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Social Finance Week: The nuts and bolts of charities and nonprofits running a business

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In 1996, Family Services of Greater Vancouver set up a social enterprise business to provide mentoring and development opportunities for homeless youth in Vancouver. Street Youth Job Action (SYJA) helps youth between the ages of 15 to 24 learn skills that prepare them for the workforce. Community partners hire SYJA youth to perform services like street garbage and graffiti removal, needle sweeps and other odd jobs. This project is self-funded by the revenue earned through its community contracts.

Derek Gent of Vancity Community Foundation notes that the SYJA program has been successful because the organization “took their time, brought on strong management and learned to clearly define where the business activities end and the service delivery or support for marginalized individuals fits in.”

In fact, as Gent notes, “A broad range of nonprofits have found interesting opportunities starting, expanding, or collaborating with others in earned income strategies with businesses.” Such a business can diversify a charity or nonprofit’s income stream and can also be a different and even more effective way for an organization to accomplish its mission.

However, just as there are exciting opportunities, there are also hazards to an organization getting involved in a business. Gent says, “It’s a constant balancing act to keep the needs of the business (and customers) met while not deferring from the mission and purpose of the organization. When they are closely connected, it can work very well and represent a sustainable model for achieving impact.”

Also, just as there are distinctions between a nonprofit (organization without charitable status) and a charitable organization when it comes to social enterprise investing, so the two types of organizations have different legal regulations for operating a business.

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Replay our CharityVillage LIVE conversation on nonprofits running businesses.

Charity work

A charity can operate what the Canada Revenue Agency (CRA) calls a “related business.” Stacey Corriveau of the BC Centre for Social Enterprise says, “The difference between related and unrelated businesses is a great source of misunderstanding for social enterprise operators. Most believe that they are operating a related business. Many times, they are operating an unrelated business.”

A related business is defined by the CRA as either a business that is run substantially by volunteers OR a business that is linked to a charity’s purpose and subordinate to that purpose. Whether the profits from a social enterprise are directed to a charity or the business relates to its clients in some way does not make it a related business, under Canadian law.

According to the CRA, linkage to the organization’s charitable purpose means that the business must meet one of the following criteria: a usual and necessary concomitant of charitable programs (e.g. a museum gift shop); an offshoot of a charitable program (e.g. a church that records and sells choir recordings); a use of excess capacity (e.g. charging for church parking lot use when it is not being used by the church); or the sale of items that promote the charity and its objects (e.g. calendars, T-shirts, etc.).

Subordination means the business activity must meet all of the following criteria: it must receive a minor portion of the charity’s attention and resources, be integrated into the charity’s operations, rather than acting as a self-contained unit, make decisions guided primarily by the charity’s goals rather than the business’, and not involve private benefit (where parties outside the organization receive financial benefit).

If the business a charity wants to operate doesn’t fall under these parameters, the charity can set up a separate legal entity (usually a taxable corporation), which must operate at arms-length from the charity. Such a business may donate up to 75% of its net profits to the charity, and only pays income tax on the net profit after the donation is made.

There are however exceptions: training businesses (giving on-the-job training or skills training to increase employability) such as the FSGV’s Street Youth Job Action Program, and social businesses (what used to be called ‘sheltered workshops’ for people with disabilities) are considered as charitable activities by the CRA and can therefore be operated by the charity itself. A charitable organization can also solicit donations, sell donated goods (without modifying them), and charge fees for programs and services as part of its work.

If the CRA becomes aware of a charity or public foundation running an unrelated business, the charity is assessed financial penalties, with subsequent infraction resulting in higher penalties, suspension of tax-receipting privileges and eventual revocation of the organization’s charitable status.

Not sure if your charity is operating a related business? Read more here.

Not-for-profit business

Since there are restrictions on charities operating social enterprises, some people believe that nonprofits are a better route for operating such a business. The challenge for nonprofits comes with issues of tax compliance: the CRA can revoke tax exemption from any enterprise by a nonprofit with the intention of earning a profit. Profit is not defined in terms of bottom line at year-end but any activity that generates revenue. It also does not make a difference whether the surplus is directed to other charity-related activities.

Corriveau says, “Considering that many social enterprises are embedded within a nonprofit structure, and earn profits to feed other aspects of the organization, we can imagine how many organizations are facing a structural barrier that they simply have no awareness of.”

If a nonprofit organization generates profits (or even intends to do so), it remains as a nonprofit within its province, but must remit corporate taxes on any year-end net profits. Failure to do so will result in being assessed for taxes retroactively and there may be further penalty. The BC Centre for Social Enterprise is a nonprofit that voluntarily remits corporate taxes for its fee-for-service social enterprise technical assistance.

Thinking of starting a business? Ask yourself:

  • What are your organization’s strengths and capacity? What are you hoping to achieve with such a business? How feasible is such a business?
  • What’s your business model? Have you done a feasibility study?
  • Is the investment of organization time and money in this business likely to better achieve your objectives than traditional programming would?
  • Is the Board and community fully supportive of this venture?
  • Would you be CRA compliant? If a charity, is this a related business? If unrelated, is it structured at arms-length from the charity? If a nonprofit, are the tradeoffs of paying corporate income tax worth the gains?

And finally, here is a must-read for any organization thinking of starting a social enterprise business.

Susan Fish is a writer/editor at Storywell, a company that helps individuals and organization tell their story well. She has written for the nonprofit sector for almost two decades and loves a good story.

Photos (from top) via iStock.com. All photos used with permission.

Please note: While we ensure that all links and email addresses are accurate at their publishing date, the quick-changing nature of the web means that some links to other websites and email addresses may no longer be accurate.

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