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Social Enterprise In Canada

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What’s the best legal structure for social enterprise in Canada

What’s the best legal structure for social enterprise in Canada


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  • There has been an explosion of interest in social enterprise in recent years and government across Canada are being called upon to play a more active policy-making role. Policy makers, and others, need to understand the limitations of the charity model. It’s my task today to describe the current legal framework for social enterprise in Canada. and identify how current laws and regulations impede, or are seen to impede, the establishment of social enterprises .
  • Economists consider innovation to be a major driver of the economy, especially when it leads to new product categories or increasing productivity. This also applies to innovation in the social sector, particularly where innovation leads to solutions to complex and intractable social problems which are a significant drain on government resources. With the resources available to charities and NPOs in decline, interest in innovation approaches both to financing the sector and tackling the challenging social issues, is on the rise.
  • Canadians tend to use the terms “non-profits” and “charities” interchangeably. In fact, all charities are non-profits, but not all non-profits are charities. While I am going to deal with the distinctions between the two in detail, when I refer to a charity I mean a charity registered as such under the Income Tax Act of Canada (the “ITA”), and when I refer to a “non-profit” or “NPO”, I am referring to a non-profit organization that is not a charity and that has tax-exempt status under the ITA.
  • Understanding the current legal framework for the carrying on of social enterprise in Canada begins with an understanding of how organizations are legally formed. There are a number of possible organizational forms available to be used by anyone who wants to carry on an undertaking. The most common of these is the corporation, which is a legal form that has the status of a “person” at law. Other forms include sole proprietorships, partnerships, trusts, and cooperatives.
  • There are two types of corporations in Canadian law.
  • The first is a share capital corporation, in which the company issues shares in exchange for consideration, generally money. The shareholders are the “owners” of the corporation; their ownership of shares gives them the right to appoint directors, receive dividends out of profits and participate in the sharing of the assets on a winding-up of the corporation.
  • The second is the non-share capital corporation, in which there are no shares to be sold and there are no “owners” as such. Legislation governing non-share capital corporations requires that the undertaking of the corporation be restricted to one that is of a patriotic, religious, philanthropic, charitable, educational, agricultural, scientific, literary, historical, artistic, social, professional, fraternal, sporting or athletic nature or the like (although the wording varies slightly from province to province).
  • Members of a non-share capital corporation have the right to elect directors, and certain other rights, but the undertaking of the non-share capital corporation must be carried on without pecuniary gain to its members, and any profits or other accretions in value must be used to further the undertaking of the corporation.
  • The partnership, and in particular the limited partnership (where the liability of the partners is limited to the amount they contribute to the partnership), is another frequently used legal form for business because it offers great flexibility. The relationship among the partners is established contractually, by drafting a partnership agreement that allocates management powers, profits and losses among the partners as they may agree. It is not necessary to allocate profits based on the degree of ownership interest. Profits or losses are determined at the partnership level, and are then “passed through” to the partners and taxed in their hands, as though they had earned them directly, with no tax consequences at the partnership level.
  • Notwithstanding that charities and non-profits in Canada cannot use the partnership form, I mention it because of two organizational forms that are available elsewhere.
  • The asset lock feature of the CIC is not dissimilar to the requirement of the non-share capital corporation that none of the property or assets can be used to benefit members.
  • Now let’s examine NPOs and charities in a little more detail, including from a CRA perspective. First, NPOs.
  • Although the undertaking of a non-share capital corporation is quite severely restricted, as described in the slide, under corporate law a non-share capital corporation nonetheless may earn profits. Any profits earned, however, must be used to further its undertaking, and cannot be used to benefit its members.
  • Case law in Canada over the years established that an NPO may engage in profit-making activities and remain tax-exempt if there is a causal relationship between the profit-making activities and its non-profit purposes. For example, earning passive investment income, even if substantial, would not disqualify a NPO from tax-exempt status, unless the earning of such income was both an operating motivation of the NPO and a focus of its activities.
  • However, in late 2009 and in 2010, CRA issued several technical interpretations that took a more restrictive view than that contemplated by earlier case law. The CRA took the position that an NPO would not qualify for tax-exempt status where it intended to invest cash to earn investment income that would, in turn, be used to support its activities, because investing cash is an activity intended to earn a profit, contrary to section 149(1)(l) of the ITA. According to the CRA, the only exception would be where the cash or other income-generating assets will be used within a reasonable time frame to meet the NPOs not-for-profit objectives. To put it another way, unless it is intended to be used in the immediate future, maintaining capital property for the purpose of generating income means that the NPO has a profit-making purpose. The CRA stated that none of a NPO’s purposes can be to earn a profit, even if that profit is used to meet the not-for-profit purposes of the NPO. This is called a “destination test” and, unlike the U.K., there is no destination test in Canada.
  • The CRA is of the view that charities may engage in business activity if it is “directly related to and advances the goals of the charity”. This is known as “related business”, and, as related business is considered to be charitable activity, there is no limit on the amount of such activity that may be carried on by the charity.
  • On the other hand, if the business activity is not directly related to or advance the goals of the charity, then the activity is considered to be unrelated business, and the charity risks losing its charitable status if it carries on those activities. (Under CRA administrative guidelines, private foundations may not carry on any business activity).
  • The CRA’s policy states that business activities that are linked to a charity’s purposes are “a usual and necessary concomitant of charitable programs”, either necessary for the effective operation of the programs (hospital parking lots, cafeterias); or to improve the quality of service delivered in the programs (gift shops in art galleries, student book stores); or are an offshoot of a charitable program, where in the ordinary conduct of its business the charity has created an asset that can be exploited; or involve the use of excess capacity of the charity’s assets or staff (University's renting out space in the summer months); or involve the sale of objects that promote the charity or its objects. Business activities that are subordinate to a charity’s purposes are those that remain subservient to the dominant charitable purpose. This would be the case where, relative to the whole, the business activity receives a minor portion of attention and resources; where the business activity is integrated into the charity’s operations, rather than a self-contained unit; where the charitable goals continue to dominate decision-making; or where the organization continues to operate for an exclusively charitable purpose by, among other things, permitting no element of private benefit to enter into its operations (for example, by not permitting. employees in the business activity to earn more).
  • It is helpful to think of it as a continuum of approaches, from the purely charitable approach on the one end, to the purely business approach on the other end. The terminology might refer to a charity, an enterprising charity,. a non-profit, an enterprising non-profit, a social enterprise, a social purpose business, a socially responsible business (with CSR policies in place), corporate philanthropy and pure business.
  • The question sometimes arise as to how you differentiate between social enterprise generally and corporate philanthropy and CSR. The answer is really one of perspective and expectations of the stakeholders.
  • Tom Kelly and others have pointed to a number of attributes common to social enterprises.
  • Just to summarize
  • Transcript

    • 1. The Legal Environment for Social Enterprise in Canada Presented to Second Biennial Symposium Law, Philanthropy and Social Enterprise: New Direction or Distraction? September 21, 2011
      • Janice Y. Lederman
    • 2. The Legal Environment for Social Enterprise in Canada
      • Objectives
      • Janice Y. Lederman
    • 3.
      • Understand the limitations of the charity and non-profit model in relation to carrying on business activities
      • Understand how the current legal environment impedes social enterprise
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 4. The Legal Environment for Social Enterprise in Canada
      • Why is it Important?
      • Janice Y. Lederman
    • 5.
      • Social sector is seeking more effective tools for tackling challenging social issues
      • The system for funding as currently structured is not sustainable; new funding models are required
      • Trend towards social enterprise is itself an innovation, aimed at creating sustainable, self-financing, solutions to intractable social issues
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 6. The Legal Environment for Social Enterprise in Canada
      • Not the Sole Solution
      • Janice Y. Lederman
    • 7.
      • Social enterprise:
        • not a panacea for all that ails the social sector
        • not an alternative to charities or non-profits
      • Access to capital is a challenge across the spectrum of organizational forms
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 8. The Legal Environment for Social Enterprise in Canada
      • Distinction Between Charities and Non-Profit Organizations
      • Janice Y. Lederman
    • 9.
      • All charities are non-profits
      • Not all non-profits are charities
      • To be a charity, the entity must be registered as a charity under the Income Tax Act (Canada) (“ITA”)
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 10. The Legal Environment for Social Enterprise in Canada
      • Organizational Forms
      • Janice Y. Lederman
    • 11.
      • There are a number of different legal structures, and each structure carries with it a basket of rules, including rights, obligations and liabilities
      • The most common structures are:
        • sole proprietorships
        • partnerships (and limited partnerships)
        • cooperatives
        • corporations
        • joint ventures
        • trusts
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 12.
      • The corporation is the most common legal form
      • A corporation is considered in law to be a legal person, separate from its shareholders
      • There are two kinds of corporations in Canadian law: the share capital corporation and the non-share capital corporation
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 13.
      • In a share capital corporation, the Corporation issues shares in exchange for consideration, usually money
      • There generally are no restrictions on the type of business that may be carried on
      • Shareholders are the “owners” of the Corporation
      • Ownership of shares gives holders the right to appoint directors, receive profits and receive the assets or remaining property when the corporation is wound up
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 14.
      • In a non-share capital corporation, there are no shares to be sold to raise money, and no “owners” as such
      • The undertaking of the non-share capital corporation must be restricted to one of “patriotic, religious, philanthropy, charitable, educational, agricultural, scientific, literary, historical, artistic, social, professional, fraternal, sporting or athletic nature, or the like” ( The Corporations Act (Manitoba))
      • Members have the right to elect directors, and certain other rights, but have no right to participate in the profits
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 15.
      • The activity of the non-share capital corporation must be carried on without pecuniary gain to members; and
      • Any profits must be used to further the work of the non-share capital corporation
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 16.
      • Most for-profit businesses are established as share capital corporations or partnerships
      • Most not-for-profits and charities are established as non-share capital corporations
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 17.
      • The partnership, and in particular the limited partnership, is often used in for-profit business activities because it offers great flexibility
      • The relationship between the partners to a great extent is determined by contract; management powers, profits and losses are allocated by agreement between the partners
      • The allocation of profits, losses, or management powers, need not be the same, and need not be proportionate to the amount invested
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 18.
      • The partnership form is not used by non-profits or charities in Canada because the legal definition of partnership requires that the relationship be “for the purpose of carrying on a business in common with a view to earning profits”
      • The U.S. has an organizational form known as the limited liability company (“ LLC ”), a hybrid of a corporation and a partnership which combines the advantages of both legal forms into one entity
      • The U.S. has more recently established another version of the LLC called a low profit limited liability company (“ L3C ”)
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 19.
      • L3Cs were specifically designed to support program-related investments by foundations
      • The U.S. also has a structure called a Benefit Corporation (“ B Corp ”), which is a regular corporation with public benefit objectives. It can either be voluntary, by adopting a code and subjecting to review and certification, or several states have created enabling statutes
      • The U.K. has an organizational form known as the community interest company (“ CIC ”), a corporation with some special features designed specifically for businesses that want to combine commercial activities with community benefit purposes
      • Key special features of a CIC include a “Community Interest Test” and an “Asset-Lock”, but otherwise can operate as a company, pay salaries, raise debt or equity capital
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 20.
      • There currently is no equivalent in Canadian corporate or tax law to the LLC, L3C, B Corp or CIC structures (although B.C. has announced it will enable a CIC structure)
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 21. The Legal Environment for Social Enterprise in Canada
      • Non-Profit Organizations
      • Janice Y. Lederman
    • 22.
      • The undertaking of an non-share capital corporation must be restricted to one that is of patriotic, religious, philanthropic, charitable, educational, agricultural, scientific, literary, historical, artistic, social, professional, fraternal, sporting or athletic nature or the like
      • Under corporate law, a non-share capital corporation may earn profits, but profits earned must be used to further the corporation’s undertaking and cannot be used to benefit its members
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 23.
      • However, if a non-share capital corporation wants tax exempt status under the Income Tax Act (Canada) (“ ITA ”), it must comply with the requirements of paragraph 149(1)(l) of the ITA which provides an exception from tax for non-profit corporations if:
        • they are not charities
        • they are organized and operated exclusively for any purpose except profit
        • none of the income is available for the benefit of its members
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 24.
      • Thus in order to be eligible for tax exempt status under the ITA, a NPO may not have a profit making purpose
      • Historically in Canada, the case law provided that a NPO could engage in profit-making activities and remain tax exempt if there was a causal relationship between the profit-making activities and its non-profit purposes
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 25.
      • In late 2009, and in 2010, CRA issued several technical interpretations that took a more restrictive view than that of the earlier case law
      • CRA’s current view is that a NPO will not qualify for tax exempt status where it intended to earn a profit
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 26. The Legal Environment for Social Enterprise in Canada
      • Charities
      • Janice Y. Lederman
    • 27.
      • To be considered a charity under the ITA, an organization generally must:
        • have as its purpose the pursuit of and the carrying out of activities that are considered charitable by the common law; and
        • it must devote substantially all of its resources to charitable activities carried on by the organization itself
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 28.
      • At common law, an organization will only be considered charitable if:
        • all of its purposes are exclusively and legally charitable; and
        • the benefit is available to a sufficiently large section of the population so as to be considered a public benefit
      • The CRA is of the view that charities may engage in a business activity if that activity is “directly related to and advances the goals of the charity”; if so, it is a “related business”
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 29.
      • The CRA considers a “related business” to be charitable activity, so there is no limit on the amount of related business that may be carried on by a charity
      • On the other hand, if the business activity is not “directly related to or advance the goal of the charity”, then the activity is considered to be an “unrelated business” and the charity risks losing its charitable status if it carries on that activity
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 30.
      • Private foundations may not carry on any business activity
      • There are two kinds of related business activities:
        • businesses that are run substantially by volunteers; and
        • businesses that are linked to a charities purpose and subordinate to that purpose
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 31.
      • A charity that carries on a business activity that does not fall within the CRA’s definition of a related business risks losing its charitable status
      • What constitutes a linked and subordinate business?
        • the fact that profits are directed to the charitable purpose is not a sufficient link
        • business activities that are linked are “a usual and necessary concomitant of charitable programs”
        • business activities that are subordinate to a charity’s purpose are those that remain subservient to the dominant charitable purpose
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 32. The Legal Environment for Social Enterprise in Canada
      • Corporate Social Responsibility By For-Profit Business
      • Janice Y. Lederman
    • 33.
      • Corporate social responsibility (“ CSR ”) reflects an early effort to promote socially beneficial activity by mainstream for-profit business corporations
      • The legal debate around CSR focuses on the extent to which directors of a corporation may allow corporate assets to be used to serve the interests of stakeholders other than the shareholders
      • Historically, directors of for-profit corporations had a legal obligation to maximize financial returns for their shareholders
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 34.
      • Case law in Canada and the U.S. has more recently settled the fact that in making their decisions, directors may consider the interests of a broader group of stakeholders, even if it has some negative effect on the bottom line
      • There is no “bright line” test as to the parameters of how far directors can go
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 35. The Legal Environment for Social Enterprise in Canada
      • Social Enterprise
      • Janice Y. Lederman
    • 36.
      • There is no legal definition of social enterprise in Canada, or elsewhere
      • The United Kingdom’s Prime Minister’s Strategy Report describes social enterprise as “organizations which, like mainstream businesses, trade in order to build long term sustainability but which operate for social purpose and use their profits to this end”
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 37.
      • The December 2010 Report of the Canadian Task Force on Social Finance describes social enterprise as “any organization or business that uses market-oriented production and sale of goods and/or services to pursue a public benefit mission”
      • These definitions are broad and cover many organizational forms and approaches
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 38.
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
      From Charities Aid Foundation (CAF) Venturesome Working Paper: September 2010 “ Financing Big Society: Why Social Investment Matters ” (2010)
    • 39.
      • Proponents of corporate philanthropy and CSR generally accept that the corporation’s core function is to produce profits to benefit its shareholders
      • Proponents of social enterprise see the corporation’s objectives as pursuing “multiple bottom line” or “blended value” results giving equal, and in some cases, paramount consideration to social and environmental outcomes
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 40.
      • There are a number of attributes of a typical social enterprise:
        • they want a blend of social purpose and financial objectives
        • they desire to bring business or market-based solutions and measurements of success to social problems
        • they want to be operationally self-sustaining, rather than reliant on donations
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 41.
        • they want to grow their operations to scale
        • they want to be seen to be doing good
        • their managers see themselves primarily as business people
        • ( Thomas Kelley, “ Law and Choice of Entity on the Social Enterprise Frontier ”, April, 2009; see also Nancy Roob and Jeffrey L. Bradach, “ Scaling What Works ” April, 2009)
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 42. The Legal Environment for Social Enterprise in Canada
      • NPO’s and Business Activities
      • Janice Y. Lederman
    • 43.
      • NPO’s (that are not charities) historically could engage in profit-making activity as long as such activity was ancillary to its non-profit purposes
      • There is no destination test in Canadian law
      • CRA has more recently taken a more restrictive position to provide that none of an NPO’s proposed purposes can be to earn a profit, even if the profit is used to further its non-profit purposes
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 44.
      • An NPO which carries on an activity intending to earn a profit may be taxed by the CRA as a for-profit business
      • Many NPO’s incorporate a share capital corporation to carry on the profit making activity; the for-profit business operates as a subsidiary of the NPO
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 45. The Legal Environment for Social Enterprise in Canada
      • Charities and Business Activity
      • Janice Y. Lederman
    • 46.
      • Charities may lawfully carry on related business activities without affecting their tax status
      • There are two types of related business:
        • those that are substantially run by volunteers; and
        • those that are linked and subordinate to the charities purpose
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 47.
      • The fact that profits are directed to the charitable purpose is not a sufficient link
      • Charities in Canada that wish to carry on business activity that falls outside the scope of the related business definition, or that cannot be said in certainty to fall within the related business definition, have been incorporating share capital corporations to carry on their profit making activity; the for-profit business operates as a subsidiary of the charity
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 48. The Legal Environment for Social Enterprise in Canada
      • The Best Model For Social Enterprise in Canada within the Current Legal Framework
      • Janice Y. Lederman
    • 49.
      • On balance, the most effective model for social enterprise currently in Canada is the for-profit share capital corporation, using legal agreements to “work around” some of the challenges
      • The charity model is the least attractive vehicle for carrying on a business activity
      • The requirement that the purposes of a charity “be exclusively and legally charitable” restricts their income-producing capacity to activities that are ancillary to its charitable purposes
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 50.
      • A non-charity NPO has a little more latitude than a charity to earn profits
      • However, m ore recent limitations on the scope of the profit-making function of a NPO likely will disqualify many enterprising NPOs from tax exempt status under the ITA, thereby further diminishing their financial viability
      • Also, because of the “purposes restriction”, the range of permissible activities for an NPO may be too narrow for many social enterprises
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 51.
      • Share capital corporations generally can pursue profit-making activities without restriction, and generally are free to carry on any type of business activity
      • Share capital corporations have a flexible capital structure, allowing them to raise capital from multiple sources with varying terms and conditions
      • As long as the shares are not widely distributed, agreements between a corporation and its shareholders can be effective in restricting the activities of the corporation to its social purposes and directing how its profits are to be applied
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 52.
      • There nonetheless are drawbacks to using a for–profit share capital corporation for social enterprise:
        • because corporations generally are free to do what they choose without regulatory oversight, they also are free to change their social purposes from time to time
        • “ work-around” agreements can be effective in preventing this, but such agreements can be complex, and confusing for stakeholders and potential funders
        • without a distinguishable brand for the social enterprise (similar to the “community benefit” brand presented by a charity or an NPO), it is more difficult for the social entrepreneur to market the business as a social enterprise
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 53.
        • where the corporation has multiple shareholders with different interests, there are limits on the extent to which the directors can allow the for-profit corporation to pursue social objectives without breaching its fiduciary obligations to maximize financial returns
        • by incorporating as a for-profit corporation, the social enterprise cuts itself off from the more traditional sources of funding for social enterprises (namely, donors, foundations and governments)
      • The Legal Environment for Social Enterprise in Canada
      • Janice Y. Lederman
    • 54.
      • | Janice Y. Lederman | 204.934.2349 | jyl@tdslaw.com |