The Legal and Regulatory Framework for CSO Self-Financing in Croatia

The Legal and RegulatoryFramework for CSO Self-Financing in Croatia

This guide examines the legal and regulatory framework that governs the use

of "self-financing" (i.e., income-generating, commercial) activities of civil soci-

ety organizations (CSOs) in Croatia and provides an assessment of the relevant

law and its practical effects in order to identify areas where the law might be

improved. In Chapter 1, the guide explains the importance of understanding

the regulatory environment as it relates to self-financing, defines the concept

of CSO self-financing, and explains the methodology used by NESsT in

researching and assessing the legal framework in Croatia. Chapter 2 outlines a

generally-accepted typology initially developed by the International Center for

Not-for-Profit Law (ICNL) for evaluating the legal framework that regulates

CSO self-financing. Chapter 3 presents the current regulatory framework and

its application in Croatia. The chapter illustrates that although some CSO self-

financing activities are permitted in Croatia, legal and tax regulations vary

based on the type of organization and the level and relatedness of the activity

to the overall mission and purpose of the organization. Finally, in Chapter 4,

five criteria are applied to critique the Croatian legal framework, assess its cur-

rent strengths and weaknesses, and make recommendations for improvement.

Croatia January2006

Nonprofit Enterprise and Self-sustainability Team (NESsT)

NESsTLegalSeries English

Copyright c 2006 NESsT. All rights reserved. No part of this publication may be sold in any form orreproduced without prior written permission of NESsT.

This publication contains information

prepared by sources outside NESsT, and

opinions based on that information. NESsT

strives to provide accurate information and

well-founded opinions, but does not

represent that the information and opinions

in this publication are error-free. The laws

and regulations cited herein may change

regularly and NESsT does not undertake to

update this publication.

This publication is for informational

purposes, and NESsT is not engaged in

providing legal advice. As legal advice must

be tailored to the specific circumstances of

each situation, the information and opinions

provided herein should not be used as a

substitute for the advice of competent

counsel.

For more information on NESsT, itspublications and services please contact:Nicole Etchart, Co-Founder & CEO, NESsT, José Arrieta 89, Providencia, Santiago, Chile. Tel: +(56 2) 222-5190. [email protected]

Written and edited by Snjezana Bokulic, Nicole Etchart and EvaVarga.

The Legal and Regulatory Framework for Self-Financing in Croatia

January 2006

The International Center for Not-for-Profit Law(ICNL) provided the typology for classifying the use ofeconomic or commercial activities among CSOs and theframework for assessing the Croatian legislation. Piera Lombardi and Jose Neira of Tesis provided thedesign and layout of the guide.

Finally, NESsT wishes to recognize and thank the StaplesTrust, one of the Sainsbury Family Charitable Trusts inLondon, for the generous support that made thisresearch and publication possible.

Nicole Etchart and Lee DavisCo-Founders & CEOsNESsTJanuary 2006

NESsT

NESsT wishes to acknowledge the followingindividuals and institutions for their invaluablecontribution to the development and publication ofthis guide.

The term "civil society organization1" (CSO)encompasses the wide diversity of not-for-profit,non-state organizations as well as community-based associations and groups that fall outside therealm of the government and business sectors.Given the limited philanthropic and governmentassistance, many CSOs undertake self-financing togenerate revenues in support of their mission andprograms.

NESsT has documented hundreds of CSOs inLatin America and Central Europe that engage inthese types of activities and has analyzed theimpact of these strategies on the organizations'performance and sustainability. An important fac-tor that emerged from these investigations is theneed for a clear and supportive legal and regula-tory framework to foster the adoption of self-financing strategies among CSOs. This frameworkdefines whether CSOs can or cannot engage inself-financing activities and influences the circum-stances under which and degree to which theywill do so. In addition, the tax structure, the levelof bureaucracy, and the clarity of the applicablelegal rules have a direct bearing on the use of self-financing activities. CSOs are often unaware of

Setting the Stage:Purpose and Methodology

Chapter 1The Legal and RegulatoryFramework for Self-Financingin Croatia

1These organizations are often also referred to as nonprofit organiza-tions (NPOs), nongovernmental organizations (NGOs), charities, orvoluntary organizations. The term "CSO" is a broadly encompassingterm that includes all of these subgroups.

these rules. Many believe that they cannot prac-tice self-financing; others feel that if they do, itwill damage their public image or their relationswith donors. Even when CSOs are aware of therelevant legislation, they often do not understandwhat taxes they need to pay, what forms to file, orwhat procedures to follow. In Croatia, self-financ-ing activities by CSOs remain a rare practice, part-ly because of the lack of capacity and entrepre-neurial spirit on the part of the CSOs, but in partalso because of the lack of a clear interpretationof the legal framework which, in principle, allowsCSOs to engage in commercial activities.

Croatian legislation encompasses a variety of typesof CSOs engaging in activities aiming to achievegeneral or common interest. They include associ-ations, institutions, foundations, funds and non-profit commercial companies. This guide willattempt to clarify the legal framework faced byCroatian associations, non-governmental organiza-tions which constitute the bulk of Croatian civilsociety. The guide will, then, assess the degree towhich this framework provides an enabling envi-ronment for these organizations to pursue self-financing strategies.

1.1 What is Self-financing and Why is it Important?

Self-financing strategies are used by CSOs to gen-erate revenues in support of their missions. Theuse of self-financing is a response to the currentfunding paradigm in which CSOs compete for alimited pie of existing government and philan-thropic resources from both national and interna-tional sources. This reality makes many CSOsheavily dependent on short-term, project-basedfunding and prevents them from focusing atten-tion on the long-term, strategic development oftheir organizations. Through the self-financing,CSOs may be able to increase their long-term via-bility and independence by generating some oftheir own resources to supplement support frompublic and private donors.

Self-financing need not lead to the commercial-ization of CSOs. Rather, self-financing can provideCSOs with a greater level of independence andsustainability without compromising their missionobjectives or values. Self-financing income can beone alternative for CSOs to support work that isoften difficult to finance through traditionalsources of funding (e.g., core operating expenses,new programs, advocacy efforts). NESsT does notargue that CSOs should entirely replace their tra-ditional sources of funding with self-financing,but instead posits that self-financing can provide apowerful complement to government and philan-thropic support. Through self-financing, manyCSOs are not only financially strengthened, butalso institutionally empowered by their ability togenerate new revenues and to determine thecourse of their work with fewer constraints fromfunders.

Furthermore, when pursued in a socially and envi-ronmentally responsible manner, the enterpriseactivities of CSOs can help create an "alternativeeconomy" more responsive to the needs of localcommunities, small producers and low-incomepeople. By purchasing products and services soldby CSOs, consumers are simultaneously promot-ing the mission of CSOs and contributing to amore equitable and sustainable world.

Types of self-financing activities include the fol-lowing:

- Membership fees: raising income through duesfrom members or constituents of the organiza-tion which is not considered a fee for some kindof product, service, or other benefit provided bythe CSO to its membership.

- Fees for services: capitalizing on some existingskill or expertise of the organization by contract-ing work to paying clients in the public or pri-vate sector (e.g., a CSO provides consultationservices to businesses or local government).

NESsTThe Legal and Regulatory Framework for Self-Financing in Croatia

January 2006

Chapter 1

NESsTThe Legal and Regulatory Framework

for Self-Financing in CroatiaJanuary 2006

Chapter 1

- Product sales: selling, rather than giving away,the products of CSO projects (e.g., books orother publications); reselling products (e.g., in-kind donated items) with a mark-up; or produc-ing and selling new products (e.g., T-shirts,mugs).

- Use of “hard” assets: renting out CSO realestate, space/facilities, equipment, etc. when notin use for mission-related activities.

- Use of “soft” assets: for example, generatingincome from license of CSO-held patents orother intellectual property, or by endorsingproducts with the CSO name/reputation.

- Investment dividends: passive investments suchas savings accounts and mutual funds, or othermore sophisticated financial transactions (e.g.,active trading on the stock market).

CSOs engage in self-financing activities primarilyto strengthen their financial resources, to advancetheir social mission, or both. On the one hand, aCSO may be purely interested in generating prof-its that it can use to fund its core mission pro-grams. In these instances, the organization is notconcerned with advancing its social missiondirectly through the self-financing activity, butrather indirectly by applying the revenues fromthe activity to further its social mission. An exam-ple of this is a health education organization thatstarts a printing press and uses the revenues tofund the organization's research projects. Thisactivity would be considered non-mission-related.

On the other hand, a CSO may be primarily inter-ested in using a self-financing strategy to advanceits social mission. For example, a CSO whosesocial mission is to offer carpentry training andjob placements to recovering substance abusersmay begin selling the furniture that the traineesproduce in order to pay for the costs of materialsand the salaries of the trainees. This activity wouldbe considered mission-related.

Yet these examples are not mutually exclusive -and neither are the financial and social goals thatmotivate CSOs engaging in self-financing activi-ties. Many times, CSOs aim to achieve financialand social goals simultaneously through a self-financing activity. The health organization may bebetter positioned to disseminate the findings fromits research by publishing its own materials, andthe job training organization may be able to applysurpluses from its furniture sales to fund otherprograms of the organizations or its core operat-ing expenses. In each of these scenarios, theobjectives of CSO self-financing activities and therelation of these activities to the organization'sprimary mission strongly influence the success ofthe activities and may play a role in determiningthe legal treatment of these activities, as thisguide will illustrate.

1.2 Purpose and Contents of this Guide

In an attempt to diversify their funding base, anumber of Croatian CSOs have initiated self-financing strategies. For the most part, however,they have done so with little know-how, capital orother forms of support. NESsT research on theuse of self-financing among CSOs in Croatiademonstrates that many of them have limitedinternal capacity (i.e. staff skills and time, ade-quate financial resources, business plans) or theexternal support (i.e. financing, consulting sup-port, favorable legal/regulatory environment) toengage in self-financing activities. When suchorganizations nevertheless attempt to pursue self-financing strategies, they have to deal with arange of legal, financial, management and organi-zational issues for which support is not readilyavailable. If CSOs decide to pursue self-financingactivities, it is important that they do so with theappropriate types and levels of technical andfinancial assistance and within an enabling exter-nal environment

The pressures and demands faced by CSOs engag-


January 2006

Chapter 1NESsT

the five criteria of the typology are used as abasis for the assessments and recommendationsoffered in Chapter 4.

1.3 Background and Methodology

This guide is a component of NESsT's efforts tofoster self-financing among CSOs in Croatia. In1997, NESsT began conducting applied researchon CSO self-financing in Central Europe in orderto identify the typical challenges and needs in theregion. The objectives of the applied researchwere as follows:• To assess the current use of self-financing activi-

ties among CSOs in Central Europe. NESsTcompleted case studies documenting successesand obstacles in CSO self-financing activity infour Central European countries: Hungary,Slovakia, Czech Republic and Slovenia.

• To examine the current legal environment forCSO self-financing in the region overall, includ-ing the regulatory and tax framework in place atlocal and national levels that affects the self-financing activities of CSOs.

• To disseminate lessons from the research - bypublishing case studies and legal guides and byorganizing local workshops - for stakeholdersfrom all sectors in an effort to develop strategiesfor assisting CSOs in the use of self-financing.

In 2005, such research was conducted in Croatia.It was conducted using a methodology developedby NESsT to evaluate the legal environment forCSO self-financing activity in a particular country.The following four areas were considered:

1. What the law states. What is the current legaltreatment of CSO self-financing activities(including current legislation, legal provisions,

ing in self-financing activities highlight the needto understand the legal environment affectingthem in Croatia. In this context, the purpose ofthis guide is twofold:

1. To outline key laws, regulations and proceduresgoverning the use of self-financing by CSOs inCroatia. Chapter 3 explains what the Croatian lawsays about the use of self-financing and discusses theadministrative and tax regulations that apply toCSOs engaging in such activities. It also explains theprocedures - forms that must be completed and feesthat must be paid - required to initiate such activi-ties. It offers a general overview of the relevant lawsand regulations, so that Croatian CSOs have an ideaof where they fit within the legal system and whatthey have to do if they wish to undertake self-financ-ing.

2. To assess the relevant laws governing CSO self-financing in Croatia, to evaluate their practicaleffects and to identify areas where the lawmight be improved. This guide identifies thestrengths and weaknesses of Croatian laws -whether they help or hinder the use of self-financing, and whether they foster the develop-ment of the sector as a whole. The legislation isconsidered within a tax treatment typology thatmakes it easier to understand and assess.

The typology was first developed by theInternational Center for Not-for-Profit Law2

(ICNL) to examine the legal treatment of CSOeconomic/commercial activities in Central andEastern European countries; it has nowbecome a widely accepted typology for under-standing and assessing the tax treatments ofsuch activities. The ICNL typology is presentedin Chapter 2; Croatia's legislation is analyzed inthe context of this typology in Chapter 3; and

2ICNL is an international organization whose mission is to facilitateand support the development of civil society and the freedom ofassociation on a global basis. ICNL, in cooperation with other inter-national, national, and local organizations, provides technical assis-tance for the creation and improvement of laws and regulatory sys-tems that permit, encourage, and regulate the not-for-profit, non-

governmental sector in countries around the world. ICNL maintainsa documentation center for laws, regulations, self-regulatory materi-als, and other relevant documents; provides training and education;and conducts research relevant to strengthening and improving lawsaffecting the nonprofit sector. For more information on ICNL, seewww.icnl.org.



Chapter 1

history of the law, revisions of the law, regulato-ry approach, tax rates, reporting requirements,other laws or regulations, legal cases, andorganizations or lawyers providing advice orassistance)?

2. How the law is understood. Are the regulationsof CSO self-financing activities understood byCSOs?

3. Effects of the law. What is the effect of currentregulations on CSO self-financing activities?

4. Recommendations for the law. What are themost important recommendations for address-ing current regulatory problems?

NESsT contracted a consultant on civil society inCroatia who conducted primary and secondaryresearch for the purposes of this guide. Theresearch encompassed extensive interviews with15 Croatian CSOs engaging in commercial activi-ties, analysis of relevant laws and a review of relat-ed literature. The guide was then reviewed bynonprofit lawyers with extensive expertise of theCroatian regulatory framework for CSOs.


January 2006

Chapter 1

This chapter presents a typology for analyzing thelegal rules that govern CSO self-financing activi-ties. The typology was developed by theInternational Center for Not-for-Profit Law3

(ICNL). NESsT has expanded and modified it tomake it more applicable. The following sectionpresents four key areas that are vital for under-standing the legal structure for CSO self-financingbefore assessing the specifics of Croatia: 1) thelegal characteristics of CSOs, 2) the legal defini-tion of self-financing, 3) the criteria for permit-ting self-financing, and 4) the taxation of self-financing activities.

It is important to note that in its texts, ICNL usesthe term "nonprofit organizations" or "NPOs,"which refers to a subgroup of the broader classifi-cation of "CSOs," the term used by NESsT. Thisguide uses the term "CSO," except in parts thatspecifically draw upon the ICNL typology, whereit maintains the original ICNL terminology.Croatian laws make reference to the term "associ-ation" (udruga) which is consistent with thebroad scope of organizations encompassed by theterm "CSO."4

Presenting a Typology for Assessing the Legal and Regulatory Framework


3The overall typology presented in this chapter was adapted, withpermission, from the paper Regulating Economic Activities of Not-for-Profit Organizations that was first prepared by ICNL for the"Regulating Civil Society" Conference in Budapest, Hungary, in May1996 (copyright ICNL, 1997) and from the Handbook on GoodPractices Relating to Non-Governmental Organizations, Appendix I:Economic Activities and Taxation (copyright ICNL, 2000).

4Foundations, funds and other forms of CSOs in Croatia, are notencompassed by this guide.

2.1 Legal Characteristics of Nonprofit Organizations

These characteristics highlight the key differencesbetween nonprofit and for-profit organizationsand therefore provide a context for understand-ing how NPOs engage in self-financing or com-mercial activities. The discussion that follows inthis chapter and the rest of the guide addresses asubgroup of all NPOs - those whose not-for-profitpurposes are intended to promote the public ben-efit. It is important to recognize that some NPOs,such as mutual associations of stamp collectors orchess players, may not pursue these goals. Theseorganizations are still considered NGOs and gen-erally the same regulations apply, but this guidewill address only those NGOs that pursue the pub-lic benefit. There is no fixed way of determiningwhat constitutes the public benefit, and Croatianlaws do not distinguish between NPOs on thisbasis as the concept of public benefit is non-exis-tent in this context.5 ICNL, however, does makethis distinction, and its typology accordingly iden-tifies two basic legal assumptions that distinguishpublic benefit NPOs from for-profit entities:

1. Non-distribution constraint. Although NPOs arenot prohibited from generating profits, theseprofits may not be distributed to private partieswho might be in a position to control them forpersonal gain, such as founders, members, offi-cers, directors, agents, employees, or any relat-ed party.

2. Public-benefit purpose. By definition, this classof NPOs is organized and operated primarily toprovide a public benefit.

These characteristics are not primarily dependenton the particular legal form of the NPO. Accord-ingly, this discussion addresses NPOs of variouslegal forms as long as they provide a public bene-fit and uphold the principle of non-distribution.

2.2 Legal Definition of Self-financing

There are many terms and definitions, both legaland non-legal, currently in use to describe activi-ties that generate revenues for CSOs (e.g. com-mercial activity, economic activity, nonprofitenterprise, social enterprise, social-purpose busi-ness, earned income, income-generating activity).ICNL uses the term "economic activity" to refer toself-financing activity. ICNL defines economicactivities as "regularly pursued trade or businessactivities," with the exception of those that havetraditionally been excluded (i.e., ticket sales forcultural events, tuition fees at educational institu-tions, and patient fees at nonprofit hospitals).NESsT, on the other hand, uses the term "self-financing" to refer to activities that generate rev-enues for the CSO, including the six types ofactivities described in the previous chapter. InCroatia, the terms "self-financing," "economicactivities," and "commercial activities" are usedinterchangeably to indicate both mission relatedand non-mission related activities undertaken byCSOs for revenue-generating purposes.

2.3 Criteria for Permitting Self-financing

According to ICNL, “a threshold issue is theextent to which NPOs should be permitted toengage in economic or commercial activities with-out losing their not-for-profit status.”6 At this stageof the analysis, the question is not whether suchactivities should be tax-exempt, but under whatcircumstances they should be permitted at all.

There are two typical tests used by governmentsaround the world for determining whether eco-nomic activities are “nonprofit” or “for-profit”:

1. Principal-purpose test. The principal-purposetest provides one legal model for regulatingNPO self-financing. It does not prohibit the useof self-financing activities, but rather empha-sizes that the NPO is established and operated

5Although the public benefit status is not defined in Croatian legisla-tion, Article 17 of the Law on Foundations and Funds, for instance,obliges the state to promote foundations and their activity wherebysuch organizations are inexplicitly and effectively treated as publicbenefit organizations.


January 2006

Chapter 2

6Regulating Economic Activities of Not-for-Profit Organizations,(copyright ICNL, 1997).



Chapter 2

primarily for not-for-profit purposes and notfor private gain. The test implies that self-financing would be for mission-related, not-for-profit purposes and/or would not be the prin-cipal activity of the organization.

2. Destination-of-income test. Contrary to the prin-cipal-purpose test, the destination-of-incometest, in its pure form, ignores the economic orcommercial nature of the activity in questionand focuses exclusively on the purposes forwhich profits from the activity are used. Underthis test, an organization must devote all of itsincome to its not-for-profit purposes in order toqualify as an NPO. Accordingly, an organiza-tion that spends 99% of its time pursuing com-mercial endeavors, spends 1% of its timeundertaking public-benefit activities, anddevotes all of its profits to these public-benefitactivities could still qualify as an NPO.

Under either test, an NPO is permitted to engagein economic activities that further the not-for-profit purposes for which it is organized. But whatjustification is there for governments to permitNPOs to conduct self-financing activities? Thereare two main public policy rationales for permit-ting NPOs to engage in such activities:

a. Self-financing applies non-public resources tothe public good. Income from economic activitiesis a primary source of funds for NPOs (particular-ly in countries in transition, where there is anabsence of private capital and philanthropic tradi-tion) and enables them to do their public-benefitwork with less dependence on governmental sup-port and charitable donations.

b. Self-financing accomplishes public-good objec-tives. Certain economic and commercial activitiesdirectly accomplish public-benefit purposes. Forexample, although the selling of a book on teach-ing techniques by an educational organization isan economic activity, the distribution of the bookdirectly serves the public-benefit purpose of pro-

moting education. Preventing NPOs from usingsuch commercial and economic means to attaintheir goals could directly impair their ability toserve public-benefit purposes.

Preventing NPOs from using commercial andeconomic means to attain their goals coulddirectly impair their ability to serve public-bene-fit purposes.

2.4 Taxation on Self-financing Activities

While the legal treatment of CSO self-financingvaries on a practical level from country to country,most have ruled out polar extremes (i.e., a com-plete prohibition against economic activities orallowing economic activities to be the principalactivity of the organization). Beyond this decision,the issue becomes the tax treatment of such activi-ties. Governments have typically employed fourapproaches, singly or in combination, to deter-mine the tax treatment for CSO self-financingactivities:

1. Blanket tax. A blanket tax policy taxes incomefrom all economic activities, regardless of thesource or destination of the income. Underthis approach, the organization is not limitedby level or type of activity, but is taxed for allrevenues generated through these activitiesregardless of how those revenues are used.

2. Destination-of-income tax. A destination-of-income tax policy exempts income from eco-nomic activities that is used for public-benefitpurposes. Under this approach, the organiza-tion is not limited by level or type of economicactivity, but is taxed on all income that is notused to further its public-benefit purposes. Thedestination-of-income tax should not be con-fused with the destination-of-income test. Thetest is used to establish that CSOs may conducteconomic activities without compromising theirnonprofit legal status as long as any revenues


January 2006

Chapter 2

are destined to the organization’s mission. Thedestination-of-income tax, on the other hand,focuses purely on the tax treatment of nonprof-it organizations.

3. Source-of-income tax (or relatedness test). Asource-of-income tax policy focuses on thesource of the income, granting a tax exemp-tion only when the income results from activi-ties that are related to the public-benefit pur-poses of the organization. Under thisapproach, the organization is taxed for allincome generated from non-mission-relatedactivity even if the income is usedto support mission-related activi-ties.

4. Mechanical tax. A mechanicaltax policy makes a rigid dis-tinction based on fixed crite-ria in order to determine thedifference between economicactivities that are taxed andthose that are not. An example ofa mechanical test is an exemption ceiling (i.e.,an income level below which economic activi-ties are tax-exempt and above which they aretaxable).

Some governments havecreated hybrid tax poli-cies that are based ontwo or more of theseapproaches. For exam-ple, it is possible to allow net income from eco-nomic activity to be tax-exempt below a specifiedthreshold and to apply a mission-relatednessmechanical test to determine whether net incomeabove that threshold should be taxed.

CSOs in Croatia are explicitly permitted toengage in commercial activities, in line with thenon-distribution constraint. They are allowed toengage in both mission and non-mission relatedactivities, with the obligation of allocating all of

the earned income for organizational purposes.As the following chapter will discuss, in Croatia,CSOs are exempt from taxes on income generat-ed from their economic activities. If, however,under procedures which are not entirely clear, thecompetent tax authority establishes that a CSOhas gained an "unjustified privilege on the mar-ket," the CSO's income will be taxed at the regu-lar corporate income tax rate. In this respect,CSOs would be taxed for income from their eco-nomic activities along the lines of the blanket taxtreatment presented above. In practice, however,there have been no such rulings and no case law

is available which would assist in the inter-pretation of the criterion.

There is no consensus on which ofthese tax approaches is best, sinceeach entails certain benefits andcosts and defines a different public

policy objective. ICNL applies fivecriteria to shed light on the practical

implications of each approach.

a. Simplicity or complexity of administration.Blanket taxation of all economic activity is the

simplest approach toadminister—once eco-nomic activities aredefined, NPOs are treatedthe same way as for-profitorganizations. The desti-nation-of-income rule is

slightly more complex to administer. The maindifficulty is establishing and enforcing criteria forwhat constitutes an expenditure in furtherance ofpublic-benefit purposes. A relatedness test is themost complicated to apply because it is difficult tospecify the necessary connection between the eco-nomic activity and the public-benefit purposes.

b. Effects on revenue collection. Assuming the taxrates under the various treatments are equal, thelargest potential tax revenue is generated using

NESsT

Governments have typically employedfour public policy approaches, singly or incombination, to determine the tax treatment for CSO self-financing activities.



Chapter 2

the blanket taxation approach, since it subjectsthe greatest number of NPO self-financing activi-ties to taxation. However, empirically, it is unclearhow much tax would in fact be collected, because,other things equal, the level of commercial activi-ty by NPOs will presumably be lower under thisrule than under the others (because taxation pro-vides a disincentive for NPOs to initiate commer-cial activities).

In its purest form, the destination-of-income rulehas the lowest potential to produce tax revenuebecause all income from whatever source is freefrom tax if it is applied to performance of public-benefit purposes. In practice, many countriesimpose limits upon the amount of income that isexempt under the destination-of-income rule,thus limiting potential losses to the state’s revenuebase. The mission-relatedness test also potentiallyreduces the size of the tax base, but probably lessso than the destination-of-income test, becausethe former has the effect of channeling NPO eco-nomic activity into specific areas that producepublic benefit.

c. Effects on the commercial sector. The blankettaxation approach to NPO income from econom-ic activities is most favorable for the commercialsector, since there is no possibility of “unfair” orprejudicial competition (i.e., NPOs do not receivepreferential tax treatment compared with theirfor-profit peers). The destination-of-income rule,in its purest form, does nothing to prevent claimsof unfair competition, since the nature of the useof income may give NPOs a tax advantage thattheir for-profit competitors do not share. Natur-ally, a limit on this benefit reduces the compara-tive advantage for NPOs. The mission-relatednesstest minimizes unfair competition by encouragingNPOs to focus on activities that produce a publicbenefit and by applying the standard tax treat-ment used for for-profit enterprises when NPOactivities are conducted purely for profit. The dif-ficulty in implementing this mission-relatedness

rule lies in establishing which economic activitiesadvance the public benefit and which do not (orwhich do not advance it enough).

d. Effects on the development of the NPO sector.The blanket taxation approach reduces resourcesfor the nonprofit sector, essentially transferringmoney away from NPOs and into the governmen-tal sector. It is generally accepted that NPOsdevoted to public-benefit purposes, if not eligiblefor state subsidies, should at the very least not berequired to transfer resources to the state (in thesame fashion as for-profit enterprises). Blankettaxation of all NPO income from economic activi-ties eliminates the incentive to engage in income-generating, public-benefit activities and is mostunfavorable to the nonprofit sector. At the veryleast, NPO proponents claim, such taxes shouldbe at a lower, preferential rate than taxes for for-profit enterprises.

The destination-of-income rule provides the great-est potential revenue to NPOs, since virtually anyincome can be made tax-exempt if channeledinto public-benefit activities. The mission-related-ness test is less favorable to NPOs because activi-ties that are undertaken purely to obtain revenueenjoy no tax exemption. However, the mission-relatedness test still provides significant tax bene-fits for NPOs, particularly when they focus onactivities associated with public-benefit purposes.Moreover, the relatedness test channels NPO eco-nomic activities into more socially beneficialdirections than the destination-of-income test,which encourages NPOs to engage in economicactivities that can earn the greatest potentialfinancial return.

e. Practical implementation issues. The blankettaxation approach is the easiest approach toimplement, since there are uniform rules forNPOs and for-profit organizations alike. The des-tination-of-income rule uses a mechanicalapproach that is relatively easy to administer,although it is necessary to define what constitutes

an expenditure in furtherance of public-benefitpurposes and to supervise the actual use of prof-its. Nonetheless, it is still necessary to monitorNPOs and their use of funds, and this “policing”function may prove to be administratively diffi-cult. Moreover, this approach creates a greaterpotential for abuse by unscrupulous individualsseeking to use NPOs as vehicles for tax evasion.The relatedness test is relatively difficult to imple-ment, since a precise definition and applicationof this concept is elusive, and tends to work bestwhen developed over time through administrativepractice. On the other hand, this relatednessapproach is the most likely to keep NPOs focusedon economic activities that also benefit the publicgood.


January 2006

Chapter 2

The Croatian legal framework is favorable towardthe commercial activities of CSOs to the extentthat such activities are explicitly permitted by lawand they are not taxed. CSOs are exempt frompaying corporate income tax on income generat-ed through commercial activities unless suchexemption has lead to the acquisition of "unjusti-fied privilege on the market." Should the compe-tent tax authority reach such a finding, which hasnot happened in practice thus far, a blanket tax islevied on the CSOs income resulting in the sameobligations as those incurred by for-profit entities.Although such legal framework is nominally favor-able, a number of open issues remain, not theleast the definition of the unjustified market privi-lege criterion. Moreover, Croatian legislation doesnot recognize the concept of public benefit whichwould greatly aid in the establishment of anenabling environment for the civil sector.

3.1 General Regulations for CSOs

CSOs in Croatia are governed by the Law onAssociations, NN 88/01, adopted in October 2001(Zakon o udrugama, NN 88/01)7. The amend-ments included in this Law, compared to its 1997

The Croatian Legal and Regulatory Framework


7

Zakon o udrugama - Law on Associations, NN 88/01, available at

www.nn.hr/clanci/sluzbeno/2001/1496.htm.

version, resulted in the decrease of the number offounders, the equalization of the status ofCroatian and foreign founders, regulation ofinformal and foreign associations, change in thecompetent registration bodies, explicit permissionfor NGOs to conduct commercial activities as wellas more precise regulation of state financial sup-port.8 The 1997 Law on Associations replaced theearlier Law on Social Organizations andAssociations of Citizens,9 adopted and amendedin the 1980s, which was inherited from the previ-ous system.

In its Article 2, the Law defines the association as"any form of free and voluntary association of pri-vate or legal persons who subject themselves tothe rules determining the constitution and activi-ties of such type of association for the purpose ofprotecting their wellbeing or undertaking to pro-tect human rights and liberties, as well as environ-mental, humanitarian, information, cultural,national, pro-birth, educational, social, profession-al, sports, technical, health, scientific or otherconvictions and aims, all without the intention ofacquiring profits."10 This Law is not applicableon political parties, religious communities, unionsand associations of employers.

In addition to defining an association, the Lawprescribes its membership, scope of activities,management and its bodies. The Law also pro-vides for associations which are not incorporatedas legal entities, and allows for the incorporationof foreign NGOs. Moreover, it specifies the assetsand liabilities of the association, the supervisoryauthority and procedures for its termination aswell as prohibition of activity. Finally, it containspunitive provisions in cases of misdemeanor

The Law requires that each association have anassembly, as the highest body of the association,and one or more legal representatives. Theremaining bodies of the association, such as amanagement board, executive board, supervisory

board or presidency, are determined by the asso-ciation's statute.11 The statute, moreover, mustdefine the name of the NGO, its seat, and theconditions for membership in the association, aswell as for its termination. It specifies the mannerin which the publicity of its operations is ensured.The statute must contain provisions on the aimsof the association and the activities it undertakeswhich must be in accordance with the aims.

The term for CSO used in Croatian legislation is"association" (udruga), which is generally under-stood to be a nonprofit entity operating to furtherits aims, as prescribed in its statute, for the benefitof its membership, the public at large or certainsectors thereof.

3.2 CSOs and Commercial Activities

Although the Law is clear in that the purpose ofthe establishment of an association may not bethe acquisition of profits, but rather the promo-tion of wellbeing of certain interest groups, suchas the founders or members, the promotion ofpublic interest or the protection of certain convic-tions and aims,12 NGOs are not prohibited fromundertaking revenue-generating activities. Thenot-for-profit status of an association, in fact,implies that its mission-related or revenue-gener-ating activities, as determined by its statute, maynot be performed for the purpose of acquisitionof profits for its members or other private or legalentities.13 Nevertheless, in Article 5, the Law isexplicit that in addition to its basic activity, anassociation may engage in revenue-generatingactivities, in which case any profit earned must beallocated exclusively for the implementation andpromotion of mission related activities, as deter-mined by the NGO's statute. According to expertlegal opinion, the Law is not entirely clear onwhether the mandatory content of the statuteshould also include provisions on the NGO's self-financing activities. It is thus recommended thatthe statute should cite in broad terms the com-

8

Q&A from the ICNL Workshop on the New Law on Associations held

in Zagreb on 5 April 2002. Document available at

www.zamirnet.hr/icnl/pdf/brosura.doc.

9

Zakon o društvenim organizacijama i udruženjima gracana - Law on

Social Organizations and Associations of Citizens, NN 7/82, 5/85,

47/89 and 2/90.

10

Zakon o udrugama - Law on Associations, NN 88/01, Article 2.


January 2006

Chapter 3

11

Ivanovic, Mladen. Kako registrirati udrugu u Republici Hrvatskoj. ICNL,

Budapest and B.a.B.e. Zagreb, 2002.

12

Ibid, p.9.

13

Ivanovic, M. and Marija Zuber. Prirucnik o pravnom, poreznom i carin-

skom sustavu za nevladine organizacije u Republici Hrvatskoj. ICNL,

Budapest, 2001, p.6.



Chapter 3

mercial activities which the CSO wishes to under-take in order to achieve its aims. Such incomemay not be distributed to founders, members,and officers of the organization. The revenue-gen-erating activity may be both mission-related andnon-mission-related.

The amount of revenue which may be earned thisway is not limited. By the same token, the rangeof revenue-generating commercial activities whichan NGO may undertake is not restricted. In prin-ciple, an NGO may engage in any activity whichhas been prescribed by its statute, with the excep-tion of those which have been explicitly prohibit-ed by law. Moreover, different kinds of commer-cial activities are regulated by specific laws whichmust be considered when determining the futurecourse of action. The most common are the Lawon Trade, the Law on the Publishing Activity, theLaw on Social Welfare, The Law on the CateringActivity, etc.14

Associations may undertake commercial activitiesboth within the framework of the existing not-for-profit legal entity or through a separate for-profitcommercial company established by the NGO. Inthe latter case, Company Law applies on the firmwhich enjoys no special status but is treated as anyother for-profit entity.

3.3 Taxes on Commercial Activities

3.3.1 Income Tax1. Corporate Income Tax

If an NGO has established a for-profit companyfor the conduct of commercial activities, suchactivities are taxed at the regular corporate taxrate of 20%. The basis of the tax assessment is theprofit determined in accordance with theaccounting regulation as the difference betweenthe revenue and the expenditures before tax, withadditions or deductions in accordance with the

provisions of the Law on Corporate IncomeTax.15

If, on the other hand, the commercial activity isconducted within the framework of the not-for-profit entity, such income is not subject to taxa-tion. Pursuant to Article 2 of the Law, NGOs,along with a number of other state institutions,political parties, associations, boards, clubs andfoundations, are exempt from the corporateincome tax. Exceptionally, if such tax exemptionwould lead to the acquisition of unjustified mar-ket privileges, the Tax Administration may rulethat such entities must comply with the corporatetax liability. In the case of such a finding, an NGOwill be taxed at the rate of 20% for the incomeearned from commercial activity. Such a motionmay be initiated by the Tax Administration or anyother taxpayer or interested party. In practice,however, it is not clear how the TaxAdministration interprets the term "unjustifiedprivilege on the market." To avoid misunderstand-ings, an NGO may apply to the tax authority foran official interpretation of the term in its specificcase. If the Tax Administration has issued a deci-sion that an NGO has incurred the corporate taxliability, all of its revenues, including income fromnon-commercial activities, are subject to taxation.To date, apparently, the Tax Administration hasnot issued a single such decision. Most CSOswould not turn to the Tax Authority for such rul-ing; they try to avoid paying tax in a different way:they might prefer to receive their commercial rev-enue in the form of donations from clients (be itcorporate or individual customers) and thus makesure that they don't show high revenues fromcommercial activities on their financial state-ments.

2. Personal Income Tax

A progressive personal income tax rate is appliedin the following manner:

14Ibid, p.6.15Law on Corporate Tax, NN 177/04, available atwww.nn.hr/clanci/sluzbeno/2004/3067.htm.

- the rate of 15% is assessed on the basenot exceeding the amount equal to the double ofthe basic personal deduction;- the rate of 25% is assessed on the differ-ence between the double and quintuple basic per-sonal deduction;- the rate of 35% is assessed on the differ-ence between the quintuple and fourteenfoldbasic personal deduction, while- the rate of 45% is assessed to the baseexceeding fourteenfold personal deduction.16

This personal income tax is assessed on all work-related income earned by individuals. It is notlevied on NGOs, however, if an NGO employseither full-time employees or external consultants,it has the obligation to deduct the amount of thepersonal income tax from any wages and pay outonly the net amount. Any employer is also liablefor employer's contributions which include socialsecurity, healthcare, and employment contribu-tions.

3.3.2 Value-Added Tax17

Pursuant to the Law on Value Added Tax,18 anNGO acquires the VAT registration liability if theannual value of its goods and services soldexceeds HRK 85,000 (approximately USD14,000). Grants, donations and membership feesdo not constitute the basis for the VAT liability.The exception are membership fees which are infact fixed fees for services provided to beneficiar-ies, in which case the VAT rate may be applicable.The VAT rate, charged on virtually all goods andservices, amounts to 22%. The obligation tobecome VAT registered is incurred at the begin-ning of the financial year following the year inwhich the income from commercial activities has


January 2006

Chapter 3

exceeded the VAT threshold. If the income fromcommercial activities earned by an NGO in afinancial year does not reach HRK 85,000, theNGO may, if so wishes, request VAT registration.Such option may be reasonable if the nature ofthe commercial activity is such that it involves sig-nificant purchase of goods and services for whichVAT is paid. VAT registration allows the NGO todeduct the paid amount from its obligation mak-ing it eligible for potential tax return. In this case,the NGO has the obligation to remain VAT regis-tered for a period of five years, regardless of theamount of income from commercial activitiesearned in that period.

If an NGO is VAT registered, it may reclaim onlythe amount of VAT paid for goods and servicesused in the commercial activity. If the goods andservices are used for both mission-related activitiesand commercial activities, the NGO may reclaimonly a share of the VAT, in proportion with theuse of the goods and services in the commercialactivity. This share can be determined on the basisof the physical indicators of use, or, if this is notfeasible, on the basis of the most acceptable pro-portion given the actual use of the goods andservices in question. Such an NGO also has theobligation of charging the VAT for all goods andservices it delivers to its clients.

Until April 2004, NGOs whose projects were fund-ed by foreign grants were exempt from payingVAT on goods and services acquired for theimplementation of these projects. The regulation,however, was changed, becoming effective on 8May 2004 and NGOs no longer may enjoy this

16Zakon o osobnom dohotku - Law on Personal Income Tax, NN177/04, available at /www.nn.hr/clanci/sluzbeno/2004/3066.htm. 17Udruge u poreznom sustavu Republike Hrvatske, IJF, August 2002,available atwww.pu.mfin.hr/contentData/PDF%20Datoteke/Brošure/PROSPEKT_05.pdf 18Zakon o porezu na dodanu vrijednost - Law on Value Added Tax,NN 47/95, 104/98, 105/99, 54/00 and 73/00, available atwww.nn.hr.

19

Pravilnik o izmjeni pravilnika o porezu na dodanu vrijednost -

Regulation on the Amendment of the Regulation on Value Added

Tax, NN 55/04, available at


20

http://zaklada.civilnodrustvo.hr/casopis/sadrzaj/broj_1/pitate_odgo

varamo/



Chapter 3

exemption.19 Nevertheless, this VAT exemptionremains in effect for projects funded by the grantsfrom the European Commission and the UnitedStates Government.20

3.3.3 Other Taxes

Several other taxes apply to CSOs conductingcommercial activities or irrespectively of it. Theyare the consumption tax, the trade of real estatetax and the inheritance and gift tax. A number ofother taxes may be applicable, depending on thetypes of commercial activities carried out byCSOs.

1. Consumption Tax

The consumption tax is a municipal tax levied onthe consumption of alcoholic and non-alcoholicbeverages in restaurants, bars and other venues.The tax may amount to up to 3% of the product'ssales price net of the VAT. The applicable rate isset by the municipal council.21

2. Trade of Real Estate Tax

The trade of real estate tax is a joint tax paid tothe unit of local self-government by the acquirerof real estate. The tax is applicable also in thecase of exchange of real estate. The tax, however,is not levied on the acquisition of newly built realestate in which case the VAT is charged.22

3. Inheritance and Gift Tax

The inheritance and gift tax is a county tax leviedon legal and private entities that have inherited

certain assets or received them as a gift. The taxamounts to 5% and is charged on cash, financialclaims and securities, as well as movable propertythe value of which exceeds HRK 50,000 respec-tively.23 If the gift is made by the government ofthe Republic of Croatia or a unit of local self-gov-ernment in relation to the Homeland War, the taxis not levied. Moreover, CSOs are exempt fromthe obligation to pay the inheritance and gift taxif the donation is received for purposes estab-lished by special regulation.24

3.4 Tax Filings

Accounting obligationsThe bookkeeping and financial reporting proce-dures applicable to CSOs are specified by the Lawon Accounting,25 the Decree on the Accountingfor Non-profit Organizations26 and theRegulation on Bookkeeping and Accounts forNon-profit Organizations.27 According to thelegal stipulation, CSOs whose revenue and assetsdid not exceed the value of DEM 5,000 (approxi-mately USD 3,000) in the course of the previousfinancial year, are not obliged to fulfil all theaccounting and reporting requirements. SuchCSOs must keep only the book of revenues andexpenditures and the book of cash receipts anddisbursements. CSOs whose assets and revenueexceed the DEM 5,000 threshold, are required bylaw to keep their books in line with double-entryrecording requirements. The books include thejournal, the ledger and auxiliary books such asthe book of cash receipts and disbursements,book of inventory, book of supplies, book of pur-chase and sales invoices, etc. If an organization isVAT registered, it must, moreover, keep the book

19

Pravilnik o izmjeni pravilnika o porezu na dodanu vrijednost -

Regulation on the Amendment of the Regulation on Value Added

Tax, NN 55/04, available at


20

http://zaklada.civilnodrustvo.hr/casopis/sadrzaj/broj_1/pitate_odgo-

varamo/

21

www.pu.mfin.hr/porezi/v_poreza16.asp?id=b02d1

22


23


24

Udruge u poreznom sustavu Republike Hrvatske, p. 16.

25

Zakon o racunovodstvu - Law on Accounting, NN 90/92, available at


26

Uredba o racunovodstvu neprofitnih organizacija - Decree on the

Accounting for Non-profit Associations, NN 112/93, available at

/www.nn.hr/clanci/sluzbeno/1993/2140.htm.

27

Pravilnik o knjigovodstvu i ra;unskom planu neprofitnih organiyacija -

Regulation on Bookkeeping and Accounts for Non-profit

Organizations, NN 20/94, available at


of purchase and sales invoices in line with theVAT regulation. If an organization has the obliga-tion to pay the corporate income tax, it must keepits books in line with the Law on Accounting asapplicable to for-profit companies.28

Reporting obligationsA CSO keeping its books in line with double-entryaccounting, must twice a year submit the follow-ing financial reports: balance sheet, statement ofrevenues and expenditures, and notes on finan-cial reports. The reports are compiled on pre-scribed forms available in stationary shops, or cre-ated by accounting firms or the organizationitself. The reports are submitted to the localbranch of the State Auditing Office. Moreover,CSOs are obliged to submit quarterly and annualstatistical reports to the Payment TransactionsInstitute. Non-profit organizations whose assetsand revenues do not exceed DEM 5,000 are notobliged to submit any reports.29

CSOs which are VAT registered must file the VATreturn on a monthly basis or quarterly if theirannual revenue does not exceed HRK 300,000.The return must be filed before the end of themonth following the expiration of the reportingperiod, within which period any due balance mustbe settled as well. In addition, CSOs must file theannual return, and settle any due balance, beforethe end of April of the following financial year.30

3.5 Miscellaneous Reporting Obligations

CSOs engaging in commercial activities mustkeep additional registers depending on the typeand volume of commercial activities, as prescribedby relevant laws. In addition to the above men-tioned, this includes the book on the inflow andoutflow of foreign currency in case the organiza-tions receive payments from abroad. CSOs withpermanently employed staff must keep anemployment register, a payroll register and otherrelated books.31

List of Laws Concerning CSOs

Zakon o udrugama - Law on Associations, NN88/01Zakon o ustanovama - Law on Institutions, NN76/93 and 29/97Zakon o zakladama i fondacijama - Law onFoundations, NN 36/95

List of Laws Concerning CSO Operationsand Commercial Activities32

Opci porezni zakon - General Tax Law, NN127/00Zakon o porezu na dodanu vrijednost - Law onValue Added Tax, NN 47/95, 104/98, 105/99,54/00, 73/00Zakon o porezu na dobit - Law on CorporateIncome Tax, NN 127/00Zakon o porezu na dohodak - Law on PersonalIncome Tax, NN 127/00Zakon o porezu na promet nekretnina - Law onTrade of Real Estate Tax, NN 69/97Carinski zakon - Customs Law, NN 78/99, 73/00Zakon o sportu - Law on Sports, NN 111/97,13/98, 127/00Zakon o stopama doprinosa za zdravstveno osigu-ranje - Law on the Rate of HealthcareContributions, NN 54/00Zakon o radu - Labor Law, NN 38/95, 54/95,65/95, 17/01, 82/01Zakon o zapošljavanju - Law on Employment, NN59/96Zakon o platnom prometu u zemlji - Law on In-country Payment Transactions, NN 27/93, 97/00Zakon o osnovama deviznog sustava, deviznogposlovanja i prometu zlata - Law on theFundamentals of the Foreign Currency System,Foreign Currency Operations and Trade of Gold,NN 91A/93, 32/01Zakon o racunovodstvu - Law on Accounting, NN90/92Zakon o državnoj reviziji - Law on State Audit, NN


January 2006

Chapter 3

28 Udruge u poreznom sustavu RH, pp. 3-4, Zuber, pp. 66-67.29Zuber, p. 68.30Udruge u poreznom sustavu RH, p. 7.

31Zuber, pp. 68.32Taken from Zuber, pp. 68-70.



Chapter 3

70/93Zakon o humanitarnoj pomoci - Law onHumanitarian Aid, NN 83/92Zakon o tehnickoj kulturi - Law on TechnicalCulture, NN 76/93, 11/94Zakon o financiranju jedinica lokalne samoupravei uprave - Law on the Financing of Units of Localand Regional Self-Government, NN 117/93,117/01Zakon o trgovackim društvima - Law onCommercial Companies, NN 111/93, 34/99,52/00, 118/2003

3.6 Expertise Needed to ManageCommercial Activities

The civil society sector in Croatia has grown sig-nificantly over the past decade and a half both asregards the number of active CSOs as well as thequality of the services they provide and activitiesthey implement. This growth has been accompa-nied by an increasing need for legal, accounting,management and financial expertise crucial forthe sustainability of CSOs. Although a small num-ber of organizations provide capacity buildingservices in these fields, either for a fee or as partof their program activities, CSOs still lack suffi-cient access to such services. For CSOs conduct-ing commercial activities, the problem is com-pounded both by the unclear interpretation ofthe legal framework regulating CSO commercialactivity and the limited practice of CSO self-financing activities.

In addition to legal and accounting firms provid-ing technical assistance for a fee, clarifications ofrelevant legal, taxation or related issues can besought from the competent authorities. This pro-cedure, however, is time consuming and providesno guarantees that the reply will offer satisfactoryclarifications.

List of organizations providing support to NGOsector:

CERANEO - Centar za razvoj neprofitnih organi-zacijaNazorova 5110000 ZAGREB,Tel. 48 95 829Tel/fax 48 12 384E-mail: [email protected]: www.ceraneo.hr

Government Office for Cooperation with NGOsUlica grada Vukovara 7810000 ZagrebTel: 01/610-6500Fax: 01/610-9972E-mail: [email protected]: www.uzuvrh.hr

Institut za javne financijeKatanciceva 510000 ZagrebTel (+385 1) 4886 444, 4819 363 Fax: (+385 1) 4819 365E-mail: [email protected]: www.ijf.hr

International Center for Non-profit LawApaczai Csere Janos u. 171st Floor, Budapest 1052Tel. 361-318-6923Fax 361-266.1479E-mail: [email protected]: www.icnl.org

National Foundation for the Development of CivilSocietyAdresa: Zagreb, Kušlanova 27Tel: 01/23 99 100Fax: 01/23 99 111E-mail: [email protected]: http://zaklada.civilnodrustvo.hr/

SlapNeumanova 2a31000 OsijekTel: +385 31 213 556


January 2006

Chapter 3

Tel: +385 31 213 556Fax: +385 31 213 557E-mail: [email protected]: www.pomak.hr

SMARTBlaža Polica 2/451000 RijekaTel: (051) 332-750Fax: (051) 320-792E-mail: [email protected]: www.smart.hr


for Self-Financing in CroatiaApril 2002

Chapter 3

Fax: +385 31 213 557E-mail: [email protected]: www.pomak.hr

SMARTBlaža Poli?a 2/451000 RijekaTel: (051) 332-750Fax: (051) 320-792E-mail: [email protected]: www.smart.hr

Decree No. 3,475 of 1980)

CSOs should take special note of the tax laws pertainingto donations. These laws enable for-profit entities or pri-vate individuals to receive tax deductions on donationsmade to certain types of CSOs and thus encouragedonations to CSOs that fall into these various groupsbased on their missions.

Tax laws relating to donations

• Law No. 18,681 of 1987 (Article 69 provides a taxincentive for donations to universities and public orprivate professional institutes)

• Law No. 19,895 of 1990(Article 8 contains the “lawon donations for cultural pur-poses” amended by Law No.19,721 of 2001)

• Law No. 19,712 of 2001 (Articles 62 and followingenumerate special tax treatment on donations forsports clubs)

• Law No. 19,247 of 1993 on donations for educationalpurposes. Under this provision, a for-profit juridical per-son that makes capital donations for projects that are incollaboration with SENAME and other educational insti-tutions can deduct up to 50% of the donation from itstaxes and another 50% from its expenses—a total taxreduction of 42.5%.• Law Decree No. 3,063 on Municipal Rents (Article 47provides a tax incentive on donations to private nonprof-it institutions engaged in education, creation and dis-semination of art and science, or conducting socialaction programs for the benefit of the neediest popula-tions). This provision states that a for-profit juridical per-son with accounting systems in place that makes a cash

donation of no more than 10% of its profit can classifythe donation as an expense and deduct it from itsincome, thereby reducing its tax burden.

Civil and commercial laws

• Law on Money Credit Operations (Law No. 18,010 of1981)

• Civil Code (assets and other property issues, juridicalacts, contracts, etc.)

• Code of Commerce and supplementary laws(Bankruptcy Law, Law on the Securities Market, Law

on Bills of Exchange and Notes,Law on Checks, General BankLaw, Law on Investment Funds,etc.)• Supreme Decree No. 110 of1979, issued by the Ministry of

Justice, contains regulations on granting legal statusto corporations and foundations

• Supreme Decree No. 292 of 1993, issued by theMinistry of Justice, approves the model bylaws towhich “nongovernmental development organizations”may adhere.

Public-law legislation

• Penal Code (enacted in 1874) and subsequent amend-ments and supplementary laws (defines, among otherthings, the crime of “illicit association”)


April 2002

Chapter 3

Nevertheless, the Ministry has broadpowers to act autonomously in overseeing CSOs and their activities.



Chapter 3

• Law No. 18,603 of 1987, Constitutional Organic Lawon Political Parties (sets special objectives reserved forthis kind of organization, which are incompatible withand exclusive of the objectives of any trade, neighbor-hood, student, charitable, or other type of organiza-tion)

• Annual Budget Law for the Public Sector (reproduceseach year a provision that subjects nongovernmentalorganizations receiving funds contemplated in theitems of such Budget Law to oversight of such fundsby the Office of the Comptroller-General of theRepublic)

• Law No. 18,593 of 1987 on Regional Electoral Courts(regulates elections in certain intermediate bodiesdescribed in the law), and subsequent amendmentsthereto

• Law 18,695 of 1988, Constitutional Organic Law onMunicipalities, and successive amendments thereto

• Law 18,962 of 1990, Constitutional Organic Law onTeaching

• Municipal ordinances on payment of licenses, rates,and duties (regarding payment of patents, duties, andconcessions, and, from another angle, citizen partici-pation at the local or municipal level)

Labor, social security, and social laws

• Labor Code and subsequent amendments (the consoli-dated text is contained in Law Decree No. 1 of 1994,issued by the Ministry of Labor and Social Security)

• Law on Pension Funds (Law Decree No. 3,500 of 1980and successive amendments thereto)

• Law on Social Security HealthCare Institutions (Isapres)(Law No. 19,833 of 1997)

• Law on Occupational Accidents and ProfessionalDiseases

• Law on the National HealthCare System (Law No.18,496 of 1986)

Special laws on certain organizations

• Law Decree No. 2,757 of 1979 and Law Decree No.4,163 of 1980, both on Trade Associations

• Law on Homeowners’ Associations and otherCommunity Organizations (Law No. 18,418 of 1996)

• Law No. 19,638 of 1999 on Churches, Creeds, andReligious Institutions

• General Law on Universities, Law Decree No. 1 issuedby the Ministry of Education, of 1980

• General Law on Cooperatives, whose consolidated textis contained in Supreme Decree No. 502 issued by theMinistry of Economic Affairs, of 1978

• Law No. 19,233 of 1993, on Agricultural Communities(reformed from Law Decree No. 5 of the Ministry ofAgricultural of 1968)Law No. 19,253 of 1993, on Protection andDevelopment of Indigenous Peoples

• Water Code (contains specific provisions applicable tocommunities and water and canal associations)

3.7 Expertise Needed to ManageCommercial Activities

The growth of CSOs in Chile over the past fifteenyears has generated an increasing need for legal,accounting, management, and other technicalexpertise not traditionally associated with the sec-tor. While Chilean professionals specializing inthese areas are not in short supply, CSOs lack thefinancial resources to pay for this assistance.Making high quality technical expertise afford-able and accessible to CSOs is a pressing need forstrengthening the sector in general. This need is

Box 3c SPECIFIC LAWS CONCERNING CSO COMMERCIAL ACTIVITIES


April 2002

Chapter 3NESsT

even greater for CSOs conducting commercialactivities, which by their very nature entail a levelof financial risk that must be managed by person-nel with experience and expertise.

Unfortunately, there is currently a large gapbetween the small supply and the large and grow-ing demand for affordable technical expertisefrom CSOs. Some government assistance is avail-able from municipalities, each of which is man-dated by Chilean law to have a Directory ofCommunity Development (commonly known as a“Dideco”) that is intended to support nonprofitand community groups in their formation andcapacity building. However, this aid tends to bemore in the form of advice than action and isoffered unevenly throughout the country basedon the resources and priorities of each localoffice. Various individual professionals withexpertise in legal, accounting, or other areas offerassistance free of charge or at discounted rates toCSOs. Often, these professionals do not specific-ally publicize their willingness to assist CSOs, butaccept solicitations from individual organizationsreferred by personal connections or throughword of mouth within the sector. More important-ly, an expanding group of nonprofit organizationsoffer assistance to CSOs in various areas:

Access S.A. was created in 1988 with the mission

of providing technical, professional, and trainingservices in a private and independent manner todevelopment organizations. The organization ismade up of professionals from diverse disci-plines—consulting and auditing, law, finance,administration and human resources, accountingand tax systems—who share common character-istics: 1) extensive work experience and 2) commitment to the challenge of social andeconomic development in the country. Currently,it is working from Arica to Punta Arenas in part-nership with small, medium-sized, and large socialdevelopment organizations. For more informationabout Access S.A. contact:

Access S.A.Avda. Ramón Freire 7051Pudahuel, Santiago, ChileFono: (56-2) 7476309 / Fax: (56-2) 7487174Email: [email protected]

Corporación Simón de Cirene is a nonprofitorganization whose mission is to provide nonpro-fit entities with organizational capacity buildingand leadership support. It offers workshops andintensive consulting in these areas, attracts volun-teers from the for-profit sector, and distributes amanual that explains its methodology. TheCorporación offers a workshop and informationon the process for legally establishing a nonprofitorganization. For more information aboutCorporación Simón de Cirene:

Corporación Simón de CireneEl Bosque Norte 0440, Piso 8 Las Condes, Santiago, Chile



Chapter 3

27

Fono: (56-2) 2035202 / Fax: (56-2) 2035270Email: [email protected]: www.simondecirene.cl

Foundación Pro Bono is a nonprofit organizationwith a mission to promote social responsibility inthe legal profession by offering legal services on apro bono basis. It provides support 1) to nonprofitorganizations that channel legal assistance needsto low-income persons and 2) to individuals,groups, and organizations that safeguard and pro-tect civil liberties or rights in the public interest.In order to pursue its objectives, Fundación ProBono receives solicitations for pro bono assistancefrom nonprofit organizations and it refers thesegroups to law firms and attorneys that are mem-bers of the Pro Bono Project. For more informa-tion about Fundación Pro Bono contact:

Fundación Pro Bono(No address at the time of publication)Phone: (56-2) 6324554 / Fax: (56-2) 6325759Email: [email protected]: www.probono.cl

Fundación Valora is a nonprofit organizationwhose mission is to generate changes in the lead-ership and administration styles of nonprofitorganizations with the objective of optimizingtheir resources and impact. To pursue this goal,the foundation offers tailored consulting servicesin areas of leadership and volunteerism; participa-tory workshops in Santiago and throughout thecountry; and trainings in legal, accounting, andadministrative aspects of managing a nonprofit.It also promotes partnerships between foundationo not benefit CSOs in their commercial activities.Yet this situation has not prevented CSOs current-ly engaging in commercial activities from adopt-ing strategies, some of which are commonly usedby for-profit entities, to reduce their tax burdens.For example, in some cases where there is not asignificant volume of activity, CSOs do not chargefor the sale of a product or service, but rather askfor a donation, which is not taxable either to the

consumer (there is no VAT) or to the CSO. Some-times this donation is for a suggested amount andtherefore strongly resembles a sale. In anotherexample, when CSOs set up separate, for-profitcompanies to generate revenues for their non-profit missions, they often apply as many costs aspossible to their businesses in order to reduce tax-able income, much in the same way that for-profitbusinesses do. In some cases, for example, theCSO rents services to its own for-profit company,thereby increasing the for-profit company’s costsand decreasing the taxable portion of the income.A third strategy adopted by many CSOs is toreport incoming funds as nontaxable donations,rather than as taxable fees-for-services. All of thestrategies mentioned above are perfectly legal aslong as the activities are conducted at low levels.A CSO engaging in one of these strategies at ahigh volume might arise suspicion in the Ministryof Justice or the SII, with possible penalties rang-ing from the payment of taxes to the nullificationof the organization’s legal status. In order toavoid problems with the government institutionsthat oversee CSOs, it is prudent for CSOs to havetwo distinct legal entities: one for their nonprofitactivities and the other for the commercial or self-financing activities that are intended to generaterevenues for the organization. This separationallows for accounting that more accurately reflectsthe particular nature of the nonprofit or for-profitactivities that each entity conducts.

The following case studies present the experi-ences of two CSOs that engage in commercialactivities. The first is Fundación Hogar de Cristo,the largest welfare institution in Chile, which isheadquartered in Santiago but operates through-out the country. Hogar de Cristo, which is thebeneficiary of presidential recognition thataccords it an income tax exemption, engages incommercial activities at relatively high levels for aCSO. The second is Corporación CIEM, a com-munity development corporation of moderate sizethat is located in the town of San Felipe, north ofSantiago, and that is not a beneficiary of presiden-

The Legal and Regulatory Framework for Self-Financing in Chile

April 2002

Chapter 3NESsT

tial recognition. These case studies present twoCSOs in distinct situations operating under differ-ent rules to illustrate some of the diversity of CSOexperiences with respect to commercial activities.

Corporación CIEM Aconcagua is an organization thatsupports community development efforts in theAconcagua subregion located 80 Km. north of Santiagoin Region V. From its base in the town of San Felipe,CIEM’s wide-ranging programs emphasize small businessdevelopment, conservation and dissemination of thelocal cultural heritage and the arts, education, environ-mental protection, and capacity building among youngpeople and artisans in traditional arts and trades.

Founded as an independent corporation in 1995, theorganization has always received institutional and finan-cial support from the local Roman Catholic diocese. Forexample, CIEM operates out of a physical space knownas Centro El Almendral, which it occupies under a “gra-tuitous loan agreement” in which the diocese allows itto use the facilities free of charge for a term that isautomatically renewable every ten years. At the sametime, CIEM has attempted to develop financial inde-pendence through various initiatives to generate its ownresources.

Some of these initiatives are organized specifically ascommercial activities, although most are directly relatedto the organization’s mission. CIEM has obtained licensesfrom the local municipality for each of its commercialactivities, but this process is relatively easy and the costsare usually minimal (CIEM has not applied for an exemp-tion from these license fees, for which it may be eligibleunder Article 27 of the Law of Municipal Taxes—see sec-tion 3.4.2).CIEM’s commercial activities include operationof a printing press, which publishes both its own materi-als and those of small businesses and other CSOs in theregion; a store that markets and sells products pur-chased from local artisans; a café that sells coffee and

homemade food; and rental of equipment and space.CIEM applied for presidential recognition as a welfareinstitution, but it was denied this status and thereforemust pay first-category tax on income. All of CIEM’scommercial activities are operated at low levels, so theorganization makes provisional monthly payments ofapproximately 2% on all profit during the course of theyear. CIEM can recoup these monthly payments at theend of the year if its balance sheet shows no surpluses,but it may be required to pay the full first categoryincome tax of 17% if it has generated significant rev-enues. The organization must also make monthly VATpayments, the majority of which it can recoup as dis-cussed in section 3.4.2.

The organization also charges fees for activities that arenot deemed commercial as such. It charges for the train-ing programs it offers to youths in arts and trades, butdoes not pay VAT since the programs are consideredaducational and are exempt from this tax. The organAs presented in the previous chapter, the basic

legal framework applicable to CSOs conductingcommercial activities in Croatia differs from theframework governing the operations of for-profitentities in that CSOs undertaking commercialactivities in line with their statute are exemptfrom the corporate income tax. Nevertheless, thecaveat here is that CSOs remain exempt unlessthe competent tax authority establishes that suchexemption has resulted in the CSO acquiring an"unjustified privilege on the market." To date,apparently, the tax authority has not found thisprivileged position in a single case. It wouldrequire further research to establish what exactlyare the reasons for this: whether there had beenno cases filed due to the modest level of commer-cial activities of CSOs or whether the tax authoritysimply overlooks this type of activities. What weknow is that there is no data collected and pub-lished on the commercial activities of CSOs inCroatia today.

Chapter 4 evaluates the practical effects ofCroatian laws on CSO commercial activities, dis-cusses the strengths and weaknesses of the legal

Interpreting and Critiquing The Croatian Legal and RegulatoryFramework


framework, and offers recommendations for thereform of the system which would enhance thedevelopment of CSO commercial activities, and,in turn, increase and sustain the contributions ofthe sector to Croatian society as a whole.

4.1 Evaluating the Croatian LegalFramework for CSO CommercialActivities

A legal framework that is grounded in fair princi-ples and applied accurately and consistently isessential to the social, political and economic sta-bility of any country. In this respect, the Croatianlegal system has a long way to go on the roadtowards the rule of law and judicial competenceand independence. Indeed, Croatia's feeble judi-ciary remains a major obstacle in the country'sprocess of accession to the European Union. Inthe more specific area of legal treatment of CSOsconducting commercial activities, the frameworkis seemingly favorable yet unclear. On the onehand, the law explicitly allows CSOs under certainconditions to engage in commercial activitiesgranting them a preferential tax treatment. Inpractice, however, the benefits of it remain evasiveas much of the interpretation is left to competentauthorities, such as the tax office, still operatingin a climate and espousing an outlook which arefairly hostile to CSOs. This section evaluates theCroatian legal framework with respect to the fiveanalytical criteria established by the ICNL typolo-gy and presented in Chapter 2.

Simplicity or complexity of administration

Since CSO commercial activities are tax exempt,such a system is relatively simple to administerfrom the state point of view. In case, however, theyshould lose the exemption status because of the"unjustified privilege on the market", the blankettax treatment would apply which, again, is thesimplest system to administer. A practical difficultyis posed by the lack of definition of the unjusti-

fied market privilege criterion. In this respect, amore precise interpretation of the term wouldprovide legal security and facilitate broaderengagement in commercial activities by CSOs.Adherence to the non-distribution constraint byCSOs is ensured by the financial reporting systemand occasional audits by competent authorities.

Effects on revenue collection

ICSOs enjoy the tax exemption and are not obli-gated to pay any taxes on the earned income.Thus this model yields no revenue to the stateand, in this respect, is the least favorable for thestate. If the unjustified market privilege criterionwere to be invoked, then the blanket tax wouldapply, in which case the largest potential revenuewould be created. In practice, however, this yieldslittle revenue, as to date there have been noinstances of the application of such criterion, and,moreover, the level of commercial activitiesundertaken by CSOs is low.

Effects on the commercial sector

Because of the tax exemption, CSOs are, de jure,in a privileged position in comparison to the com-mercial sector. This could give rise to unfair com-petition claims by for-profit businesses. In prac-tice, however, given the volume and type of activi-ties undertaken by CSOs, there has been no causefor complaint from the for-profit sector, and nosuch claims have been recorded.

Effects on the development of the NPO sector

While the effects of such system on the develop-ment of the NPO sector would appear positive atthe first glance, in reality its impact has been lim-ited. At issue here is not the fiscal framework,which at least in terms of taxation remains posi-


January 2006

Chapter 4NESsT



Chapter 4

�

Simplicity or com-plexity of admin-istration

Effects on revenue collection

Since CSO commercial activities, with the exception of those conducted by CSOsclassified as exempt from paying income tax by the President of the Republic,are uniformly regulated not only within the sector but also in line with the for-profit sector, the system is relatively simple to administer. The same rules applyto all persons or entities engaging in commercial activities with respect to regis-tration, reporting, and tax filing. Under the ICNL typology, this system would beclassified as "blanket tax treatment," which is the most simple of the varioussystems to administer.

The income tax exemption for CSOs classified as welfare institutions by thePresident represents a form of mechanical test, although it is more qualitative innature than quantitative. The ruling is not related to amount of income generat-ed, which is the classical mechanical test. Instead, it is determined by whetherthe organization is classified as a welfare institution. Once an organization isexempted, then it falls under the "source of income" ruling that exempts allrevenues generated from mission-related commercial activities as long as thatincome is destined for the mission. This exemption applies only to income taxand does little to complicate the administration of the overall system.

From the perspective of CSO proponents, the simplicity of the system under-scores its problems, for the uniform treatment of commercial activities conduct-ed by CSOs and for-profit businesses fails to recognize and specifically promotethe public benefits achieved by CSOs. The authors of this guide thereforebelieve that even though administering the system would be necessarily compli-cated as a result of the reforms proposed later in this chapter, such complica-tions are small sacrifices in return for the greater benefits that would be pro-duced from these reforms.

The Chilean tax system is one of the most modern and effective systems in LatinAmerica, and the collection of taxes with respect to CSO commercial activities isno exception. To the degree that Chilean CSOs conduct commercial activitiesthat are recognized as such, the process of revenue collection is successful.

Yet aspects of the system, particularly the absence of tax discounts for CSOsengaging in commercial activities, have an impact on the level of revenue collec-tion in two specific areas. First, many CSOs are discouraged from initiating com-mercial activities because they perceive that the incumbent tax burden makes itdifficult or impossible to yield a profit. Thus, CSOs under the current system areconducting commercial activities at lower levels than they might be within a

�

Mo

der

ate

Poo

r

Go

od

Mo

der

ate

Poo

r


April 2002

Chapter 4NESsT

�

�

Go

od

Mo

der

ate

Poo

r

more supportive regulatory environment. At the same time, those that are con-ducting such activities are also paying the full income tax. It is unclear whetherthis revenue base would increase or decrease with a higher level of CSO com-mercial activity but a lower rate of taxation. Granting CSOs full tax exemptionswould obviously decrease revenue collections.

Second, CSOs that currently engage in commercial activities have adopted manyof the strategies used by for-profit entities to reduce their tax burdens. Thesepractices, which will be discussed in section 4.2, have primarily emerged becauseof the absence of tax breaks for CSO commercial activities. Tax discounts forCSO commercial activities would probably help decrease such practices, thoughit is unlikely that they would entirely disappear unless CSOs were fully exemptfrom paying income tax. Full tax exemption, of course, would eliminate revenuecollection from CSO commercial activities rather than increase it.

Because CSOs receive the same legal and regulatory treatment as for-profit busi-nesses, there is no "unfair competition" between the two sectors. Each individ-ual commercial activity competes in the marketplace under the same rules, sothere has been no cause for complaint from the for-profit sector. Taxing CSOs atthe same level as their for-profit counterparts is considered strongly favorable tothe commercial sector.

While some CSOs receive income tax exemptions based on their recognition bythe President as welfare institutions, these organizations do not generally con-duct commercial activities at high levels and have therefore not provoked criti-cisms of unfair competition from the for-profit sector.

The flip side of the "good" effects of the current system on the commercial sec-tor is its undeniably "poor" effects on the development of civil society. On thewhole, it is fair to say that CSOs tend to enter the commercial arena at a dis-advantage relative to their for-profit counterparts because of the prioritiesexpressed in their missions and values, the experience and skills of their staffs,

Effects on thecommercial sector

Effects on thedevelopment ofthe NPO sector

OVERALL CRITIQUE: COLOMBIAN LEGAL FRAMEWORK FOR CSO COMMERCIAL ACTIVITIES



Chapter 4

tive for CSOs, but the overall environment inwhich CSOs operate in Croatia. The governmentsector remains largely distrustful towards the civilsector, while the business sector, by and large, stillhas not developed an appreciation for the civilsociety, the work it does and the role it plays.

Practical implemenation issues

In practical terms, the implementation of the sys-tem is easy, as long as no party raises the issue of"unjustified privilege on the market." As there isno case law to rely on, it is unclear in which direc-tion authorities will rule should such a claim bebrought forward and which implications thiswould have on the system's practical implementa-tion.

4.2 Working within the System

Although the legal framework is clear inasmuch itexplicitly allows CSOs to undertake commercialactivities, this practice is not very common inCroatia. CSO representatives cite a variety of rea-sons ranging from the lack of capacity and initia-tive among the civil sector to unclear interpreta-tion of the legal framework by the relevantauthorities. CSOs are thus hesitant to engage incommercial activity, fearing that that may be sub-ject to adverse actions from the tax authoritiesshould their operations be deemed in breach ofregulations. Many of them have thus devisedstrategies which allow them to collect proceedswhich are not automatically classified as revenue.Thus in some cases CSOs may not charge for thesale of a product or service but rather acceptdonations which are not recorded as revenue.Moreover, instead of issuing invoices for the saleof services, CSOs may sign contracts on coopera-tion with prospective partners.

In order to avoid accounting complications andrisk being in breach of regulations, CSOs maychoose to set up a separate for-profit entity,

owned by the CSO, which conducts the income-generating activity on its behalf. Any profitsearned this way are directed towards the CSO inthe form of a donation or similar. It is importantto bear in mind that such an entity is treated asany other business and enjoys no preferentialtreatment or tax breaks. There have been someexamples of CSOs in Croatia resorting to thissolution; however, these occurrences are veryrare.

4.3 Competion with the For-Profit Sector

In spite of the seemingly favorable fiscal frame-work which puts CSOs conducting commercialactivities in a privileged position in comparison totheir for-profit counterparts, to date there hasbeen no record of complaints of for-profit entitieson the account of unfair competition. The mainreason for this probably lies in the fact that thenumber of CSOs engaging in self-financing is rela-tively limited, as is the volume and type of com-mercial activities they undertake. As a matter offact, the competent tax authority has to datereceived no complaints from any interested partyon the ground of a CSO having acquired an"unjustified privilege on the market."

4.4 Perception of CSOs

Although forms of civil engagement and associa-tion have existed prior to 1990, civil society inCroatia started gaining ground only with thechange of the regime. It is unfortunate that thisprocess coincided with the war in Croatia, whichcreated a very hostile environment in which thecivil sector ultimately emerged. As Croatia's inde-pendence from former Yugoslavia was accompa-nied by fierce state nationalism, centralizationand corruption, any dissenting views on thecourse of events were automatically perceived bythe authorities as subversive and anti-state. Since amajor impetus for the development of civil societywas provided by foreign actors, largely donors


April 2002

Chapter 4NESsT

Hogar de Cristo was founded in 1944 by theJesuit priest Father Alberto Hurtado and iscurrently the largest operating and grantmak-

ing foundation in Chile. It provides assistance to themarginal poor, with projects focused in six key areas: 1)children and youth; 2) community centers; 3) senior citi-zens; 4) hospices; 5) health; and 6) social risks. Amongits various programs, Hogar de Cristo operates shelters,hospices, and homes for children and the elderly; pro-vides funeral services to those who cannot afford them;offers scholarships to children and youth to attendschools; extends credit to unemployed individuals tostart their own businesses; and provides housing sup-port.

Hogar de Cristo is an extremely large and far-reachingorganization with over 2,000 staff members and fiftyaffiliate offices throughout the country. It has been spe-cially recognized by the President of the Republic as awelfare institution and is therefore exempt from payingtaxes on income generated from commercial activities,as long as these activities are related to the organiza-tion’s mission and the levels of income are not dispro-portionately high.

Most of Hogar de Cristo’s activities are either classifiedas donations or considered mission-related, so the foun-dation does not pay tax on income generated by theseactivities. Income received from membership dues, PadreHurtado products, announcements made on behalf offamily and friends at religious services, and advertise-ments in Noticias magazine, which is distributed to theorganization’s members, are all treated as donations andare therefore exempt from income tax. Contract feespaid to the foundation by the government and voluntaryfees for services paid by clients are all tax-exempt, sincethey are considered directly related to the foundation’smission and are treated as a subsidy.

Box 4a. CASE STUDY: FUNDACIÓN HOGAR DE CRISTO

Hogar de Cristo has also established a private business,the Hogar de Cristo Funeral Homes, which is set up togenerate profit and therefore pays income taxes.Frequently these profits are low because Hogar de Cristoowns the funeral limousines and rents them to theFuneral Homes, an arrangement that raises the costs ofthe business and thus reduces its taxable profit. All prof-its after taxes are donated to Hogar de Cristo for mis-sion-related purposes. In this way, Hogar de Cristo col-lects tax-free rents from its business on money thatwould otherwise be taxed as income.

Hogar does sell services and products, but it treats mostof these sales as donations and does not provide a bill orcharge VAT. For example, the majority of the productsfrom Hogar’s gift shops are offered to customers with asuggested donation. Although this exchange stronglyresembles a sale, it is legally treated as a donation andtherefore is not taxed. The only exception to this is forthe sale of Christmas cards, which Hogar sells to cus-tomers with the 18% VAT included in the price. Like for-profit businesses, Hogar is also able to recoup the VATthat it pays in purchasing the materials necessary to pro-duce the cards.

Hogar de Cristo conducts a range of activities that gen-erate income for the organization. Some, like the funeralhome and the sale of Christmas cards, are specificallyorganized as for-profit ventures and are therefore taxed,while others, like the sale of gift shop items, member-ship dues, and advertisements in Noticias magazine, aretreated as donations and are thus tax-exempt. Theseactivities are vital to both the financial sustainability ofHogar de Cristo and the promotion of its social mission,and they do not in any way reflect the commercializationof the organization.



Chapter 4

providing humanitarian aid and funding forhuman rights and anti-war initiatives, CSOs wereoften accused of being agents of internationalagendas and interests. Although the environmenthas changed significantly since the 1990s, a gener-al distrust toward the civil sector has persisted todate. Against this backdrop, it becomes especiallyimportant that CSOs engage in self-financingactivities and social enterprise in a transparentand ethical manner, being very clear about howthe self-financing activities can potentiallyenhance their mission goals.33

4.5 Reforming the System

Thus far, this guide has provided an overview ofthe legal framework regulating CSO commercialactivities in Croatia and a review of its practicalimplications. This section presents a critique ofthe existing system and offers recommendationsfor improvement of the current situation. It ishoped that these ideas will inform the debate onhow CSO commercial activities are regulated withthe ultimate objective of promoting such activi-ties, strengthening the organizations that conductthem and enhancing their abilities to contributeto Croatian society. Emphasis is placed on threeaspects of the system which could be improved tocreate a more favorable environment for CSOsand their commercial activities.

1. The interpretation of the unjustified marketprivilege criterion is lacking. As reviewed in sec-tion 3.3.1, CSOs are exempt from taxation onincome generated through commercial activity.Nevertheless, CSOs may lose the exemption statusif the competent tax authority finds that the CSOsas a result of this activity have acquired an "unjus-tified position on the market." The interpretationof the criterion is not provided by the law and, todate, none has been offered by the competentauthorities. This allows much room for arbitrari-ness as the interpretation is left to officials gener-ally lacking an understanding of the significance

and role of the civil society and operating in anenvironment which is still hostile to CSO activity.

2. Enabling environment for CSOs to engage incommercial activities is lacking. Although CSOsare by law allowed to engage in commercial activi-ties, their scope and volume have not beendefined. In practice, therefore, CSOs may bedenied registration if their statutes include refer-ences to commercial activities. Moreover, exces-sive bureaucracy of the state administration posesadditional burdens on CSOs planning to orengaging in commercial activities. This impliesthat in effect, the legal and administrative frame-works are not truly conducive to the engagementof CSOs in commercial activity which is vital forthe sector's sustainability in Croatia.

3. The law does not recognize the concept of pub-lic benefit status. Croatian regulatory frameworkis not familiar with the concept of CSOs whosenot-for-profit purpose is intended to promote apublic good. This is a serious shortcoming as vari-ous types of associations pursuing various goalsare placed on the same standing, effectively disad-vantaging CSOs operated to provide a public ben-efit.

In response to the three criticisms presentedabove, the following recommendations areoffered:

1. Clarify the criteria for allowing CSOs to engagein commercial activities so that no undue obsta-cles arise during the registration process.

2. Provide a solid and unequivocal interpretationof the unjust market privilege criterion within thecontext of the CSO commercial activity.

3. Consider introducing the concept of publicbenefit organizations in legislation regulating civilsociety specifying the criteria, rights and obliga-tions of organizations receiving such status. Amore particular legal framework taking into

33

See NESsT's "Commitment to Integrity" - Guiding Principles for

Nonprofits in the Marketplace, www.nesst.org/SEEINIT.htm


January 2006

Chapter 4

account the subtleties and varied needs of CSOswould be more conducive to the development ofcivil society in Croatia.34

- As the experience of countries in which the con-cept of public benefit organization (PBO) existshas shown, such legislation would also tend tohave a positive impact on commercial activitiesundertaken by CSOs through the breaks PBOsmay receive on various local taxes and customsduties that could be imposed on profits of theircommercial activities. Those PBOs whose missionactivity coincides with their commercial activitycan even receive complete exemption from cor-porate income tax.

4. Implement these recommendations in a partici-patory manner, involving a broad base of CSOs inthe process.

ConclusionAs indicated in the previous chapters of thisguide, the Croatian legal framework allows CSOsto engage in commercial activity under circum-stances which are nominally more favorable thanthose regulating the activity of for-profit entities.Although under the present systems CSO com-mercial activity is tax exempt, the practice of self-financing is not widespread among CroatianCSOs. The reason for this partly lies in the lack ofcapacity and entrepreneurship on the part of theCSOs and partly is due to the shortcomings of thesystem as it is vulnerable to potential arbitrarinessby tax and registration authorities.

34Public benefit status is constantly on the agenda of nonprofit professionals in Croatia. The latest development is a workshop organ-ized by ECNL and the National Foundation for Civil Society Development in Zagreb, in December 2005.The goal of the workshopwas to compare the current regulatory framework affecting public benefit status in Croatia with European regulatory practices.Analysis concluded that there was a need to adopt a more coherent policy on the issue. The key recommendation was to introducea uniform public benefit organization concept and clearly define the criteria that each legal entity must meet, should they wish toobtain this status and the corresponding tax benefits. This way, public benefit would not be a function of legal entity type or fieldof activity and would not allow for discrimination based on these.

The Legal and Regulatory Framework for CSO Self-Financing in Croatia

Documents

Transcript of The Legal and Regulatory Framework for CSO Self-Financing in Croatia