For NPO’s interested in engaging in social enterprise (business) activity, the key starting point is the definition of the Non-Profit Organization’s own legal structure, as outlined in the federal Income Tax Act. It lies in a section – 149(1)(l) – which covers miscellaneous tax exemptions.

In this legislation, NPO’s are defined as, among other things, having been formed ‘for any other purpose except profit’.

A common thinking error is the assumption that as long as NPO profits are directed to social causes, then profit generation by the NPO is permitted. This is called the ‘destination of profits test’ and is not accepted in Canada.

Canadian NPO’s are expressly allowed to generate ‘incidental’ profits that arise from the NPO’s community-focused activities. This allowance is not permissive enough, when considering forming a profit-generating social enterprise.

The safest solution (assuming that the social enterprise activity isn’t charitable) is for the NPO to form a completely separate taxable business structure, to hold its profit-generating social enterprise. The NPO would be the sole shareholder of this new corporate structure, and would continue to carry on its regular pursuits within the ‘parent’ NPO for which those activities were formed to host.

Lower-profit enterprises (such as those aiming to create employment and training opportunities to those traditionally excluded) might be safely positioned within the NPO. Likewise, if a higher-profit generating social enterprise needs space to develop, or some time for testing, it might be incubated within the NPO, then moved to a taxable corporation once it becomes profitable.

The NPO can transfer post-tax profits from its corporation to the NPO via dividends. Issuing dividends does not reduce the corporate income tax owing on social enterprise profits. The dividends flowing to the parent NPO would have already had income tax paid through the corporation, which is why these are not viewed as problematic income sources for the NPO. That is, tax has already been paid on these funds.

The NPO is not advised to fund the taxable subsidiary structure with NPO resources (whether by loan or gift). Doing so suggests that excess profits have been generated by the NPO, pointing to the likely existence of non-incidental profits within the NPO.

Should the NPO wish to open a taxable structure to hold its profit-generating social enterprise, any taxable corporation would be acceptable. For example, in BC: