The importance of the charitable, the nonprofit and voluntary sectors appears to be Canada’s secret, a hidden truth as it were. Yet taken together, as a percentage of the population they are the second largest in the world. They are also a huge employer, with more than two million paid workers… They contribute almost eight per cent of Canada’s GDP — this is more than the retail industry, it is more than mining, oil and gas together.
– Right Honourable Paul Martin, 2007.
This article is written for individuals and organizations currently looking at the changing environment of nonprofits and charities in Canada. This is not legal advice, but can serve as something to consider when looking at current options for incorporation and sustainability. On July 26th 2012 the Canada Revenue Agency (CRA) released a new ‘guidance’ document on Community Economic Development (CED) and both charitable and non/profit organizations.
This document is titled “Community Economic Development Activities and Charitable Registration (CG-014),” which indirectly compliments the March 31st 2003 ‘policy statement’ on “What is a Related Business (CPS-019).” It should be noted that among the nonprofit/social enterprise community that the CRA is drafting a revision of this document.
From my understanding, a ‘related business’ is an acceptable revenue-generating enterprise for charities to be involved in. This is especially relevant when these revenue-generating enterprises focus on Community Economic Development (CED) activities. I believe these two documents (CG-014 & CPS-019) should both be considered when introducing social enterprises into a charity, to mitigate some of the risks associated with charitable status and ‘related businesses/CED activities’.
An enterprise is a ‘related business’ when the activities are run primarily by volunteers (where not less than 90% of the staff are unpaid), or if they are “linked and subordinate” to the work of the charity parent organization. Below are a series of criteria to be met (Social Finance.ca offers a list as well),
- Complimentary (ie not primary) to the charity’s purpose
- Have a common and/or necessary connection to the charity
- Contribute less than 50% of the total revenue of the charity (“subordinate”)
- Leverage capacity of the charity
- Involve the sale of items that promote the charity
- CED activities are defined by activities that,
- Relieve poverty;
- Advance education;
- And/or benefit the community in other ways the law regards as charitable
With the exception of charities entirely lead by volunteers, it appears the reason why a charity would participate in a ‘related business’ is to save the tax dollars lost on the remaining 25% of revenue (of which 100% could have been ‘donated’), had the business been ‘unrelated.’ That is because ‘unrelated’ enterprises can donate up to 75% of their pretax net-profits to a charity, and only pay income tax on the remaining 25% of net-profits. Moreover, for a charity to be a majority (or sole) shareholder in a for-profit corporation, there may be required changes to their bylaws, their culture, and to their governance roles. Setting up a new separate enterprise structure also creates additional obligations such as, submitting tax returns, seeking new capital outside of the grant world, etc. Charities currently running enterprises within their structure (presumably) are doing so because it is simpler and less risky (and more easily reversed). However, there is always the chance the CRA will declare these activities as not ‘related’ business. For more information on this, check out CISED.
To clarify, CED activities are not only delivered through ‘related’ businesses, and ‘related’ businesses do not necessarily have to participate in only CED activities. However, I would argue in this current political climate, as a best practice, that charities looking to introduce a social enterprise into their nonprofit, should create a ‘related business’ that focuses on CED activities. One very easily understood type of CED activity would be to hire low-income or disabled persons for the revenue-generating enterprise itself that provides activities which relieve unemployment, or increases access to post-secondary education for at-risk or vulnerable populations, or other activities that are “undertaken in areas of social and economic deprivation.” As long as all these revenue-generating activities are reintroduced into the charitable purpose, the CRA should be comfortable with it as a ‘related’ business.
In an attempt to understand how nonprofits and charities are addressing these legalities, I asked George Brown, former City of Ottawa Councillor and proprietor of George Brown Law, “how is the legal community addressing the growing needs for some charities to participate in Social Enterprising activities?”
To be blunt, the CRA document (CG-014), although an improvement on the previous version, has not clarified the law as it relates to social enterprise in Canada. Until they do, every situation is unique and organizations must ensure that they get proper legal guidance before moving forward with any of the myriad options open to them. For example, the current opinion among most lawyers who practice in this area is that the simplest and ‘cleanest’ way for a charity to proceed who wishes to establish a revenue generating social enterprise in an unrelated business area is to create a separate ‘arms length’ for-profit enterprise. This enterprise will pay standard corporate taxes just like any other corporate business… but can ‘donate’ the maximum amount allowable of its net profits to the charity.
Also, It is important to realize that the CRA does not recognize CED activities as a distinctly charitable in and of itself. Therefore, the more a charity follows the criteria of ‘related’ businesses set out by the CRA, and focuses on CED activities, it should be able to maintain its status as a charity without question. So if your charity’s enterprise focuses…
- On activities that relieve poverty, advance education, and/or benefit the community in other ways the law regards as charitable;
- And your charity’s enterprise CED activities are, complimentary to the charity’s purpose, have a common and/or necessary connection to the charity, leverage capacity of the charity, and/or involve the sale of items that promote the charity;
Then the charity should consider parenting the ‘related business’ under the charitable status. To avoid all of the complexities and extra taxes of having an arms-length ‘unrelated business’, which donates to the charity
If all of these criteria are not met, it is far more straightforward to make it an arms-length ‘unrelated business’ and donate 75% of the pretax net-profits to the charity and donate the remaining 25% after tax dollars. CED activities can also be understood in terms of social finance, and social enterprise as well, which will be the topic of my next article.