The social enterprise movement is gaining momentum in the non-profit and charitable sectors. There are frequently articles in the popular news about “successful” not-for-profits expanding their activities to include revenue generating activities. There are enterprises like the old standby enterprise of selling used clothes and goods, but we hear more about ambitious plans like one recently highlighted in the Calgary Herald discussing how the local legion is becoming something akin to a real estate developer where “rentable office space in the new headquarters will make the branch money”. Contrast this runaway momentum with the cautionary words that legal and accounting advisors to the sector have to say to their clients who want to, or indeed already have embarked on these kinds of ventures. We have to tell clients what the law states and how it is being interpreted by the enforcers of it (read Canada Revenue Agency) from time to time. There is much confusion.
Every once and a while a light seems to shine through that gives us hope for some certainty in this area. The recently released report called Mobilizing Private Capital for Public Good: Priorities for Canada written by Canada’s National Advisory Board to the Social Impact Investment Taskforce and released by the MaRS Centre for Impact Investing is such a shining light. In this report The National Advisory Board has identified two priority areas:
- Addressing legislative and policy barriers to social entrepreneurship and impact investment in the non-profit and charitable sector, with a focus on the Income Tax Act;
- Encouraging impact investment through “catalytic capital” measures.
As advisors to the not-for-profit and charitable sector we are often advising our clients on exactly how they become and remain exempt from paying income tax and the rules relating to carrying on a business. For our not-for-profit clients we advise them that the CRA’s position from their publications is generally as stated below.
Section 149(1)(l) of the Income Tax Act provides that the taxable income of an organization is exempt from tax if the organization meets all of the following conditions:
- it is a club, society or association;
- it is not a charity;
- it is organized and operated exclusively for social welfare, civic improvement, pleasure, recreation or any other purpose except profit; and,
- its income is not available for the personal benefit of a member or shareholder.
Whether any particular organization has met the above requirements is a question of fact that can generally only be determined on audit at the end of a taxation year and CRA cannot provide an advance ruling confirming that an organization is being operated in a manner which satisfies the requirements. An organization will not be exempt from tax pursuant to paragraph 149(1)(l) of the Income Tax Act if earning profits is a purpose of the organization, even if the profits are destined to support the not-for-profit purposes of the organization or another organization. This “destination of funds” argument has been rejected by the CRA on numerous occasions.
For our clients who are charities registered under the Income Tax Act we advise them that the CRA’s position from their publications is generally as follows. The Income Tax Act says that charities can lose their registration if they carry on an unrelated business and the CRA’s policy for determining whether or an existing registered charity is carrying on an acceptable business (a “related” one) or an unacceptable business (an “unrelated” one) is laid out in their policy documents. (see Canada Revenue Agency Policy Statement CPS-019).
There are two kinds of related businesses:
- businesses that are run substantially by volunteers (this is not really applicable in your case), and
- businesses that are linked to a charity’s purpose and subordinate to that purpose in one of the following ways.
They must be linked in one of the following ways:
- A usual and necessary concomitant of charitable programs. E.g. hospital parking lot, museum gift shop, university book store
- An off-shoot of a charitable program. E.g. selling assets that are a by-product of a charitable activity, such as a Heritage village selling the produce or flour it grows or grinds or a church that records its choir and sells CDs
- A use of excess capacity. E.g. an arts charity renting out its tents when not using them, a university renting its residence rooms in the summer, a church renting out its parking lot during the week
- The sale of items that promote the charity or its objects. E.g. t-shirts, golf balls, pens with names and logos.
The four factors indicating that a business is probably subordinate are as follows:
- Relative to the charity’s operations as a whole, the business activity receives a minor portion of the charity’s attention and resources
- The business is integrated into the charity’s operations, rather than acting as a self- contained unit
- The organization’s charitable goals continue to dominate its decision-making
- The organization continues to operate for an exclusively charitable purpose by, among other things, permitting no element of private benefit to enter in its operations
It is refreshing to read the National Advisory Board report on these points for two reasons. First they acknowledge the issue that exists in advising charity and not-for-profit clients on their business activities as outlined above. Secondly, the report makes a very pointed recommendation to the Government of Canada and other levels of government that it is time to examine these rules and their interpretation that govern revenue generating activities both for the not-for-profit sector as well as the charity sector. One recommendation from the report in this area was to:
Allow charities and a sub-set of NPOs with clear public benefit objectives to pursue certain related business activities on an income tax exempt basis, and to pursue other business activities subject to income tax.”
According to the report, “this would provide charities and NPOs with increased flexibility to generate revenue for the purpose of advancing their public benefit objectives, while addressing concerns about unfair competitive advantage and mission drift”.
The report contains a very lengthy discussion of how the group came to these recommendations and we commend this report to anyone who needs good background on the issue. The report is rich with success stories of not-for-profits and charities that have had impact by operating successful “social enterprises”. The report also identifies organizations that have had struggles, such as Habitat for Humanity with their ReStores, in maintaining a legally viable structure under the current rules.
One hope for the use of this report is that the government examine this area of policy and law sooner rather than later. It contains a good summary of how other countries approach this issue. Finally it is hoped that this report is widely circulated for everyone’s reading so it will enlighten public opinion on one of the very important questions that you get when you tell people that charities and not-for-profits are not allowed to operate in any way that maximizes their profit from certain activities for the sole purpose of generating revenue to allow them to carry on their benevolent work. The question you always get when you tell people that this is really prohibited under the current interpretation of the law by the Canada Revenue Agency is “You’ve gotta be kidding, right?” It is hoped that in the future this will not be the question that gets asked.
By C. Yvonne Chenier, Q.C.