HYBRID ORGANIZATIONS
The idea of creating for-profit businesses focused on achieving social purposes has been taken up by a new breed of social entrepreneurs. These “double bottom line” enterprises are proliferating under current for-profit corporate forms. However, a number of states are considering, or have recently created, new legal structures under which these hybrid entities can incorporate:
Low-profit Limited Liability Corporations (L3Cs) have been recognized in eight states (Illinois, Louisiana, Maine, Michigan, North Carolina, Utah, Vermont and Wyoming), and are being considered in at least 10 others. An L3C is primarily dedicated to a charitable or educational purpose. The primary benefit of this status is to verify that the corporation is eligible to receive program-related investments (PRI’s) from foundations and donor-directed funds, thus potentially raising new revenues for socially beneficial purposes.
Benefit Corporations were first legally established in 2010, and are now available as a corporate form in Maryland, Vermont, New Jersey, Virginia, Hawaii and California. These laws allow for-profit entities to provide a “general public benefit” to consider the interests of stakeholders (e.g., employees and communities), their environmental impact, and other social factors in making business decisions, without facing the risk of lawsuits by investors and shareholders who might perceive those decisions as detrimental to their financial interests.
Flexible Purpose Corporations have also recently been established in California. Under this form, the company’s articles of incorporation have to specify the “special purpose” in which the corporation engages; that purpose can include, but is not limited to, charitable activities.
IS Position
In response to a request from the Senate Finance Committee for recommendations regarding possible federal recognition of hybrid organizations, the Independent Sector board of directors has adopted the following position on September 2011:
Independent Sector opposes extending the privileges of tax-exemption or tax-deductible contributions to hybrid organizations, which by definition have as one of their purposes the creation and distribution of profits to shareholders/owners. Further, Independent Sector opposes the recognition of hybrid corporations as a separate category of entity (i.e., neither for-profit, nor nonprofit) in federal tax law at this time. The need for such a category has not been demonstrated, and creating a hybrid organizational category will increase the complexity of the tax law, further confuse the public about the public purposes of hybrids vis-à-vis nonprofits, could hinder transparency and accountability, could be used to divert charitable assets to private gain, and could result in decreased charitable contributions to the nonprofit sector.
Of paramount concern regarding a new legal classification for hybrid organizations is their ultimate tax treatment under the law, specifically whether or not they will receive tax benefits similar to those provided to nonprofit, tax-exempt organizations. While none of the recently-enacted state laws creating new legal structures for hybrids have included special tax advantages, advocates have been clear in their desire to attach tax benefits at both the federal and state level. In fact, the city of Philadelphia has already begun to offer $4,000 tax credits to companies that have undergone an assessment by B-Lab and paid a licensing fee to use the B-Corp logo, despite the fact that Pennsylvania has not enacted legislation recognizing benefit corporations.
Conferring tax preferences on hybrid organizations raises the potential for a number of serious conflicts that should give Congress pause. First and foremost, hybrid organization executives must serve contradictory missions – namely, maximizing profits for shareholders or owners on the one hand, while working to serve a social purpose on the other – with the former likely dominating the latter.
Another serious conflict could result from removing legal restrictions on inurement, which will make it difficult to guard against charitable assets being converted to private gain, particularly given current oversight capacity at the state and federal levels. The real danger lies in attracting “bad actors” seeking to game the system, and the resulting erosion of donor confidence about their contributions to charitable organizations. It is not clear that any additional social benefits provided by hybrid organizations would outweigh these risks.
Concern also arises over the possible perception that support for hybrid organizations, either through cause-marketing campaigns or the purchase of products, is a substitute for charitable giving. As nonprofit organizations struggle to keep pace with ever-increasing demand in the face of declining revenues, a further reduction in charitable giving would harm the millions of individuals and families served by nonprofit organizations across the country.
Additionally, singling out “socially good” companies risks the implication that corporations not so classified are somehow “bad,” despite the fact that many existing corporations have been serving the social good and behaving in environmentally and socially responsible ways for many years, all within the confines of the current tax code. Indeed, some question whether today’s social entrepreneurs need a new legal regime to spur the creation of for-profit firms that address societal needs.
Improved access to capital is a primary argument in favor of creating a new framework or structure for hybrid entities, but it is not clear that creating a new structure would necessarily solve the problem. L3C corporations and many nonprofits face challenges attracting sufficient resources because current regulations are unnecessarily cumbersome for funders and do not reflect modern business practices. Improvements to existing law and regulations would be the preferred course of action.
For example, under current law, each foundation interested in participating in a PRI must seek a separate IRS determination that the investment is permissible. Enabling multiple entities to rely on an IRS determination would facilitate needed investments in projects which the IRS has found to meet all applicable criteria. In addition, to help modernize PRI regulations to meet today’s needs, the American Bar Association Section of Taxation has submitted a number of new examples to supplement the existing IRS guidance.
Given that the need for such a category has not been demonstrated, Independent Sector opposes the recognition of hybrid corporations as a separate category of entity, and further opposes extending the privileges of tax-exemption or tax-deductible contributions to hybrid organizations. Additionally, Independent Sector has prepared the attached list of questions to assist lawmakers in evaluating any legislative proposals regarding hybrid organizations.
QUESTIONS FOR EVALUATION OF LEGISLATIVE PROPOSALS CONCERNING HYBRID ORGANIZATIONS
Legal Compliance and Public Disclosure
- What public, social, environmental or other purposes will be required to qualify for benefits under this new corporate form? How do these differ from the purposes for which nonprofit organizations are created?
- What federal, state and local laws will apply to the new corporate form? Will new laws be needed, or will it be subject to the laws that apply to other specific corporate forms (i.e., charitable nonprofits, S-Corporations, LLCs, etc.)?
- What public disclosure requirements are necessary and appropriate, particularly if the organization is permitted to accept charitable contributions, program related investments or other tax-preferred capital investments?
- What requirements would safeguard against the conversion of charitable assets for private inurement and other conflicts of interest? What requirements should be in place to ensure appropriate distribution of any remaining assets if a company is dissolved?
Effective Governance
- What mechanisms should be required to ensure that the board appropriately balances the social purpose of the organization against its fiduciary responsibilities to shareholders?
Strong Financial Oversight - What state and/or federal body will monitor and exercise oversight responsibilities for these organizations?
- What annual public reporting requirements should apply to these organizations?
Responsible Fundraising - Should these entities be permitted to solicit and accept charitable contributions? If so, will the requirements that now apply to charitable nonprofits also apply to them, including restrictions on lobbying and electioneering?
- Should donations to these entities be subject to the gift tax?
