Charities and non-profit organizations are important actors in the social service sector whose ability to engage in market-based activities (e.g. invest and earn profits) is directed by federal taxation legislation and regulations. In particular, the federal government has authority over the taxation benefits of non-profit organizations and charities under the Income Tax Act (ITA).[69] Some of the federal rules governing non-profits and charities are included in the ITA and its regulations, while others flow from Canada Revenue Agency (CRA) policy.

Commenting on the current taxation rules with respect to charities, government officials noted that the ITA “aims to strike a balance between allowing charities to engage in business activities … as a source of revenue while ensuring that charities ultimately remain focused on their charitable purposes and activities.”[70]

However, some witnesses observed that the activities of social finance, which blend charitable/non-profit and private sector activities, are not accurately reflected in current taxation regulations. For those charities and non-profit organizations that wish to engage in entrepreneurial and social finance activities, these rules may, in some cases, act as a barrier to these activities. As Sarah Doyle of the MaRS Discovery District noted:

This is primarily about regulations and guidance that originate from the Income Tax Act, which we would view as being somewhat out of date. They don’t take into account the value of these emergent trends of social entrepreneurship and impact investment.[71]

Witnesses identified four key aspects of current taxation law and policy as potential barriers to the growth of entrepreneurial and social finance activity among charities and non-profit organizations. Each of these issues is discussed below, along with a brief explanation of the current taxation rules that apply to registered charities and non-profit organizations.

A. Carrying on a Related Business

The ITA recognizes three types of charities: private foundations, public foundations, and charitable organizations. Two types of charities – public foundations and charitable organizations – are permitted to conduct business activities under certain conditions but, as will be described in a later section of this report, private foundations are not permitted to conduct any business activities.

The ITA states that charitable organizations and public foundations can lose their registration if they carry on “a business that is not a related business of that charity.”[72] Charitable organizations and public foundations may therefore, by implication, carry on a “related business” without risk of losing their tax exempt status.[73] The CRA defines a “related business” as either a business that is “linked to a charity’s purpose and subordinate to that purpose,” or a business that is “run substantially by volunteers” (which may or may not be related to the charity’s purpose).[74] As Stanley Hartt explained:

A hospital can run a gift shop or a parking lot and apply their revenues to the hospital’s budget, but it would run afoul of our laws if the commercial activity were more substantial or ambitious, even if the proceeds were all expressly directed to the good works for which the charity was founded.[75]

The Committee heard that there is no limit to the revenues that a public foundation or a charitable organization can raise through a related business.[76] However, the restrictions on the business activities of public foundations and charitable organizations may, by their nature, limit the amount of revenue that can be generated by these charities.

An official of the Department of Finance indicated that, with the exception of private foundations, charities that wish to engage in unrelated business can establish a separate entity – usually a corporation – that would then carry out the unrelated business, provided there is a clear separation between the income generated by the separate entity and the charity.[77] The income generated by the separate corporation would be taxed, but up to 75% of said income could be sent back to the charity to support its charitable activities.[78]

The Committee heard that some charities establish separate legal entities in order to carry on unrelated business activities to generate profits for a charitable purpose. For example, Éric Hébert-Daly of the Canadian Parks and Wilderness Society described the legal requirements for his organization to purchase a profit-generating building:

The kind of model that I'm talking to you about, the idea of a building, means that you have to end up creating a for-profit corporation that gives 100% of its profits, essentially, to the charity as a gift. It's a bit of an odd model, but that's what it ends up having to be in order to make it easy for a charity, for example, to be able to carry out a profit-making venture. There are probably places around charities, in terms of the Income Tax Act and other places, where there could be ways to break down some of those barriers so that charities can actually make that work.[79]

Given the limitations on the scope of business activities in which charities can engage, and noting that a lack of clarity in the application of the tax rules has held back the development of social finance among charities, some witnesses suggested that taxation rules should allow charities to engage in business activities without jeopardizing their registered status under the ITA. While these witnesses acknowledged that allowing tax-exempt charities to do business could create an unfair competitive advantage, they maintained that such concerns could be addressed by taxing the business activities of charities above a certain threshold. Sarah Doyle suggested that federal tax rules should allow charities and non-profits (discussed below) to engage in greater business activities:

[W]e think that charities and a subset of non-profits that have clear public benefit objectives should be allowed to engage in any kind of business activity without fear of penalty. We further think that some of those activities should be tax-exempt and some should be subject to income tax in order to deal with potential concerns about unfair competitive advantage.[80]

Some witnesses suggested in particular that federal legislation allow for a “hybrid” (i.e., for-profit and non-profit) corporation with a social purpose that would be taxable under certain conditions. Stanley Hartt, for example, suggested “a hybrid standard whereby business activities beyond those currently tolerated by our system would be taxed, subject to certain de minimis rules, but the charity would not be exposed to losing its registered status.”[81]

B. Investing in Limited Partnerships

As noted above, while charitable organizations and public foundations may carry on a “related business,” the ITA bars private foundations from carrying on “any business.”[82] The CRA states that “[a] charity that becomes a limited partner in a partnership is carrying on a business and is not simply making an investment, even though the charity plays no active role in the business.”[83]

Consequently, private foundations cannot hold an interest in a partnership, and few charitable organizations and public foundations are in a position to hold interests in a limited partnership because they can only engage in related businesses. Limited partnerships are used as investment vehicles to pool funding, but also to structure social impact investments.[84]

The Committee heard that the rules on limited partnerships precluded charities from making investments in social enterprises that are limited partnerships. Witnesses from private foundations and other investors in particular expressed concern about this restriction and suggested that charities should be allowed to make such investments. For example, Stephen Huddart of The J. W. McConnell Family Foundation noted:

I think the first thing is that it would be very helpful to clarify the regulatory environment here. This field is moving very slowly, because a lot of obstacles are there. I’ll mention one, which is the limited partnership rule. That, I can tell you, has prevented us from getting involved in or seeing develop a number of very promising initiatives because people just don’t understand, and they can’t afford the necessity of building a trust structure to allow an impact investment to be made.[85]

In Budget 2015, the federal government announced its intention to permit charities to invest in limited partnerships in order to allow charities to diversify their investment portfolios and to engage in social impact investments.[86] Specifically, the proposal is to amend the ITA such that a charity will not automatically be considered to be carrying on a business, solely because it invests in a limited partnership.[87] The investment would need to remain a passive one: the measure would only apply if the charity holds 20% or less of the interest in the limited partnership, and if the charity deals at arm’s length with the partners of the limited partnership.[88]

Finance officials further explained that, since there are many social impact investments that are structured as limited partnerships, this proposed measure has the potential to make additional funds available for social enterprise projects in Canada.[89] Adam Spence, testifying shortly after the announcement was made, stated that “[w]e certainly welcome the recent announcement allowing foundations to invest in limited partnerships. It is a good first step toward reducing these limits.”[90]

C. Program-Related Investments

Program-related investments (PRIs) are non-conventional investments made with the goal of furthering a charitable purpose, and do not necessarily yield a market rate of return. A witness from the CRA indicated that charities can make PRIs in non-profit organizations or private business through the purchase of shares, loans, loan guarantees, or leases of lands and buildings.[91]

Witnesses, foundations in particular, discussed the limitations around the possibility of making below market-rate investments, or PRIs. While one witness mentioned that the government’s recognition that PRIs can serve to meet required disbursements quotas (the minimum amount a charity is required to spend on its own charitable programs or on gifts to qualified donees)[92] was helpful,[93] another witness suggested that the PRI environment is still murky and requires further clarity:[94] According to Ian Bird of the Community Foundations of Canada, PRIs are still a barrier that members of his organization face.[95]

Adam Spence of SVX, which operates out of the MaRS Centre for Impact Investing indicated that foundations need to be able to make below market-rate investments in order to advance their charitable objectives:

We certainly welcome the recent announcement allowing foundations to invest in limited partnerships. It is a good first step toward reducing these limits. We also believe foundations should be allowed to make below-market rate investments, where appropriate, to advance their charitable objectives, ensuring no part of these investments, or any associated opportunity costs, would be considered as gifts to non-qualified donees. These kinds of investments at below-market rate are needed.

Early-stage social enterprises or non-profit organizations seeking capital may not be able to offer risk-adjusted market returns. Many of these kinds of social finance arrangements require capital with different risk and return expectations for different investors. For example, a foundation might take a first-loss position in a fund or infrastructure project to leverage additional capital.[96]

A new guidance was issued by the CRA in July 2012 entitled Community Economic Development Activities and Charitable Registration.[97] In the Guidance, the CRA broadened the context in which charities can engage in PRIs. Whereas a prior guidance limited PRIs to qualified donees (i.e., mostly other charities), the new guidance indicates that charities can engage in PRIs involving non-qualified donees as well. In such cases, however, the PRI must be towards a “program over which the investor charity maintains ongoing direction and control, so that the program is the investor charity’s own activity.”[98]

D. Generating a Profit

Non-profit organizations are defined under the ITA as “a club, society or association” that is not a registered charity and is “organized and operated exclusively for social welfare, civic improvement, pleasure or recreation or for any other purpose except profit,” and whose income (with a narrow exception) is not “payable to, or … otherwise available for the personal benefit of, any proprietor, member or shareholder thereof.…”[99]

As the above definition indicates, in order to be considered a non-profit organization under the ITA, and thus qualify for a tax exemption, the organization must be exclusively organized and operated for an objective other than profit.[100] The CRA states that non-profit organizations may make profits that are “incidental and arise from activities that are undertaken to meet the organization’s non-profit objectives.”[101]

The Committee heard that current tax code requirements do not allow non-profit organizations to generate revenues for the purpose of saving or re-investing back into their organization. Cathy Taylor of the Ontario Nonprofit Network told the Committee:

Current interpretation of the Income Tax Act prevents non-profit organizations from generating revenue – not creating profit, but generating revenue that they can put back into their mission as part of their organization – as well as maintaining cash reserves.[102]

Jeffrey Cyr expressed similar concerns:

I'm a not-for-profit organization. I can't maintain a profit and I can't put it back in under the current tax rules governing not-for-profits. I have to come out with a zero balance every year. I have a $49-million budget. Coming out with a zero balance is tricky business sometimes.…

[W]e need to have a way to invest back into those community-based organizations so that they can generate revenue and use it for social good. Otherwise, we get trapped in our own financial systems. That's where social finance can come in handy.

I think there’s work here within the federal government and CRA that needs to be done.[103]

Ms. Taylor suggested that the ITA be interpreted to provide that “[r]evenue that is reinvested in the mission of the organization is not profit.”[104] Furthermore, in their written submission to the Committee, the Credit Union Central of Canada recommended that the ITA should be clarified to allow non-profits with a clear social and/or environmental purpose to generate significant revenues from business activities not directly related to their core mission, if such revenues are used to advance said core mission.[105] Currently, and as noted above, the ability of non-profits to generate a profit is restricted to revenues that are incidental and arise from “activities that support the organization’s not-for-profit objectives.”[106] According to the Credit Union Central, such measures would have a positive impact:

By allowing non-profits to have a supporting and independent revenue stream these organizations will be better funded and in a stronger position to demonstrate to credit unions and other lenders that they can, for example, repay a loan at regular intervals or leverage assets to provide security for a loan.[107]

As with the tax rules governing charities, some witnesses suggested that the creation of a hybrid or dual purpose corporation at the federal level could benefit non-profit organizations seeking to expand their business activities. Stephen Huddart noted that this hybrid model has been applied in other jurisdictions, including within Canada:

The key point is to allow a corporate vehicle to exist which is a hybrid, for-profit and not-for-profit corporation, and which can have share capital, but has a social purpose. That’s one recommendation that has been put in place in several countries. Indeed, even in Canada, in Nova Scotia and British Columbia, we have this type of corporation that is able to attract capital for a social purpose.[108]

However, noting that other types of initiatives might better facilitate the business activities of charities and non-profits, Ms. Taylor stated:

[W]e would encourage you to wait and see, around the concept of a dual purpose or hybrid corporate legislation at this time. There’s so much else that will provide more return for the time invested. We have new corporate legislation for the non-profit sector at the federal level. Many provincial governments are adopting new legislation for their non-profit sector at the provincial level. Quite frankly, the last thing we need right now is another piece of legislation to try to figure out what that dual purpose or hybrid piece looks like.[109]