Summary: Social enterprises that are operated by Non Profit Organizations (as opposed to Registered Charities, which have different CRA guidelines), can in some cases be operated within the original tax-exempt entity. In other cases – in particular, higher-profit generating ventures – might be hived off into a completely separate taxable corporation. This is to protect the income tax exemption of the parent NPO.

This information is not intended as a substitute for professional legal advice with respect to your NPO’s specific situation. We suggest consulting with specialists in the area of Canadian social enterprise.

Please note that if your organization is a registered charity rather than an NPO (a single organization cannot be both!), then the information in this post does not apply. A CRA ‘primer’ for charities and social enterprise can be found here.

For Non-Profit Organizations (NPOs) exploring or engaging in social enterprise (i.e. business activity), a 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.

The law defines NPOs as, among other things, having been formed ‘for any other purpose except profit’.

A common misconception is 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.

In consistent written decisions, Canada Revenue Agency (CRA) views the presence of profit within an NPO as synonymous with having a for-profit purpose. Even if that profit generation is a means to a social end. For example: an NPO that sells a good or service (that is, operates a social enterprise) in order to generate funds to support its own social programs. Click here to review CRA’s key piece of guidance related to NPOs and profit making, from 2009.

Canadian NPOs are expressly allowed to generate ‘incidental’ (or minor) profits that arise from their non-profit activities. NPOs are also permitted to generate unanticipated profits (in essence, unplanned profits); and may grow a nest egg to fund a future project that is capital in nature (e.g. saving for a new building that houses the NPO’s programs, but NOT to fund social enterprise).

It’s considered general best practice to have enough funds on hand (commonly called a ‘reserve’), to cover a modest period of general operating costs, although there is no clear guidance on how much is too much: ‘The amount of accumulated excess income considered reasonable in relation to the needs of an association [i.e. NPO] to carry on its non-profit activities and goals is a question of fact to be determined with regard to the association’s particular circumstances, including such things as future anticipated expenditures and the amount and pattern of receipts from various sources’. The guidance then goes on to give an example of an NPO that holds a reserve equal to a year’s worth of expenses, stating that this may be reasonable in some cases… and unreasonable in others. Click here to read the actual CRA guidance.

Some NPO leaders may decide that these allowances are not quite permissive enough, when considering a profit-generating social enterprise.

One solution (assuming that the social enterprise activity isn’t charitable) may be for the NPO to consider the formation of a completely separate taxable business structure, to hold its profit-generating social enterprise. In this scenario, the NPO would be the sole shareholder of this second legal structure, and would continue to carry on its regular activities within the ‘parent’ NPO.

A somewhat grey area (CRA stresses that the fact patterns of the particular situation must always be considered), some CRA guidance suggests that ‘where an organization [that qualifies as an NPO] engages in an income-generating activity that is carried out in a taxable, wholly-owned corporation, and this corporation pays dividends out of its after-tax profits to [the NPO] to enable the organization to carry out its not-for-profit activities, the organization may still qualify for the [NPO income tax exemption]’. In other words, the taxable corporation would pay corporate income tax on its profits, then the remainder, after tax, would flow to the parent NPO to support its operations. Some good information is included in this 2013 CRA guidance: although the question asked here is whether an NPO can own a Community Contribution Company (C3), the C3 is one example of a taxable corporation, so the position is applicable to all taxable corporations (including mainstream corporations and Benefit Companies as well).

Lower- or no-profit enterprises (such as those aiming to create employment and training opportunities to those traditionally excluded from the mainstream economy, and which, in common practice, therefore incur greater expenses) might be safely positioned within the NPO. Likewise, if a potentially higher-profit generating social enterprise needs space to develop, or some time for testing, it might be incubated within the NPO, then perhaps moved to a taxable corporation once it becomes profitable.

The NPO is advised NOT 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 possible existence of non-incidental profits within the NPO. Click here for more detail.

Should a British Columbia-based NPO, after seeking legal advice tailored to its own specific situation, opt to form a taxable structure to hold its profit-generating social enterprise, options include: