What truly differentiates a not-for-profit ("NFP") corporation from a for-profit business corporation?
The Essence of an NFP Corporation
The essence of an NFP corporation is the prohibition against distributing any money or other property of the corporation to its members before its liquidation or dissolution.
Dividends are the primary means by which business corporations provide a return on investment to their shareholders. A business corporation is owned by its shareholders, particularly the holders of common shares. The residual profits of the corporation, after payment of all expenses and fixed charges in favour of the holders of debt obligations and any preferred shares, accrue to the common shareholders. It is they who elect the directors, and it is the directors who in turn appoint management.
As economic agents of the shareholders, directors and management are intended to maximize the welfare of shareholders. If directors and managers fail to do so, shareholders can at any time quickly dispatch the board of directors and hire new management whose goals are better aligned with those of the shareholders. Thus, the ownership structure of a business corporation is wired to maximize profits for the shareholders (subject to any restraints imposed by the competitive marketplace or legal restraints on the activities of business corporations).
Shareholder primacy does not apply in the case of an NFP corporation. Members of an NFP corporation cannot earn a return on investment. This means that the function of an NFP corporation is not to maximize profits for investors but rather to carry out its particular defined social mandate or purpose. Under the Canada Not-for-profit Corporations Act, the purpose of the corporation must be defined in the articles.
The CNCA provides that no part of a corporation's profits or of its property or accretions to the value of the property may be distributed, directly or indirectly, to a member except in furtherance of its activities or as otherwise permitted in the CNCA. The only "exception" to this prohibition simply allows an NFP corporation to distribute its money or property to a member who is authorized to carry on activities on behalf of the corporation, if the distribution of money or property is made for that purpose.
Three Competing Theories
It might be stated that, unlike business corporations, NFP corporations "do good work". However, on close analysis, this criterion does not help distinguish NFP corporations from business corporations. To the extent that business corporations identify and meet the needs of people (or other businesses), they can equally be said to be "doing good work". Consider a pharmaceutical company that develops a life-saving drug. There is no dispute that it does good work. A school educates children. The same good work is being performed - whether the school is an NFP, or a business corporation or is being provided by the state.
Again, what differentiates an NFP corporation from a business corporation is not a subjective classification as to the social utility of their respective activities. It is whether the purpose of the organization is to make a return for owners or to provide a service without needing to provide an economic return to any group of owners.
A narrower view of the fundamental distinction between an NFP corporation and a business corporation is to point out that only NFP corporations can be charitable. No business can qualify as a charity. While these statements are true, they overlook a crucial fact: not all NFP corporations are charitable. Indeed, it has been estimated that approximately two-thirds of all corporations formed under Part III of the Ontario Corporations Act are non-charitable. Non-charitable NFP corporations include trade and professional associations, boards of trade, social and cultural clubs, sporting associations, airports and port authorities, and many Crown corporations. Therefore, charitable status cannot explain what makes these other NFP corporations distinct from business corporations.
A further point of distinction might be the tax-exempt status of registered charities and non-profit organizations conferred under the Income Tax Act. However, this suffers from some of the same explanatory shortcomings as charitable status. Not all NFP corporations are tax exempt. NFP corporate status is neither a necessary, nor sufficient, condition to being tax exempt.
Assuming that the essence of an NFP corporation is the prohibition against making distributions of money or property to members before liquidation or distribution, the next point is that the essence of the distinction between soliciting (or public benefit) corporations and non-soliciting (or mutual benefit) corporations under the CNCA is the difference in who may receive the residual assets of the corporation on liquidation or dissolution.
All registered charities and soliciting corporations must distribute their remaining property (after the discharge of any liabilities of the corporation) to one or more qualified donees under the Income Tax Act. Qualified donees are defined narrowly to include various governments, registered charities and other public benefit organizations.
All other non-soliciting corporations under the CNCA are free to distribute their residual assets in accordance with their articles. Indeed, if the articles are silent, the default rule for these non-soliciting corporations is that their net assets may be distributed on a per capita basis to members.
What characterizes an NFP corporation is its inability to distribute its money or other property to members any time before its liquidation or distribution. This prohibition changes the objective of the corporation from maximizing profits for owners and their agents (directors and management) to carrying out its social function as defined in its articles.
What characterizes a soliciting (or public benefit) corporation from a non-soliciting corporation is who qualifies to be the recipient of the net assets of the corporation on liquidation or dissolution. For a soliciting corporation (including all registered charities), only qualified donees can receive the residual assets. Other non-soliciting corporations may distribute their net assets to anyone named in their articles (including members, qualified donees or organizations having similar purposes).