Social enterprise: What is it and how does it work?

Over the last few years, a growing number of social entrepreneurs have emerged, driven by the desire to make a change in their communities or address social or environmental issues through their work. Non-profit start-ups can take on many forms. In the UK, anyone can technically launch a non-profit, but to qualify for tax relief with HMRC, you must register as a charity or CIO.

Social enterprise refers to a way of doing business, not the business structure itself. Therefore, limited companies, sole traders or partnerships can all technically be social enterprises. What distinguishes a social enterprise from a for-profit company are the following features:

• No more than 50% of its profits are paid to shareholders or company owners
• No more than half of its profits come from trading
• It must have a primarily social or environmental business objective

Non-governmental organisation (NGO) usually describe large charitable groups that act on an international basis. The NGO is not a legal entity in the UK in itself. NGOs often work on an international scale, for example, humanitarian or environmental NGOs working overseas

including the British Red Cross or the Aegis Trust. NGOs usually work on larger projects or developmental efforts. They are funded through private donations, grants, loans and sales of products.

There is no legal definition for a social enterprise in the UK. This means that companies and individuals can choose from a variety of legal forms. Where no formal legal structure is chosen, the business is usually treated as a sole trader for tax purposes. Voluntary associations are referred to as unincorporated associations. These include groups of people who are coming together regularly to work on community or environmental projects.

Here are the most common legal structures for social ventures in the UK:

• Charity
• Charitable incorporated organisation (CIO)
• Community interest company (CIC)
• Unincorporated association
• Trust
• Limited liability company
• Sole trader
• Partnership
• Co-operative

The legal structure of your charity is set out in a governing document, which records how a company is run, who runs it, its number of staff and the liabilities of founders. To receive tax break and be officially regarded as a charity, companies must register as one of the following: charity (limited), CIO, unincorporated association and trust. We’ll look at each of them in detail to help you choose the right one.

• Charity: A charity is a corporate entity that is limited by guarantees as opposed to shares. This means that founders will have no liability for the debts of the company. Importantly, a charity is distinguished from a for-profit company in that it can’t share any surplus with members. It can only use its assets to support its beneficial business purposes and it must be operated to support its registered interests.
• CIO: There are two types of CIOs: the foundation CIO and the association CIO. For smaller businesses that are governed by the trustees and no additional members, the foundation CIO is an ideal legal form. Foundation CIOs usually have a constitution as their governing document. If you’re setting up a CIO with additional voting members, choose an association CIO. You must register with the Charity Commission to be officially recognised as an association CIO. Existing charities and unincorporated charities can convert to the CIO structure.
• Unincorporated association: These are charitable groups without a corporate structure, for example sports clubs or soup kitchens. They can have many members. Unincorporated associations are often quick to set up but they cannot enter into contracts or own or sell property.
• Trusts: A charitable trust is run by a small group of people, i.e. the trustees. Trusts are a type of unincorporated association, which means they can also not enter into contracts or deal with property. Non-incorporated associations and trusts need to register with the Charity Commission where their income exceeds £5,000 annually.

To be considered by the HMRC for tax relief, charities must fulfil certain criteria. The purposes of a charitable company that the HMRC deems worthy of tax exemption include:

• Poverty relief
• Religious
• Educational/literary
• Scientific/health/life-saving
• Arts
• Sports
• Human rights
• Environmental protection
• Animal protection
• Animal cruelty prevention

According to the Charity Commission, charities in the UK must be for the public benefit . Registered charities also have an obligation to report on the work they’ve carried out in a tax year. However, an in-depth report is only required where the gross income is higher than £500,000 annually.

Registered charitable businesses are exempt from most income tax, which includes:

• Donations
• Profits from sales
• Profits from property or investments
• Taxes on acquired properties

However, they do pay taxes on certain types of income such as land development profits, certain purchases and dividends obtained from companies.

Whether your charity generates income or not, you must prepare accounts each year and keep a record of your income, donations and outgoing expenses.

Charities with an annual income of over £5,000 need to register with the Charity Commission View gov.uk’s charity registration site and all registered charities are required to prepare an annual report.

If a charity’s income was above £10,000 (but above £5,000), the company must submit an Annual Update to the Charity Commission which details the business’s income.

Where a charity’s income is between £25,000 to £250,000 per year, it will be examined independently. Annual incomes that exceed £250,000 are subject to further scrutiny and more thorough examination by the Charity Commission and UK tax office.

Besides the obvious benefit of tax relief, other advantages of being a registered charity include:

• Access to government and institutional grants
• Lower taxes on donations from individual sponsors
• Legal protection and limited liability for members and owners

Charities are generally governed by a board which sets out the long-term goals and visions for the company. A board usually consists of trustees. But what are the exact functions of each entity?

• Board and trustees: The board of a charitable company usually consists of select individuals chosen because of their skill and commitment to a company’s cause. Board members are trustees which can include directors and management staff. Board meetings can be attended by other individuals. It’s important to select your charity’s trustees wisely. You will need at least three trustees to become a registered charity. According to the Charity Commission, they cannot be individuals which have previously been disqualified in a similar role or have a criminal record. A full checklist can be found on the Charity Commission website.
• Executive staff: The day-to-day business of a non-profit is organised by executive staff members such as a chief officer and president. Executives will liaise with the board and oversee members of the management team.
• Management: Managerial staff usually deal with the operational duties of a non-profit on a daily basis. They are responsible for the developmental process, realising programmes suggested by the board, and scheduling events and fundraisers. Managers are in charge of administrative staff.
• Administrative staff: Common administrative roles in NGOs and larger CIOs include secretaries, administrators, planning and fundraising assistants. They are responsible for many of the hands-on tasks, such as scheduling meetings and events and setting up appointments with donors.

Although many charities rely on volunteers, larger companies will usually pay at least minimum wages to administrative staff. Charities must disclose the number of employees who earn over £60,000 annually.

Now that you have a better understanding of the various business structures and obligations of charities and CIOs, you may wonder: what are the advantages and disadvantages of starting a social enterprise?

Please note the legal disclaimer relating to this article.