business activity that falls outside the scope of the related business definition, or that cannot be said in certainty to fall within the related business definition, have been incorporating share capital corporations to carry on their profit making activity; the for-profit business operates as a subsidiary of the charity


Presented by


The Best Model For Social Enterprise in Canada within the Current Legal FrameworkJanice Y. Lederman

Presented By:

• On balance, the most effective model for social enterprise currently in Canada is the for-profit share capital corporation, using legal agreements to “work around” some of the challenges

• The charity model is the least attractive vehicle for carrying on a business activity

• The requirement that the purposes of a charity “be exclusively and legally charitable” restricts their income-producing capacity to activities that are ancillary to its charitable purposes


Presented By:

• A non-charity NPO has a little more latitude than a charity to earn profits

• However, more recent limitations on the scope of the profit-making function of a NPO likely will disqualify many enterprising NPOs from tax exempt status under the ITA, thereby further diminishing their financial viability

• Also, because of the “purposes restriction”, the range of permissible activities for an NPO may be too narrow for many social enterprises


Presented By:

• Share capital corporations generally can pursue profit-making

activities without restriction, and generally are free to carry on any type of business activity

• Share capital corporations have a flexible capital structure, allowing them to raise capital from multiple sources with varying terms and conditions

• As long as the shares are not widely distributed, agreements between a corporation and its shareholders can be effective in restricting the activities of the corporation to its social purposes and directing how its profits are to be applied


Presented By:

• There nonetheless are drawbacks to using a for–profit share capital corporation for social enterprise:

– because corporations generally are free to do what they choose without regulatory oversight, they also are free to change their social purposes from time to time

– “work-around” agreements can be effective in preventing this, but such agreements can be complex, and confusing for stakeholders and potential funders

– without a distinguishable brand for the social enterprise (similar to the “community benefit” brand presented by a charity or an NPO), it is more difficult for the social entrepreneur to market the business as a social enterprise


Presented By:

– where the corporation has multiple shareholders with different interests, there are limits on the extent to which the directors can allow the for-profit corporation to pursue social objectives without breaching its fiduciary obligations to maximize financial returns

– by incorporating as a for-profit corporation, the social enterprise cuts itself off from the more traditional sources of funding for social enterprises (namely, donors, foundations and governments)


Social Enterprise In Canada

Documents

Transcript of Social Enterprise In Canada