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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 ,[object Object]
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Social Enterprise In Canada

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Editor's Notes

  1. 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 .
  2. 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.
  3. 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.
  4. 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.
  5. There are two types of corporations in Canadian law.
  6. 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.
  7. 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).
  8. 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.
  9. 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.
  10. 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.
  11. 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.
  12. Now let’s examine NPOs and charities in a little more detail, including from a CRA perspective. First, NPOs.
  13. 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.
  14. 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.
  15. 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.
  16. 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.
  17. 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).
  18. 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).
  19. 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.
  20. 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.
  21. Tom Kelly and others have pointed to a number of attributes common to social enterprises.
  22. Just to summarize