March 31, 2003
Table of contents
This policy statement outlines the Directorate's policy for determining whether an applicant organization or an existing registered charity is carrying on an acceptable business (a "related" one) or an unacceptable business (an "unrelated" one).
There are two kinds of related businesses:
1. This policy applies to applicant organizations and registered charities that carry on a business.
2. The Income Tax Act says that charities can lose their registration if they carry on an unrelated business [Footnote 1]. By implication, the law allows them to carry on a related business. Charities designated as private foundations are an exception—they can lose their registration if they carry on any kind of business, whether related or unrelated [Footnote 2]. The Income Tax Act does not define a related or unrelated business, apart from saying that a volunteer-run business is to be considered a related business, even if there is no link between the business and the objects of the charity [Footnote 3].
3. Charity law, reinforced by provisions in the Income Tax Act [Footnote 4], requires that charities have exclusively charitable purposes. Running a business cannot become a purpose in its own right—it must remain subordinated to the organization's charitable purpose.
4. In general terms, a business involves commercial activity—deriving revenues from providing goods or services—undertaken with the intention to earn profit.
Whether a particular activity of a charity is a business requires the facts and circumstances in each case to be considered in the light of certain criteria established by the courts [Footnote 5]:
5. Some activities are intended to generate a profit but are not considered to be businesses:
6. Fees are charged in the context of many charitable programs. The presence of fees does not necessarily mean that a program is non-charitable [Footnote 7] or that the charity is engaging in a business activity. Programs remain charitable as long as they manifest the two essential characteristics of charity—altruism and public benefit [Footnote 8]. They can cease to be charitable programs and become businesses if these elements are lost.
7. The following are some of the indicators that a charitable program involving a fee is not a business:
8. Expenditures on a charitable program can be used to satisfy the disbursement quota, but not expenditures on a business.
9. "Carrying on" a business implies that the commercial activity is a continuous or regular operation.
10. A charity can engage in some business-like transactions, provided they are not operated regularly or continuously. Case law does not provide clear guidance in this area, although the distinction is clear enough at the extremes. On the one hand, a one-time sponsorship deal would not generally be considered to represent the "carrying on" of a business. On the other hand, making sales or providing services on a regular daily or even weekly basis, with the operation requiring ongoing care and attention, would likely be viewed as "carrying on" a business.
11. Most fundraising events are business activities. They typically involve the sale of goods and services for the purpose of obtaining income. For example, a person makes a payment to a charity and receives in return a ticket of admission to a concert. The primary purpose of a fundraising event is to raise funds, and holding the event is not an end in itself. Thus, a substantial percentage of the gross revenue from the event is actually applied for a charitable purpose. Often the costs of the event are held down because volunteers provide a significant component of the labour and many of the supplies are donated. An event conducted as a business would not have a comparable element of support for charity. A fundraising event also typically attracts a clientele who are aware the profits from the event will be applied for a charitable purpose and who generally wish to support that purpose.
12. Yet even if fundraising events are business activities, in practice they are mostly not affected by the related business provisions because they do not amount to "carrying on" a business. In locating the dividing line between a fundraising event and carrying on a business, the following factors come into play:
13. Some charities hold several fundraising events during the course of the year. These events may be quite distinct in nature, such as a charity auction, a golf tournament, a ball, and a telethon. Each event would then have to be evaluated on its own merits to determine whether it amounted to carrying on a business. Or a charity may be repeatedly holding the same event (or very similar events), such as a draw held on a monthly or weekly basis. The more similar the events are, the more likely they are to be evaluated as a group to determine whether they amount to carrying on a business.
14. Deriving income from investments can also be different from carrying on a business. Distinguishing between the two is a question of fact. In a sense, both businesses and investments depend on the use of assets. The type of asset is not always a reliable guide—while there are many kinds of assets more typically associated with investments, such as common or preferred shares and bonds, there are other assets, such as real estate and royalty interests, that may equally well be used by investors and businesses. However, income from investments does share a number of characteristics:
15. Charities need to invest their capital and any funds not required for their current operations. Charity law dictates that a charity's assets be managed so as to obtain the best return within the bounds of prudent investment principles. As long as a charity manages its investments prudently, this function would generally be regarded as a necessary administrative function and not a business activity [Footnote 9].
16. Partnerships form an exception to the description of investments as providing passively earned income. 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. This position is based on the laws governing partnerships [Footnote 10].
17. There are two kinds of related businesses:
18. The Income Tax Act defines related businesses as including those businesses that are not related to the charity's objects but which have substantially all those employed in the business serving as unpaid volunteers[Footnote 11]. As a rule-of-thumb, "substantially all" means 90%.
19. The people "employed" in the business means the people the charity "uses" to operate the business. It includes those working for the charity under contract as well as the charity's direct employees.
20. The fact that the profits from a business are applied to a charitable purpose is not sufficient to constitute the necessary linkage [Footnote 12] (Charities are required to apply their resources to charitable purposes, whether or not they are carrying on a business). Instead, it is the nature of the business, and whether it has some direct connection to a charity's purpose, that determines whether it is a related business [Footnote 13].
21. Four forms of connection or linkage have been identified. A business will be considered linked to a charity's purpose if it fits within one of the following categories:
22. These are business activities that supplement charitable programs. Either they are necessary for the effective operation of the programs, or they improve the quality of the service delivered in these programs.
23. Examples include:
24. In the ordinary conduct of its charitable programs, a charity may create an asset that it can exploit in a business. The charity carries out its charitable programs, not in order to create the asset, but to achieve its charitable purpose. The asset is simply a by-product of the charity's programs.
25. Examples include:
26. This type of business activity involves using a charity's assets and staff, which are currently needed to conduct a charitable program, to gain income during periods when they are not being used to their full capacity within the charitable program.
27. Examples include:
28. In the above examples, the charity acquired the asset in question because it was needed in its charitable programs and because it made economic sense to acquire the asset rather than to lease it. These conditions need to be met for the business use of the asset to be considered a related business.
29. If a charity has assets that it previously used to operate a charitable program, but which it no longer uses and is unlikely to use in the future, exploiting these assets as a business would not in principle be a related business. However, this is an area where fact-patterns are likely to vary and a variety of considerations may apply. For example:
30. This type of business activity is linked to a charity's purpose because it involves sales that are intended to advertise, promote, or symbolize the charity or its objects. A product may serve this promotional purpose by virtue of its design, packaging, or included materials. Usually, the items are bought by those who want to contribute to the work of the charity, and they do not compete directly with products produced and sold by for-profit entities. Examples include pens, credit cards, and cookies clearly displaying the charity's name or logo, and T-shirts or posters depicting the work of the charity.
31. A business is subordinate to a charity's purpose if it remains subservient to a dominant charitable purpose, as opposed to becoming a non-charitable purpose in its own right. This requires looking at the business activities in the context of the charity's operations as a whole.
32. In considering whether a business remains subordinate to a charity's purpose, four factors need to be considered. No one factor is likely to be decisive; nor is any single piece of evidence in support of a factor likely to be determinative. Rather, the various factors and the strength of the evidence supporting each of them need to be weighed together. The four factors indicating that a business is probably subordinate, and the types of evidence that could be relevant, are as follows:
33. What subjects dominate board meetings? How do managers allocate their time? In terms of expenditures, staffing, and assets such as buildings and vehicles, what proportion is applied to the business activity? If equipment or other resources are shared between charitable programs and business activities, how often are they used by the business?
34. If the amount of attention given to the business is high in a particular year, is this an anomaly occasioned by unusual circumstances, such as the year coinciding with the planning phase before the launch of the business?
35. To what extent is the commercial activity a stand-alone operation? In terms of its staffing, equipment, and physical location, how much is shared with the rest of the charity's operations? In its advertising, does the business make any reference to the charity and its purposes and programs?
36. Could the business operate as easily outside the charity as within it? Is it of comparable size to for-profit companies providing similar goods and services? Are the goods and services it provides indistinguishable from those offered by for-profit companies?
37. Has the charity risked the assets intended for charitable programs to support the commercial activity? For example, has it borrowed against resources used in its programs to finance the commercial activity?
38. Are decisions being made on a bottom-line basis without regard to the organization's charitable purpose? For example, is an art gallery stocking items in its souvenir shop on the grounds of what sells best and ignoring the charity's mission to promote artistic excellence? Has consideration been given to a potential adverse impact on the charity's reputation from its commercial operations? Conversely, is there any evidence that the organization has rejected certain commercial activities because these were seen as inconsistent with its charitable purpose?
39. Who gets first call on the profits from the commercial operations—the charity's program areas or the business? What percentage of the gross commercial revenue is actually applied to charitable purposes? How much delay is there in applying business revenues to charitable purposes?
40. Over time, have the charity's programs changed direction because of decisions made for the benefit of the business activity? Has there been a drop in the services provided by the charity or their quality, accompanied by an increase in business activity?
41. How decisive a role do the managers of the business operation play in directing and managing the charity as a whole?
42. How many salaried employees does the commercial operation have? Are the salaries much higher than those for equivalent positions elsewhere? How much gross revenue is left after salaries are paid to the principals?
43. Does the business activity involve the participation of for-profit firms? Did the initiative to set up the business activity come from inside or outside the charity? Are the for-profit firms at arm's length with the charity? Did the charity obtain independent expert advice before committing to the relationship? Is the relationship between the parties fair?
44. Figure 1 below is a decision-tree for determining whether an unrelated business is present. It shows how the preceding paragraphs relate to each other.
45. If an organization applying for registration is operating an unrelated business, its application will be denied. If a charity already registered is operating an unrelated business, it is in breach of the law and could have its registration revoked.
46. However, before proceeding to revocation, a charity should normally be invited to wind-up the unrelated business or to place it in a separate taxable corporation. The charity would be expected to rectify the situation within a reasonable timeframe. If it does not do so, and there are no extenuating circumstances, its registration should be revoked.
47. If the charity establishes a separate taxable corporation, it can invest in the corporation on the same basis that it can invest in any other for-profit business. The charity's directors/trustees would need to satisfy themselves that the investment represents a prudent use of the charity's assets. They also need to be alert to ensure no benefit of a private nature is conferred on the corporation.
48. As long as its own governing documents and provincial legislation allow it to do so [Footnote 14], the charity (if it is a charitable organization) can retain control over the taxable corporation through share holdings or a power to nominate the board of directors. However, the Income Tax Act does not allow a charity that is a foundation to acquire more than half of the voting shares of a taxable corporation, unless the shares are donated to the foundation [Footnote 15].
Decision-tree for identifying an unrelated business
I. Is a particular activity a business carried on by the charity?
If no to either question: the activity is not a business.
If yes to both questions:
If yes: the income-earning activity is not a business.
If no: the income-earning activity is not the carrying on of a business.
If yes: the income-earning activity is the carrying on of a business.
II. Is the business of a charity an unrelated business?
If yes: the charity is carrying on a related business.
If no: the charity is carrying on an unrelated business.
If no: the charity is carrying on an unrelated business.
If yes: the charity is carrying on a related business.