Last week we addressed some of the legal pitfalls that charities might run into. This week we turn our attention to pitfalls for non-profit organizations (“NPOs”) and to one crucial way to avoid legal conflict often overlooked by both charities and NPOs.

Restrictions on use of Resources

We have already discussed the use of resources for charities, but this is also important for NPOs. The law in this area for NPOs is less strict, and there is more flexibility as to how resources might be used. But one important restriction is ensuring that none of the assets of the NPO be made available for the personal benefit of its members.

Problems arise in situations where the boundary between the non-profit activity and the welfare of its members is blurred. One extreme example from a CRA note involved a commune where the members shared their resources, using an NPO as an intermediary. The NPO earned interest income and then used this income to pay medical and living costs for the members. This is a clear example of resources being made available for the personal benefit of the members of the NPO.

A less extreme example, which arises for strata corporations, is that some might use a part of their income to reduce strata fees. This would also be a personal benefit to members.

Personal benefit can be even more subtle than this. Say a member of an NPO, who runs a contracting business, controls that NPO. If he were to use his contracting company to perform tasks for the NPO at above market rates, this would be a personal benefit to the member. Another example might be an NPO buying a recreational property and treating it as a private condo for members.

What is not an issue are things such as wages to employees or market value fees for services. Even if the employee or contractor is a member of the NPO, this is fine. Instead, what the law is meant to catch are distributions or other private benefits from the NPO.

Revenue Generation

This area might be the most fraught for NPOs.

Though the term “non-profit” is in the NPO name, this should not be taken to say that an NPO cannot run a profitable activity. This courts have said definitively that, within certain boundaries, an NPO may indeed make profit. The issues arise primarily in those situations where profit becomes a purpose in and of itself.

It is not uncommon that an NPO might devise some source of revenue as a way of sustaining its non-profit activities. Often the rationale justifying the revenue generation is that it should be acceptable because all the profit is used for a non-profit purpose and thus the ends (funds accruing to a good purpose) justify the profit-generating means.

Unfortunately, this is unacceptable. As a rule of thumb, the CRA has said that if an NPO cannot undertake an impugned “non-profit” activity without earning profit, then the NPO has a profit purpose, putting the NPO offside ITA requirements, potentially resulting in the revocation of its NPO status.

One issue that comes up is where an NPO has funds as a reserve. The NPO might have accumulated it for the purpose of saving for a capital improvement or because an expense arises on a regular basis. Meanwhile, the cash might be invested in securities and be earning income.

The CRA has said that large reserves or retained earnings can put an NPO offside the requirements of the ITA, especially if it is earning significant amounts of income on these reserves. Accordingly, it is important in these circumstances for the NPO to consider the size of the reserve necessary for its non-profit activities and maintain it at that level accordingly.

The unfortunate result is that NPOs cannot be self-sustaining. This is an interesting policy choice made by our government and, with the rise of social enterprise blurring the lines between business and societal benefit, one might wonder whether this will one day change.

Importance of Documentation

Finally, we turn to a topic equally crucial for both charities and NPOs. Last week we discussed the importance of agreements when a charity hires an intermediary. However, documentation is important across the board.

For example, when an organization hires a person or organization, having an agreement sets its terms. More than anything, it acts as insurance. The parties return to the agreement in times of confusion, and when conflict arises, the agreement determines the result.

Another issue that can happen for charities and NPOs is that decisions might be made without proper documentation. A board might convene to make a major decision, but not draft the minutes or the resolution approving the action. An issue might not arise at that time, but a lack of documentation becomes a problem in those rare circumstances when something does go awry. Accidents happen and board conflicts arise. Having proper documentation can definitively resolve what might otherwise result in a significant issue.