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.