Historically, organizations designed to serve the community and organizations designed to maximize profits have been structured differently. This has led to the side-by-side existence of corporations that focus solely on short-term profits without considering their wider impact on society - and nonprofit organizations that are under-resourced and cannot sustain themselves, without handouts from government or profit seeking entities.
Social enterprise models, as they are commonly referred to, present a promising middle-ground between these two points on the continuum as they have the potential to become self-sustaining and sometimes wealth generating entities that also contributing to social and/or environmental progress.
The current incorporating legislation and regulations in Canada were designed for traditional corporate and nonprofit models, and therefore may restrict entrepreneurs from pursuing economic and social mandates simultaneously inside one single legal entity.
For those wishing to embark on social enterprise, there is a lot to consider. There is no designated legal structure for a social enterprise and the structural options and set up costs for all entities vary from province to province. Since there are multiple incorporating statutes in Alberta, and since tax status is governed federally, it is confusing for enterprising charities and nonprofits to understand the restrictions surrounding their ability to earn revenues or generate profits.
In Alberta, the following structures are available as options that protect the founders/owners from personal liability (which is generally advisable for most entrepreneurs). As such, these are the main structures social entrepreneurs can choose from:
Incorporating under the Alberta Business Corporations Act
Incorporating under the Canada Business Corporations Act
Incorporating under the Alberta Cooperatives Act and operating on a for-profit basis
Incorporating under the Canada Cooperatives Act and operating on a for-profit basis
Incorporating under the Alberta Societies Act
Incorporating under the Alberta Companies Act
Incorporating under theCanada Not-for-Profit Corporations Act
Incorporating under the Alberta Cooperatives Act and operating on a nonprofit basis
Incorporating under the Canada Cooperatives Act and operating on a nonprofit basis
General Differences between For-Profit, Nonprofit, and Cooperative Structures
First off, it is important for organizations and individuals that might be considering social enterprise to understand the differences between for-profits, nonprofits, and cooperatives.
Generally, for-profit corporations issue shares to the owners of the corporation. Shareholders have the right to appoint the board of directors, participate in decision-making, and share in the distribution of profits. The more capital contributed by a shareholder, the more control they generally hold over the corporation. Typically, the interest of the shareholders is to maximize the profits generated by the corporation. It is possible for a social mission to be embedded in the governing documents of a corporation, although there must be approval from shareholders. For-profit corporations pay corporate income tax.
Nonprofit corporations have no owners. The members have voting rights and elect the board of directors. Nonprofits are subject to non-distribution rules, meaning none of the organization’s income or assets are available for the benefit of its members. Any surpluses must be used to further the socially beneficial undertaking of the corporation.
If nonprofits are not organized or operated with the intention to earn a profit, they will likely benefit from a tax exemption under the Income Tax Act. The law in this area is somewhat unclear, but CRA’s current position is that none of a nonprofit organization’s stated or “unstated” purposes can be to earn a profit, even if that profit is eventually used to further a social mission.
In Alberta, the most commonly used statute for nonprofits to incorporate under is the Societies Act. However, the Societies Act contains a clause that prohibits societies from incorporating for the purposes of carrying on a trade or a business, so it is rarely the appropriate choice for an organization looking to operate a social enterprise. The Companies Act is often selected as an alternative, since Part 9, the nonprofit sections of this Act, remains law today. However, the statute is somewhat complicated and archaic. The final option is the Canada Not-for-Profit Corporations Act, which is often appropriate for nonprofits that are national in scope, or those that are looking for a more modern alternative to the Companies Act.
Nonprofits with Charitable Status
With nonprofit structures, there is also the possibility of registering for charitable status with the CRA. This is a tax-exempt status that allows organizations to issue charitable tax receipts to donors, and to qualify for donations and grants from a wider range of sources than nonprofits without charitable status.
To be considered a charity under the Income Tax Act an organization (1) must be established exclusively for charitable purposes; and (2) must devote all of its resources to activities carried on to further its charitable purposes. To satisfy the first part of the test, an organization's charitable purposes must fall under one or more of the four heads (categories) of charity:
According to the Income Tax Act and guidance of the CRA, there are very limited circumstances in which a registered Charity will be permitted to engage in commercial activities without compromising its special tax status, which restricts the options for social enterprises that can be operated inside a charity.
Charities are permitted to operate “related businesses” which are defined as either (i) businesses that are run substantially by volunteers; or (ii) businesses that are linked to a charity’s purposes and subordinate to that purpose. There is detailed guidance from the CRA as to the types of businesses that will be considered “linked” but generally, businesses must be a small part of operations and must directly advance the goals of the charity (beyond just directing profits toward the activities of the charity). There are other limited exceptions that the CRA does not consider to be “business activities,” such as charging fees for charitable programs and services.
A cooperative is a corporation that is owned by an association of persons (members) seeking to satisfy common needs, such as access to products or services, sale of their products or services, or employment. The governing mantra of cooperatives is “one member, one vote.” Surplus funds arising from a cooperative’s operations can be used to develop or improve its services; distributed to members; or used for community welfare. Cooperatives can be formed either with share capital or without share capital and thus may operate on a for-profit or nonprofit basis. Cooperatives without share capital that wish to benefit from tax exempt status under the Income Tax Act are subject to the same restrictions as nonprofit corporations on their ability to earn profits and distribute assets to members. If a cooperative hopes to receive charity status, it must have strictly charitable purposes and activities and follow all the other restrictions for registered charities. It is rare for cooperatives to obtain charitable status.
Mixed Entity Structures
Oftentimes, due to the restrictions inherent in any one structure, social enterprises are set up using multiple entities. These can be any combination of for-profit, nonprofit and charitable entities, and often include unconventional options such as trusts and limited partnerships. Mixed-entity options allow an entrepreneur/organization to generate profit and also to obtain tax benefits. However, they can be complex to establish and manage.
How to Decide
Each legal structure has both pros and cons and selecting the “optimal” structure for a social enterprise depends on an entrepreneur’s/organization’s unique vision, strategy, and circumstances. Making the right decision depends largely on how you would like to pursue your social mission; the market for your products/ services; the availability of financing; tax considerations; and preferences regarding the level of control that you wish to maintain over the direction of the organization.
The absence of clear legal guidance for social entrepreneurs around structural options, and the resulting legal responsibilities to stakeholders, has resulted in barriers to entry, and challenges to the feasibility and sustainability of these enterprises. Since major legislative and regulatory reform does not seem to be forthcoming, it is important to further the understanding of the current legal framework to allow organizations to explore these revenue earning models.
IntegralOrg has launched the Social Enterprise Legal Structures Toolkit to guide Alberta organizations and entrepreneurs interested in developing a social enterprise through the decision-making process of selecting a legal structure. Also available is a recording of IntegralOrg’s webinar: Start Your Social Enterprise the Right Way: A Panel Discussion about Social Enterprise and the Legal and Regulatory Environment. Follow us on social media, subscribe to our newsletter, and stay tuned for more information on upcoming social enterprise training and tools.
All information provided in this article is intended to be general in nature and does not constitute legal advice. We make no claims or promises about the accuracy or completeness of the information.
Kristina Roberts is a lawyer with experience in public interest matters and social entrepreneurship. At IntegralOrg, Kristina is responsible for developing a toolkit to assist organizations and entrepreneurs with structuring social enterprises, as well as overseeing and assisting with various other legal initiatives relevant to the charitable and nonprofit sector and the organizations that IntegralOrg works with.
Yvonne Chenier, QC, is a lawyer and philanthropy consultant –Yvonne brings more than 35 years of experience helping those in the philanthropic, nonprofit, and social enterprise sectors as general legal counsel and as an advisor on planning, organizational, regulatory and governance matters.