This material is based on C.D. Howe Institute Commentary  No. 343, At the Crossroads: New Ideas for Charity Finance in Canada, Adam Aptowitzer and Benjamin Dachis, March 2012.

Canadians are a generous and understanding people. We have a range of social programs designed to help people who have fallen on hard times or who otherwise are less well off. But, as a rule, we aim to help people toward self-sufficiency and independence.

Yet, despite the parallels between the desperation of individuals and charities struggling for alms to support their existence, there seems to be little appetite to help charities to self-sufficiency. There may be a variety of tools to reduce a charity's reliance on donations but perhaps the most potent is to unleash the potential that comes with charities running private businesses.

To a certain extent charities already have this power, but it is limited to those charities where the business is "related" to the objects of the charity or where the business is run entirely by volunteers.

Making an unrelated business work (sort of)

Unfortunately, there is very little actual law to help interpret the meaning of the word "related." While the Canada Revenue Agency has published a useful guidance of its understanding of the term, the CRA's interpretation is limited by a plain meaning of the law, and so it still cannot help the majority of charities looking to become self-sufficient.

There are ways in which a charity can participate in an unrelated business. One way is to have a private corporation in which the charity owns shares (perhaps all of them) run the business. This corporation then donates the profits of the business to the charity. By donating the profits to the charity they avoid taxation in the private company, and the net result is the same as if the charity ran the unrelated business.

One practical problem with this solution, though, is the limit on the extent of income which can be deducted as a result of donations to charity. Effectively, the rule requires that donors to charity pay some tax even if they want to donate 100% of their income to charity. The result is that donors cannot donate 100% of their income because some amount is needed to pay the tax. The rule extends to corporations owned by charity, and so charities that attempt to run businesses in this matter lose some amount of the profits to tax.

Would charities be unfair competition?

There are also policy problems with allowing charities unrestricted access to business markets. The first relates to competition. For-profit businesses are taxable entities. They balk at the thought that their competition may be non-taxable and able to reinvest funds which would otherwise go to taxes back into the business.

The second issue is that charities may be able to fund money-losing businesses through the issuance of charitable donation tax receipts - and of course there is the more general issue that charities receive money intended for charitable purposes that may be inappropriately spent on business ventures.

And finally, there is the simple problem that every dollar given to charity is partially subsidized through taxpayer funds, and so every time charities engage in business the government loses tax revenue.

Simple tax changes would have great impact

The good news is that there is a comprehensive way to deal with these concerns. The bad news is that it requires some knowledge of corporate taxation to appreciate it. Small businesses that are engaged in active business (i.e. not simply collecting rent, royalties or investment income) are taxed at a relatively low rate on their first $500,000 of taxable income.

Using this as a starting point, if the limit on the deductibility of charitable donations was raised to 100% on this first $500,000 of income, the actual loss in revenue to the government would be minimized. The tax rate currently on corporations that maximize the charitable deduction ranges from 2.8% in Manitoba to 4.8% in Quebec. Raising the allowable deduction limit would lower these tax rates to zero for the relevant income.  While this would obviously result in a loss of some income to the government, the actual percentages are minimal. Moreover, income not distributed to the charity would be fully taxable at the usual rates.

Policy could parallel fundraising guidance

The concern about charities using receipted funds to keep money-losing businesses afloat has an analogy under the current system. Clearly, not all fundraisers work out as planned and some lose money. To take the analogy one step further, many fundraising activities require an initial outlay of capital, and it may be some time before the charity sees a significant (or any) return on capital,

The CRA recognizes these issues and has published an administrative guidance to help define appropriate fundraising expenses. The same approach could be adapted to providing guidance for charities undertaking business ventures.

The proposed new system has other benefits as well. Perhaps the greatest is that it would facilitate the use by charities of social enterprise and social finance. There may be many opportunities open to charities, given that there are very few restrictions on the types of activities private corporations can undertake.

On the other hand, the danger exists that directors of charities may become so preoccupied with their business operations that they ignore their charitable ones. This can be easily addressed by requiring a majority of the directors of the private corporation to be arm's length from the directors of the charity. As well, there are economic benefits to encouraging groups with organization and capital to participate in the job market.

Fundamentally, there exists a relatively easy way to allow charities greater access to business markets and self-sufficiency while limiting the risks involved. If this is what we aim for as individuals, should not this be our aim for our charities as well?

Download the full paper at http://www.cdhowe.org/pdf/Commentary_343.pdf. 

Adam Aptowitzer of Drache Aptowitzer LLP is a charity law lawyer with a national practice based in Ottawa. He has been published in Canadian Taxpayer, Canadian Fundraiser (now Canadian Fundraising & Philanthropy) and the Not-for-Profit News. He has also published a widely distributed study on the regulation of Canadian charities with the C.D. Howe Institute.

As a speaker, he has presented to the National Symposium of Charity Law, the C.D. Howe Institute, the Association of Fundraising Professionals, the Canadian Association of Gift Planners, the Ottawa Estate Planning Council and various large and small Canadian charities. He has also given expert advice on Parliament Hill. Adam is an executive member of the Canadian Bar Association's Charity and Not-for-Profit Law section.

For speaking engagements and consultations, contact him at 613-237-3300 or visit http://www.drache.ca.