Introduction

Many of the most famous charities today have a history that trace back to the Christian Church in some way or other. Think of the Salvation Army, World Vision and the YMCA. But there are plenty of other less famous examples of trusts scattered throughout the cities, towns and communities of New Zealand which originated because someone who attended a Church had an idea and it was then taken on board and supported by the Church.

Those charitable trusts are often doing truly amazing front line work with people out in the community who really need different types of support. They are incredibly wide ranging from helping children, women, the poor, mentally challenged and those with drug or other addictions (to name just a few). Sometimes those trusts are completely independent and separate to the originating Church. Others advance similar purposes to the Church itself or work in the same geographic area. Sometimes they may even generate income which goes back to the Church (through day care centres or cafes). They may also provide in the governing documents that the Church itself (usually through its elders) has the ability to appoint or remove trustees of the charitable trust.

But what does all this mean when you look at the (relatively) new rules that can require financial consolidation of different entities together? Often it can be difficult to navigate the tricky waters that govern this area. Could the Church actually “control” the charitable trust through trustee appointment rights and are they related parties? Most importantly, if there is a situation of control then it may be that financial accounts consolidation is required by the two related entities and that this will then trigger their qualifying for a different set of reporting requirements if they cross over into a higher threshold of income. In this article we will look at what the rules are, what the guidelines tell us and then offer some practical examples of a few different scenarios and how they might be treated.

Part A: What are the accounting standards that apply?

Before looking at the applicable standards that apply let’s first take a look at the different reporting tiers. There are 4 of them ranging from Tier 1 which require full disclosure for larger charities whereas Tier 4 has minimal disclosure. Put very broadly the categories have the following key elements and monetary thresholds:

Tier 1: Full disclosure standards, over $30 million annual expenses;

Tier 2: Reduced disclosure, under $30 million annual expenses;

Tier 3: Simpler reporting but on accrual basis, under $2 million annual expenses; and

Tier 4: Simple format reporting on cash basis, under $125,000 annual operating payments.

The point at which the differences in the tiers become really critical is the distinction between tier 2 and 3 – that is, if an organisation has annual expenses of under $2 million but then is required report on other entities that it controls that could lift its totals to above $2 million. That would result in higher compliance cost and reporting being required and it is that situation and what constitutes control that is the subject of the rest of this article.

When it comes to Charities, it is also important to look at what Charities Services have said about this issue. In their guidance accessible here they state:

“If a Tier 1, Tier 2 or Tier 3 registered charity has control relationships with other organisations, these organisations are considered part of the charity’s reporting entity. Charities in this situation will need to include information about these organisations in their performance reports by providing consolidated financial statements and submitting these consolidated financial statements to Charities Services together with their annual returns.”

The standards are issued by the New Zealand Accounting Standards Board (NZASB) under section 24(1)(a) of the Financial Reporting Act 1993. The particularly relevant standard which we will look at here is IPSAS 6 – Consolidated and Separate Financial Statements.

While we have not gone into them in detail below (because they echo much of what follows in this part) the other two documents that should be on your radar when researching the regime that applies in this area are EG A8 – The Reporting Entity, and EG A9 – Identifying Relationships for Financial Reporting Purposes. We have also written a separate article about Accounting Standard (IPSAS) 20 – Related Party Disclosures regarding what it provides about disclosure of related parties so contact us if that is of interest.

IPSAS 6 – Consolidated and Separate Financial Statements

This standard notes in paragraph 1 the following about the reason it exists: “An entity that prepares and presents financial statements shall apply this Standard in the preparation and presentation of consolidated financial statements for an economic entity.”

Paragraph 39 states: “The definition of control under this Standard requires, subject to two limited exceptions, that there be both a power element and a benefit element…” . The paragraph goes on to note that there is a rebuttable presumption of control where there is the following power: “A unilateral power to appoint or remove a majority of the members of the governing body of an entity.” Based purely on this if a Church has the power to appoint the trustees it looks like there could be a strong argument that there was control (of course it depends on the facts – for example, perhaps the Church can only appoint 1 of 5 trustees).

Whether or not there is a benefit to the Church is also a criteria that needs to be met to show control. Even if there is a power element that is proven can it be said that the Trust provides a benefit to the Church? This will likely come back to the purposes of the Trust and how it fits within the scheme of the ministries of the Church. Paragraph A31 of the guidance notes: “it is common for special entities such as trusts to be established to provide certain services to support the operating objectives of another entity. In such circumstances, a controlling entity may benefit from complementary activities”. Is the Trust considered another arm of the Church itself that is used to reach out to the community or is it considered to be distinct and separate? This will need to be analysed in each situation to determine if there is some benefit to the Church or not.

Paragraph A6 of the guidance in the appendix to this standard draws out another dimension as it specifically talks about trusts and raises the idea of a fiduciary relationship. It states: “In the case of trusts, careful consideration is required to determine whether the relationship between an entity and a trust is such that the entity has control over the trust. If the entity’s only relationship with the trust is as a trustee of the trust, the entity is unlikely to have control over the trust because its relationship with the trust is likely to represent a fiduciary relationship rather than an ownership relationship (refer to paragraph A11).”

This goes on to note a different point which is worth also considering: “Where the entity is a beneficiary of the trust and has the ability to direct/determine the operating and financing policies of the trust (or those policies have been irreversibly predetermined), for the benefit of the entity, as a trustee of the trust or by way of an autopilot mechanism.” It is easy to imagine the scenario where a Trust does benefit the Church along the lines of that description with policies irreversibly predetermined and so there could be control.

Returning to the mention of fiduciary relationships in paragraph A6 above, could this also be used as an argument that any trustees appointed to the trust are in fact acting for the best interest of the Trust they have been appointed to? Paragraph A11 of the same guidance seems to allow for this possibility as it states: “The decision-making power of a trustee does not meet the power element of the definition of control. While a trustee may have the ability to make decisions concerning the financing and operating activities of the trust, this ability is governed by the trustee’s fiduciary responsibility at law to act in the best interests of the beneficiaries of the trust.“

It is likely that the circumstances of appointment and overall context will need to be examined to determine whether there is actually control or not. For example, one aspect we have not gone into here is what happens on a winding up of the Trust – do the assets go back to the Church (or could they)? That could impact the analysis as well. But the main point to make is that if there is control and a benefit to the Church then this could mean that consolidated reporting in accounts will be required. Knowingly failing to report according to the financial standards can also result in a maximum $40,000 fine.

Part B: What does Charities Services have to say?

In the guidance issued by Charities Services there is some commentary on the issue of what they consider control to be. Let’s take a look at that before we turn to an analysis of some hypothetical scenarios which could face Churches.

Regarding control Charities Services summarise the key elements already mentioned and analysed above in the following short form:

“Control for financial reporting purposes is the power to govern the financial and operating policies of another organisation in order to benefit from its activities. There must generally be both power AND benefit for a control relationship to exist. The benefits can be both financial and non-financial in nature.”

They go on to specify the following as indicators of power and benefits:

Indicators of Power:

Ability to veto, overrule or modify decisions of organisation’s governing group.

Appoint or remove members from the organisation’s governing group.

Set or modify policy about how revenue is raised or how money is spent by the organisation;

Close or wind up the organisation.

Indicators of Benefit:

Receiving all or a portion of the organisation’s profits/surplus, or even being responsible for the organisation’s losses (negative benefit),

The organisation provides goods or services which contribute to the charity’s objectives.

As you can expect their conclusion is tied in with how difficult a judgement call often can be:

“Determining whether charities have this control relationship can be complex. It involves an exercise of judgement, after considering the definition of control and the nature of the relationships between the organisations concerned. Control of an organisation can be attained in a variety of ways, and the underlying circumstances will vary.”

It is perhaps also worth noting the following comment about the interaction between the Charities Act 2005 and the accounting requirements being discussed here. The document EG A 8 – The Reporting Entity, states this at paragraph 14 and 15:

“The Charities Act 2005 permits entities that are affiliated or closely related to register as a ‘single entity’ and Charities Services decides how those entities are to report. For the purposes of the Charities Act 2005, the entity that requests the registration and treatment of several entities as a single entity is described as the ‘parent’ entity. This is the entity that Charities Services deals with for the purposes of the Charities Act 2005.

The term ‘parent’ entity in the Charities Act 2005 is not necessarily the same as a ‘parent’ entity (or ‘controlling entity’ as it is referred to in PBE Accounting Standards) for the purpose of preparing financial statements in accordance with GAAP. A ‘parent’ or ‘controlling entity’ for financial reporting purposes is an entity which has one or more controlled entities.”

Part C: Analysis of different hypothetical situations

In what follows we have tried to think of three different hypothetical scenarios in order to illustrate how some of the concepts already discussed could play out in reality. Of course these are made up situations to emphasise certain points. Every situation will be unique and so you need to look at all the circumstances to perform a proper analysis and determine the likely outcome. But it is hoped that this will give a feel for the different permutations which can exist in this area. As well as this you can start to see that there are different models which can be adopted which will be more or less likely to raise issues when considering if there is really control.

Scenario 1: Full control

Church elders appoint or remove all trustees of the charitable trust. This ensures that the Trust continues in the direction that the Church intends. The Trust performs a role which aligns very closely with the mission of the Church (advancing religion) and operates out of the Church facilities. The Senior Minister of the Church is also the Chair of the Trust and most of the trustees are elders of the Church or at least attend the Church.

Analysis: In this situation there are clear indications that the Church is in control of the Trust. While the use of the same facilities is probably not so important it is a symptom of the other clues here – the ability to appoint and remove trustees, the blurring of the leadership of the Trust and the Church, the purposes basically being the same. It seems very likely that this would result in a need for consolidation of the accounts (but it depends on all the circumstances).

Scenario 2: Some control

Church elders appoint 2 of the 5 trustee positions of the charitable trust. While it operates in the same geographic area and the Church refers people in need to the trust they are focussing on different purposes to the Church. The Chair of the Trust is appointed by the other trustees and currently that person attends a different Church.

Analysis: This is likely the scenario which is most closely aligned with reality – it is more of a ‘grey’ area which is where reality often sits in between the two extremes above and below. In this situation there is still some involvement by the Church in the Trust and yet it also has moved to be more independent. To provide a conclusion we probably need additional information (for example whether the Church receives any benefit from the Trust) but based on this factual situation presented it looks like the Church probably does not control the trust so there will not be a need to consolidate the accounts.

Scenario 3: Little control

The Church has no control over appointment or removal of trustees. The Trust purposes (advancing education for disadvantaged children) do not align with those of the Church. The Trust has spread beyond the original boundaries of the geographic area of the Church and now works throughout New Zealand. All the Trustees involved come from different areas and none attend the Church.

Analysis: In this situation there is clearly no control by the Church over the Trust. While it may have its origins in that one place it has moved on from those origins and now operates independently so there is no real question of needing to consolidate accounts in this situation.

Conclusion

We hope that this overview of the key issues to think about when looking at the issue of control has been helpful. Every situation is unique and cannot be looked at in isolation. While some elements may be present that indicate control others may not be present. It pays to discuss the situation with your advisers in order to be able to come to the right conclusion and ensure that your organisation is reporting under the correct tier.

And a final word…

We often find that clients who are looking into this area realise two things. Firstly, that records for the Trust are poor and need to be improved going forward and secondly that the original documents which they have were often written decades ago and can be outdated in terms of their terminology and language. Often they are difficult to understand. Sometimes processes that were meant to be followed have never been looked at – eg how to appoint trustees. Such documents can very often use a refresh in terms of presentation and ensuring they are easier to understand. Very often the purposes themselves (which are the core of what the entity stands for) will still be applicable and need little amendment but it may be appropriate to look at updating the rest of the document.

Steven Moe
stevenmoe@parryfield.com

This article is not a substitute for legal advice and you should talk to a lawyer about your specific situation. Reproduction is permitted with prior approval and credit being given back to the source. Contact Steven Moe at stevenmoe@parryfield.com to request this or for any other questions.
Copyright © Parry Field Lawyers 2017.

We attended a webinar by Charities Services on the new reporting standards. There were 1,700 participants in the webinar so there was a lot of demand from people to learn more about the statement of service performance.

The main points which were covered included:

An overview of the new reporting standards;
The purpose of the statement of service performance; and
How the service performance standards might benefit charities.

The new changes came in relatively recently and introduced new standards for the not-for-profit sector. This seminar focused on the following two tiers which have different requirements:

Tier 3: Under $2 million (accrual based accounting required); and
Tier 4: Under $125,000 (cash based accounting).

In the past there were no requirements regarding financial information submitted – the new standards require that Charities provide a “Performance Report”. This includes both financial and non-financial reporting.

Non-financial information includes describing the entity and what it does. The second part involves a statement of service performance. The purpose of that is to “tell your story” – the both “outputs” and “outcomes” can be reported on. They distinguished those as follows:

Outputs – what was done eg goods or services provided (likely statistics will show this eg number of people helped); and

Outcomes – why it seeks to do or achieve that – this will be linked to the purpose of your charity.

They mentioned that graphs, charts and pictures can be used to show what you do. There is a template on the Charities Services website. Note that tier 4 only needs to record the outputs whereas tier 3 needs to record both outputs and outcomes.

The standards also require that previous years be compared to eg “100 attended” vs last year “90 attended” – this is not needed in the first year the report is done.

The webinar emphasised the positive aspects of preparing the document – it can be used for strategic planning, improving governance and marketing purposes. Clearly because it is new there must be many who are feeling like this is an added obligation on them and so they are trying to emphasise why it can assist a charity.

More information is available on Charities Services website here.

As the report is now compulsory for registered charities it is good to be aware of the requirements and get up to speed with these new requirements. If you have any questions about what is required then let us know as we are seeing some examples coming through and happy to share some ideas about preparing them.

We are providing new updates on other cases and developments in the charity sector regularly so sign up for our newsletter to stay up to date with the latest developments.

This article is not a substitute for legal advice and you should talk to a lawyer about your specific situation.
Reproduction is permitted with prior approval and credit being given back to the source. 
Contact Steven Moe at stevenmoe@parryfield.com to request this or for any other questions.
Copyright © Parry Field Lawyers 2017.

Muhammad Yunus was in Christchurch this afternoon and spoke to several hundred people. He is from Bangladesh and received the Nobel Peace Prize in 2006 for his work in microfinance and microcredit. He founded Grameen Bank (http://www.grameen.com/) which focuses on loans being given to people in villages who are too poor to receive traditional bank loans.

He told us the idea began from wanting to help local people to avoid loan sharks and he thought – “why not loan the money myself”? So he was solving an immediate problem back when he began in the 1970s. He told us that he studied how banks operate and then he purposefully tried to do the opposite. For example, banks usually required collateral for the loans they make but Grameen Bank do not. Now there are 2,600 branches throughout Bangladesh with 9 million borrowers.

He also talked about social business and the idea that this could help to solve problems while still making money. He compared this with pure charity where the money has a “one time use” as it is used and then gone compared to a social business which is sustainable. In this context he talked about how profit might not be the only incentive for people to set up a business and that there could be other incentives – such as making people happy. It would have been interesting to gain more insights about what form of social business might work best in a New Zealand context.

He finished by commenting on the fact that the top 1% of the population owns 99% of the world’s resources and that the wealthiest 8 people in the world own more than 50%. This concentration of wealth into ever fewer hands is what he sees as a great danger and there need to be new ways to combat this. HIs main theme was to work to try and reverse the way the system currently runs and what motivates it to try and address this.

The session ended with some questions although I felt at the very end like there were a lot of unanswered questions and details that would be fascinating to find out more about and explore. I was also left wondering how the ideas, which seem to have worked well in rural impoverished Bangladesh, might apply in relatively wealthy/middle class New Zealand.

It was great to hear the challenges from a Nobel Peace Prize Winner and wonderful that the event could be hosted in Christchurch – well done to the SingularityU Christchurch (which led this) and the other partner organisations: Akina Foundation, Ministry of Awesome, OHU, Te Putahi, XCHC and CCC.

In the last blog post that you can access here on the JB Were “New Zealand Cause Report” we mentioned two key points it highlighted. This post quotes from the report and comments on some other aspects raised.

I thought the easiest way to quickly provide bite size information would be to include a few of the most interesting quotes:

The entire charitable sector plays a really important role in society: “There needs to be greater recognition that society works better with a strong and sustainable NFP sector.”
Regarding the amounts involved in the sector: “These values underestimate the real worth of the social output from the sector as they do not capture the true cost saving to society of their activities.”
As for the risk of charities not obtaining funding: “This risk of capital blockage may be starting to break with the growing interest in social and impact investing and the continued blurring of the lines between for-profit and NFP organisations.”
The number of new charities: “Since 2010 there have been 2.5 new charities commence each business day.” They note this may lead to an overall burden on supporters as more and more people are needed to be in Board positions.
On potential duplication of charities: “The real issue with charity numbers is the potential duplication of energies, ideas, incomes and assets and the lack of shared knowledge and potential public confusion and then inaction. It is a discussion worth continuing.”
Self-earned income: “Self-earned income needs to be a growing focus for most organisations. The blurring of the line between for profit and NFP will continue. While some will have philosophical debates, there is little doubt that economic growth (along with technology) has been the greatest driver of rising living standards and poverty alleviation, particularly n developing nations with microcredit a leading example. Business with a mission focus needs to be a large part of the future of the sector.”

Introduction

Alice: Would you tell me, please, which way I ought to go from here?
The Cheshire Cat: That depends a good deal on where you want to get to.
Alice: I don’t much care where.
The Cheshire Cat: Then it doesn’t much matter which way you go.
Lewis Carroll in Alice in Wonderland

New Zealand has an abundance of creative people with ideas for interesting businesses that often have social purposes at their core. Whether they know it or not, they probably fit in the definition of “social enterprises”. The number of individuals starting such social enterprises is growing. This will only continue as the next generation increasingly looks for meaning in work beyond simply returning a profit to shareholders. However, one thing New Zealand lacks in this space is a legal entity structure designed specifically for the implementation of those social enterprises.

The Cabinet paper released on 9 December 2016, “Social Enterprise and Social Finance: A Path to Growth”, is welcomed. However, more is needed than a cross-agency working group, the collection of statistics for further analysis and encouragement of investment. Instead, serious discussion of a new legal structure should be more firmly placed on the agenda. Failing to do that at this critical time represents a missed opportunity to proactively lead the way in this area.

The UK, Canada and the United States have all developed new types of social enterprise entities in the last decade. The key paper that started the process in the UK was issued in 2002, 16 years ago, so this is by no means a new concept. The lack of a legal structure in New Zealand is a real deficiency and we should not let the ‘number 8 wire’ mentality take over and mean that we simply make do and work within the existing frameworks.

If Roger Federer were given a cricket bat to play tennis I might have a chance at beating him. We use the right equipment that has been crafted specially for the particular game we are in. He could try and make do (after all, both a cricket bat and a tennis racquet are used to hit a ball) but despite being one of the best players ever he just won’t be as effective at playing the game. In the same way we can make do with existing structures for social enterprises that have some of the characteristics that we want. However, they do not recognise the key differences that distinguish social enterprises and set them apart. We need to ask for more.

In Part 1 of this paper we move beyond what exists currently and dare to dream big about what we would one day like to see. In Part 2 we discuss working within the existing constraints and what the current options are. A lot of time and energy is being spent on ways to create a better ecosystem for social enterprises. While that is important the hope is that this paper will generate discussion about the more fundamental point of the form of legal structure. If that were changed it would result in many other benefits for social enterprises which are now being focussed on as distinct issues at present (such as the ability to raise capital and a better profile and understanding of what social enterprises are).

Part 1: What could be (… the dream)

“I think there is a world market for maybe five computers.”
Chairman of IBM Thomas Watson in 1943.

There is real value in social enterprises because they do not rely on government funding or donations and instead operate as a business which employs people. However, their goals are not traditionally profit driven and instead may work to advance cultural, environmental, educational, social or other goals. They may also employ marginalised people and build locally based businesses which can contribute to particular geographic areas more than mass market or franchise models.

There are many barriers for social enterprises to overcome before they can flourish. It is easy to become distracted by all of those important issues (lack of specialised incubation, mentoring, funding options, financial and business experience, and immature support networks). The list is a long one although it is getting better. One could well argue that those issues need to be addressed prior to focussing on any development of a new legal structure. However, if we do not make changes now it will be even harder to do so in the future once more social enterprises, that have not even been thought of yet, have had to twist themselves around in order to fit into the current legal structures.

Instead of making do with what we have, a bold and innovative new approach is now required. This would place the debate about social enterprise and what it is at the top of the list for discussion. It would raise awareness and ensure this was also front of mind for those who are creating such businesses, as well as the broader community and traditional “for profit” businesses which could be challenged in their thinking and assumptions about their own business as well. Most important, it would result in a new form of legal entity tailored specifically for social enterprises.

Other countries have adopted legal structures specifically with social enterprises in mind. In the UK these are “Community Interest Companies” and in the United States there are “Benefit Corporations” and in Canada there are “Community Contribution Companies”. As this discussion progresses each of those will need greater analysis of how they work and what are the positives and negatives that can be learned from. The point for now is that they do exist and are a distinct form of new legal structures in those jurisdictions.

The fact that there is not a greater cry out for a change is a symptom of people facing other more pressing day to day challenges and not knowing that there might even be another option. And yet if another structure were available that might also be a way to address those pressing concerns regarding sourcing investors and funding, explaining the vision of a social enterprise and raising awareness of this sector.

To be specific, what we would like to see here in New Zealand is a new form of legal entity introduced which has the following key elements:

Clear name: A name for the new form of entity which makes it clear it is not a traditional limited liability company but also not a trust or incorporated society. This would assist to alert investors and others as to what type of entity it is.
Purposes: Requirement for clear articulation of the purposes (social, environmental, cultural etc) which show how they align with the social good while wrestling with the tension of also being a business.
Capped dividends: Restrictions in place on returning profits to investors to ensure that profit making is not the ‘primary’ objective.
Tax exemptions: Make the structure flexible enough so that for those who wanted to do so, and meet criteria, they could still apply for tax exempt status (this is not really a change since it can be done now).
Reinvestment: Profit/surplus to be reinvested into the purpose. Consider if there is a guideline or percentage fixed of what must be reinvested or it is left as a dynamic tension.
Reporting: Include a requirement for reporting not just on profit making goals but also on other social benefit goals.

Many of these concepts are foreign to traditional “for profit” business models and will take time to be discussed and understood. That there could be something more than maximising the dollar amount a company earns will take time to penetrate into the consciousness of society but it is something to be aimed for.

Of critical importance is the fact that the publicity around the new form of legal entity would raise awareness of social enterprises in New Zealand. As a result they would gain a new level of legitimacy and become better known. In addition, investment would be encouraged so they can grow because investors would understand what it was that they were supporting.

Part 2: What is (… the reality)

Door: It’s simply impassible!
Alice: Why, don’t you mean impossible?
Door: No, I do mean impassible. (chuckles) Nothing’s impossible!
Lewis Carroll in Alice in Wonderland

In New Zealand those who have a good idea for a social enterprise do not have a tailored legal entity structure that can be used. This means that when setting up here existing structures need to be adapted for use. Of course, as the quote says, “nothing is impossible”, and this section outlines the different models most commonly used. It also serves the purpose of illustrating why a new legal structure would be beneficial.

The most common approach we see is to set up an incorporated charitable trust or society which has a charitable purpose (so it is a “not for profit”). This approach can limit the scope of what such an entity does since it is constrained by staying within those purposes. We often see that the charity sets up a limited liability company which then operates as a trading entity making income and which ultimately seeks to maximise profits for its parent charity.

Other social enterprises adopt a direct limited liability company structure with charitable components, but operate in a manner consistent with their social enterprise purposes.

So, turning to the options in brief:

Incorporated charitable trust: The Charitable Trusts Act 1957 provides the framework for trusts and societies to incorporate. The entity needs to have a charitable purpose at its core (relief of poverty, advancement of education, advancement of religion or purposes that benefit the public). Profit is not distributed to private individuals. Provided its purposes are charitable it can also register with Charities Services under the Charities Act 2005. This type of entity can also apply for donee status (under the Income Tax Act 2007) so that donations are not taxed.

Limited liability companies: The Companies Act 1993 provides for companies to be registered where there is at least one director and one shareholder (they can be the same person). Profit is typically distributed to shareholders. It is possible to “write in” (by restrictions on activities) some social enterprise purposes in the Constitution of a company. Note that companies can also register under the Charities Act 2005.

Incorporated societies: The Incorporated Societies Act 1908 provides that members can form a society which requires a minimum of 15 members. The constitution or rules must set out its objectives.

Limited partnerships: Under the Limited Partnership Act 2008 there is a general partner and limited partners. This form of entity is slowly growing in popularity in New Zealand as it allows both commercial and charitable entities to work together without compromising their tax status. While it could be potentially used we do not think it is commonly considered as the other options are less complicated.

Co-operative companies, Maori land trusts and industrial and provident societies: We will not go into these in detail as we have only seen them used rarely and in specific situations but we simply note that they do exist and could potentially be structures that are used. The framework for them is the Co-operative Companies Act 1996, the Industrial and Provident Societies Act 1908 and the Te Ture Whenua Maori Act 1993.

We believe that the scenario we outlined above (a charitable trust which eventually incorporates a limited liability company as a subsidiary to run its trading arm) is most common and that is borne out by both anecdotal discussions and the limited research on this. The Department of Internal Affairs in 2013 published a paper on this topic and pointed to 421 respondents which it had surveyed. Of those 52 per cent (218 responses) were set up as charitable trusts. Incorporated societies made up 37 per cent while limited liability companies made up only seven per cent.

One of the main factors for any new business is access to capital. If a charitable trust structure is adopted then that lends itself to approaching individuals and groups for philanthropic grants or donations (particularly if it has tax exempt status). However, it is more difficult to attract private investors who share the risk since these entities do not return profits to shareholders and remain “charitable” under the Charities Act 2005. On the flip side of this dilemma, a limited liability company may struggle with attracting such private funding since there is an assumption that it is “for profit” because of the form of entity which is being used – in fact it has other objectives beyond returning a profit. Even if charitable purposes are built into the constitution this is still something which needs to be explained and automatic assumptions will need to be clarified.

Conclusion

Change is the law of life. And those who look only to the past or present are certain to miss the future.
John F. Kennedy

Where are we, and where do we want to be. Any new change will be difficult to understand at first – see an amusing example here. But we owe it to future social enterprises to try and make things better. This paper has outlined the currently available legal structures in New Zealand used by social enterprises. It has also set out the dream of what we would like to see some day in the future. We need change in this area. We need to request the right equipment to play the game.

In the foreword to the UK report “Private Action, Public Benefit: A Review of Charities and the Wider Not-For-Profit Sector” published in 2002, Tony Blair (it is long enough ago that he was the Prime Minister), commented as follows and about 17 years later these statements still resonate here and now for New Zealand:

“Much of the legal context for charity and voluntary action is now outdated … law and regulation have not kept pace with developments … There is also insufficient recognition in the legal system of the particular needs of social enterprises, a rapidly growing group of businesses carrying out a wide range of activities for the benefit of society rather than the individual. This report sets out a package of measures which will modernise the law …”

The result in the UK was the introduction of a new form of legal entity more than a decade ago. It is hoped that this paper will promote discussion about the possibility of turning the dream of such an entity for New Zealand into a reality sooner rather than later. Doing so would ensure that social enterprises are given a new framework in which to operate and succeed. That will ultimately benefit all of New Zealand and ensure that we continue to be forward looking and encourage even greater growth and investment in social enterprises.

Not unlike Alice in the quote at the start we need to work out where we want to go. How we get there will be complicated as there are many competing interests and points of view. Our intention in preparing this paper is to promote further discussion and engagement on this issue so that New Zealand can show real action in the area of social enterprises. With the social enterprise world forum being hosted in Christchurch in 2017 it is the right time to consider this issue and take action now.

Contact: stevenmoe@parryfield.com

This article contains a discussion of a fascinating case that came out at the end of 2016. The reason it is interesting is that the Judge had some frank words about the process that the Charities Registration Board had followed when looking at applications from two related groups for charitable status. In her conclusion the Judge notes that, “The Board has simply made mistakes”. Let’s have a look at what went on in more detail and see what we can learn from what happened. Most important let’s see what conclusions this may have for charities involved in research of some kind and whether they can (or cannot) obtain charitable status.

Two entities had applied for incorporation as charities. They were involved in research into “cryonics” and the extension of human life through preservation of humans and their reanimation in the future. They applied for charitable status in late 2011 and were declined in July 2013. There were many requests for additional information in between the application and the decision. The key finding by the Board was that:

“…the Foundation is not qualified to be registered as a charitable entity … we consider that the Foundation pursues an independent purpose to fund cryonics research (research into the cryopreservation and reanimation of people). This purpose does not advance education and or any other purpose that is charitable at law. Further, we are also not satisfied that the Foundation’s purposes provide sufficient public benefit, which is a requirement for charitable status.”

So what was the reasoning behind this conclusion? The Board felt that cryonics research was not an “accepted academic discipline” or that it was an area of “current science” or had any benefit to be researched. The Judge noted that in coming to this conclusion there had been independent research by the Board of material on the internet which helped it to come to that decision. The Judge had a dim view of that extra research which went beyond the information that had been provided by the applicants – this could be the subject of a whole article itself but the following quote gives the flavour: “…the perils of the internet are legend. It is possible to obtain web support for almost any proposition one cares to name… I consider the Board was wrong to put any store in the information obtained from the internet by the chief executive here.”

As for the conclusion regarding their educational purpose and whether there was sufficient usefulness of the research being done, the Judge disagreed on the conclusion and commented on why:

“…what all the authorities make clear is that “usefulness” as that term is applied in the cases constitutes a minimal standard designed only to exclude the “nonsensical” – areas of research and study that are demonstrably devoid of merit. While the concept of merit may raise more difficult, subjective, issues of “taste” where (for example) literature or art is the focus of an educational advancement analysis. I would think that such difficulties are much less likely to arise in matters of science. There may be some areas of research whose objects are so at odds with provable reality that purported scientific pursuit of them can be dismissed as nonsensical or an exercise in certain futility. Attempting to prove that he earth is flat might be one such endeavour. But absence of merit of that sort will be easy to establish (or refute) by reference to objective evidence.

The existence of scientific or academic controversy in a particular area is far from determinative. Nor is an acknowledgement that the goals of the research might only be achieved in the relatively distant future. By way of example only, the mars Society New Zealand Charitable Trust, whose purposes are to encourage and inspire space science and research leading to New Zealand’s participation in the exploration and settlement of Mars, was registered as a charity … the pursuit of such long term goals is likely to yield much useful knowledge along the way, regardless of whether the endpoint is ever achieved. And if that research that will be undertaken in order to work towards such a goal is likely to advance the sum of human knowledge the “usefulness” threshold will be met.”

This analysis is very helpful because it shows just what the Court will view as being “useful” – clearly it is to be interpreted in its widest sense. This is helpful to understand for any charities which may be involved in research and wondering if what they do will qualify. Having performed that analysis above, the Judge turned to the facts of the particular case before her and concluded:

“The evidence is that the proposed research is likely to lead to advances in areas such as organ transplant medicine, in vitro fertilisation, stem cell research, treatment of a range of diseases and disorders and enabling biodiversity…in the absence of clear evidence that cryonics research is “nonsense” and will not advance human knowledge, it matters not whether such research is presently “accepted academic discipline” or “current science” (whatever those terms may actually mean)… In my view the Board erred in its interpretation and application of the “usefulness” test.”

The Judge also concluded based on this that the purposes were clearly charitable under the “advancement of education” head of charitable purposes. For more on charitable purposes see here.

We hope this summary is useful and will help to better understand what research will qualify as being useful. If you have any questions about it feel free to contact us to discuss your situation. We are providing new updates on other cases and developments in the charity sector regularly so sign up for our newsletter to stay up to date with the latest developments.

This article is not a substitute for legal advice and you should talk to a lawyer about your specific situation.  Reproduction is permitted with prior approval and credit being given back to the source. Contact Steven Moe at stevenmoe@parryfield.com to request this or for any other questions.
 Copyright © Parry Field Lawyers 2017.

It is really encouraging to read the new report published this month by JB Were on the charity sector in New Zealand. A lot of number crunching has gone on to provide an analysis and it give some fascinating insights into this sector.

It can be accessed here.

One of the key points noted in the report is that there are more not for profits in New Zealand than other comparable countries. Australia has one for every 422 Australians, the US has one for every 339 Americans and in Britain there is one for every 393 people in Britain. This is compared to New Zealand which has one for every 170 people. This probably confirms what those in this sector already know – that there are a lot of different charities and not for profits out there. It also indicates a bent or leaning towards philanthropy among Kiwis that is stronger than other places too.

One of the other points noted is that 45 percent of income is generated not from donations or Government grants but from trading or membership fees. That is really interesting because as there is an increasing focus on “social enterprise” and generating income to help support the good work being done it is likely that this number will increase in the future as people look for new and innovative ways to fund the good work they are part of (rather than relying on donations).

I am still reading the report so will post another time with other observations about what they say but I encourage others to download the report and have a look through for yourself. What do the observations and conclusions mean for your organisation?

One of the interesting things about being involved in a relatively new sector like social enterprise is that there are often assumptions about what is being talked about. This article deconstructs one of the most commonly misunderstood points – what actually is a “social enterprise”? In doing this there are a lot of concepts and ideas that will be thrown on to the table – some of them contradictory – but it is hoped that by doing this there will be a clearer understanding about the issues involved and that will foster better discussion and understanding.

The term “social enterprise” will likely have different meanings for different people, depending on the background and experience of the person hearing that term for the first time. As one objective reference point outside of New Zealand, it is useful to see how the European Social Enterprise Law Association defined it in their paper, “Developing legal systems which support social enterprise growth”. They said there were three key elements:

– entrepreneurial dimension: engagement in continuous economic activity;
– social dimension: primary and explicitly social purpose; and
– governance dimension: mechanisms to ensure priority of social purpose.

They conclude that a good definition is: “an autonomous organisation that combines a social purpose with entrepreneurial activity“. It is interesting in this definition that there is no mention of the organisation being exclusively not for profit or for profit.

Canada has many similarities to New Zealand, so it is good to look at some of the thinking going on in that jurisdiction. The Canadian Community Economic Development Network includes a description on their website (https://ccednet-rcdec.ca). It gives a slightly different angle with more of an emphasis on the non-profit nature: “The term “social enterprise” is used to refer to business ventures operated by non-profits, whether they are societies, charities, or co-operatives. These businesses sell goods or provide services in the market for the purpose of creating a blended return on investment, both financial and social. Their profits are returned to the business or to a social purpose, rather than maximizing profits to shareholders.” It goes on to say: “Others use a broader definition that includes privately owned ventures that have a very strong blended financial and socially responsible return on investment.”

Closer to home, Akina (www.akina.org.nz) has been doing a great job and worked for years to promote social enterprises in New Zealand. The definition they put forward on their website seems to focus more on a distinction between an entity which is “for profit” and one which is “for purpose”. They summarise this down to: “Social enterprises are purpose-driven organisations that trade to deliver social and environmental impact”.

All these definitions are helpful and, focussing on the point of difference, it comes down to some part of the entity being involved in an aspect that is more than just the traditional goal of making money for shareholders. But there is clearly a spectrum ranging from “self focussed” to “other focussed” and it is worth asking at what point an organisation crosses over and can be given the label of a social enterprise. For example, is there a certain percentage of “good” that they need to be involved in – and how is that defined? How do you reconcile this focus on a “purpose” with the fact that simply providing employment for people is very important as that helps individuals provide for their families and communities to thrive. Where is the cut-off point?

Turning to that idea of a spectrum on which different legal forms of entity sit, it can perhaps be described like this – with some overly broad characterisations thrown in as headings to make the point.

Really ‘good’
Not for profit – these are usually traditional charities and do not exist to create a profit but instead help disadvantaged or others.

‘Good’
Social enterprises – these have community purposes at their heart but operate as businesses and do make profits that support their purpose.

Pretty ‘good’
Businesses which donate – these are companies focus on profits but do set aside a proportion of their profits for some community purpose as well.

Not as ‘good’
Profit focussed companies – these have no charitable or community purpose (except perhaps a token gift to disaster relief from time to time).

Is such an analysis really fair? It seems to overly weight the “goodness” of some organisations over others. There is a danger of going too far either way. Obviously the above is a really crude analysis, but it has been done through certain lenses. As mentioned above, the fact that an organisation offers employment to staff and contributes some product surely has immense positive value. So the challenging point is perhaps to take these lenses off and not to think in these sorts of terms at all. Instead, work out how to encourage all organisations to begin to take on board some of the concepts underlying social enterprise motivations. Even a “for profit” company could switch its sourcing of products and services in order to help some social enterprises become economically viable. How do you increase engagement with such companies, so it is not just left to “social enterprises” to be the ones who are seen to have some responsibility in this area?

One example of a label which some companies are applying for to show where they fit on the spectrum is “B Corporations”. It is worth describing them in some detail as it is another dimension to consider. The B stands for “Benefit” and it involves a certification system for companies which meet certain criteria that show they have a focus on more than just profits. B Corporations are certified by B Lab which is a not for profit organisation. Probably the most famous example of a company which has done this is Ben & Jerry’s ice cream. The B Corporation website says: “B Corps meet the highest standards of verified social and environmental performance, public transparency, and legal accountability, and aspire to use the power of markets to solve social and environmental problems”. To learn more about this have a look here: http://www.bcorporation.net/

When I first became involved in this sector I was confused by the terms and concepts so I hope this article will help to explain some of the things to consider regarding what a “social enterprise” actually is. The great part is that this is a growing and evolving area so it is actually possible to be part of the debate and even shape what happens next. In a New Zealand context it will be important to look at all the different definitions and discussions overseas and use that as a basis for constructive dialogue. This article has provided an overview of some of the key issues with the purpose of enabling a more informed discussion.

One of the most confusing aspects about setting up a social enterprise is getting the legal structure right. You might have thought the hard work was done when you had the great idea that you hope can become a self funding business that also achieves good in the community. In fact that is just the beginning of the journey because you also need to find the right type of entity (separate to you as an individual) which can move the idea forward.

In New Zealand there is currently no legal structure which is specifically aimed at being a vehicle that social enterprises can use with confidence. In another article this lack has been discussed in more detail and that issue can be further explored here. For now, we need to make do with the legal structures which are available and the two most common are setting up as a company, or setting up as a trust. This article looks at both of those options.

One of the key points to consider before we look at the detail of each option is to remember that you need to “tell your story” in a compelling way to future investors, funders and the community. Choosing the right structure is therefore really important because that becomes a fundamental part of that story. Will it be easy to explain to funders who offer grants that you have a company structure and are the sole shareholder? Probably not. If you want investors who are seeking returns on their investment then will they easily understand that you have set up as a trust? You get the idea. So thinking through who your story needs to be told to will be important when thinking through the structure that is most appropriate.

Why set up as a Company?

A company structure offers a model which is well known and is easily explained. We see this used quite a lot in New Zealand not just in “for profit” scenarios. The word “limited” at the end of all company names in New Zealand is there for a reason – it is an effective way of limiting and containing liability that the entity may incur. That provides comfort for shareholders who will not be personally liable if the venture does not succeed. The contrast with trying to run a social enterprise in your personal name should be obvious – in that situation you have 100% control but could also be personally liable for debts that are incurred.

One of the other main advantages of this structure relates to governance. The founders who had the great idea can also be the shareholders and therefore retain control over the direction of the company. The company will have a board made up of at least one director and they are usually appointed by the shareholders which again offers another level of control to those who founded the company.

One of the downsides of setting up as a company has been hinted at earlier: people assume that a company structure is being used because there is a desire to make a profit. If your strategy is to approach foundations or other groups who might provide large scale funding for your idea then that can make it tough to explain. One of the ways to deal with this is to try and hard wire your purpose into the company structure itself by stating clearly in the founding document (in the case of the company, the Constitution) what the purpose of the company will be. This will be essential if you decide to apply for registration of the company as a charity with Charities Services because they will look at the purposes which are set out there to decide if your entity meets the criteria to be registered as a charity. For more on these issues see this article here.

Why set up as a Trust?

Setting up a trust is probably the most common form that is used in New Zealand. It is a structure which is easily explained and because there are no “shareholders” as such it provides a clean story to explain to people. There is something of an inbuilt assumption that if you are a trust then it is automatically assumed that this is a “for good” type of entity. This is in contrast to the company structure where there can be an assumption that there is a “for profit” element as a main objective.

A trust does not have shareholders and is instead guided by trustees who form a Board. In some ways this might be seen as providing less control to the original founders. However, in practise the founders will choose trustees who share the vision for the trust so that they can ensure it follows in the direction intended. One of the key decisions at an early stage is how to make decisions about replacement trustees – will they be shoulder tapped by current trustees, elected or some combination of both those options? Governance issues will sooner or later become a key point for the trust so it is best to get this sorted early. This aspect and the issues involved is explored further in this article about governance here.

The purpose is also safeguarded by the founding document for a trust, the Trust Deed, which will have a “purposes” section that sets those out clearly. It is really important to make sure that the purposes decided on accurately reflect what the trust is intended for. As with a company structure if you go to Charities Services this will be really important when they decide to register you as a charity (or not). One of the weaknesses we see is that people do not define the purpose using terminology and ways of describing what they will do so that they fit within one of the four recognised charitable purposes. For more on this, see the article here.

What about two for one?

As can be seen each of the most commonly used structures has both pluses and minuses. One option we have seen people do is to set up using both structures in order to try and get the unique advantages that each provide. In that scenario there is usually a trust which has been registered as a charity and has donee tax status. When telling the story to funders and donors that is a structure that can be easily explained and they can get on board with.

At the same time the trust may have a trading arm which is set up as a company. Usually the shareholder will be the charitable trust. The income that is generated by the business of that company then usually will go back to the trust for it to continue carrying on its charitable purposes. But having the company may provide more flexibility such as a vehicle to enter into joint ventures with other entities or seek other investors into the company. Like most structuring it is important to get good accounting advice on some of the tax and accounting implications of setting up in this way as well.

Conclusion

We hope that this overview of the two main options for social enterprises in New Zealand has provided some clarity over why each structure might be used. Ultimately it would be great if there could be a new form of entity which took the best aspects of both the company and trust structures and that could be used going forward. For now though we need to make do with what is available and adapt the structures that we can use in order to further advance social enterprises in New Zealand.

Navigating the rocky shores of “control” where a Church may exercise some power over other organisations and the implications that may result in the need for consolidation of accounts and a change in the reporting tier used by that Church.

Introduction

Part A: What are the accounting standards that apply?

Part B: What does Charities Services have to say?

Part C: Analysis of different hypothetical situations

Conclusion

Christchurch CBD

Christchurch

Rolleston

Hokitika