Wednesday, 2 November 2016

Should Social Enterprises Be Regulated Under New And Separate Laws?

There is no legal definition of a Social Enterprise. There are myths and ambiguities surrounding these entities. They are currently popular, but, not quite positioned within either the business or the social sector. They continue to hover between for-profit and non-profit, but, at the same time, clinging resolutely on to the ‘social’ tag! We spoke to a few social enterprises to understand their views. 

To begin with how would you distinguish a Social Enterprise (SE) from a non-government organisation (NGO)?
Nisha Bora, is Director at Elrhino Eco Industries Pvt Ltd. They manufacture tree free hand crafted paper and paper products from forest waste and use it as a platform to generate support for the conservation of the One Horned Rhino and Asian Elephant. Nisha says “I think there is none at all, except that I can sell my company, and an NGO cannot be sold for personal profit. I think an SE is more or less an NGO, with greater restrictions in terms of compliances - for e.g. minimum labour laws, no possibility to raise non sales funds. In fact, as an NGO I would have been better placed to receive funds.”

Tilisa Gupta Kaul is Director at The Artisan Foundation (TAF). This SE was founded with the belief that there is a need to bring rural artisans into the mainstream market. Their focus is to preserve and promote traditional art & craft through sustainable livelihood initiatives. Tilisa feels, “While both social enterprises and NGOs are part of the social sector, the distinction really lies in the philosophy, and it shows up prominently in the organization’s social value creation objectives and its revenue model.”

Anukriti Goyal is Co-founder of Apni Shala Foundation. They deliver life skills education programmes to schools and non-profit organisations that wish to focus on social, emotional and cognitive development of children. Anukriti tells us that the distinguishing factors between both are continuously evolving. “Both Social Enterprises and NGOs are for social good. The commonly discussed differentiating factors are based on their revenue model, their orientation to bring the long term systemic changes etc. NGO itself is not a legal term, commonly grouping trusts, societies and Section 8 companies under the NGO umbrella. There is a need to assign legal terms on basis of revenue models - donation based models and social business based not-for-profit (Section 8) and for-profit companies. The latter coming under the umbrella of Social Enterprises.”

The law, particularly the Income Tax Act does not accommodate a hybrid. The SE must decide whether it desires to be for-profit or non-profit. As of the moment, the only possible ‘hybrid model’ is to have two distinct and separate entities (one for-profit and the other a non-profit) work parallel to each other within a common social space. One entity functions as the commercial business arm and the other as the platform for receiving grants and donations and implement activities at the grassroots level.

What are the legal challenges faced by Social Enterprises?
Tilisa reinforces what most SEs feel. “There is a lack of standardized legal structure (regulations concerning incorporation and compliance) for social enterprises in our country. Further, due to limited use of e-government platforms and lack of communication between various government ministries the entrepreneurs struggle to obtain simple clearances and exemptions. A social enterprise has to deal with central, state and local government departments to obtain various clearances. Moreover taxation is often a major issue as all non-profit organizations are registered as tax exempt but, tax authorities have not come to terms with social enterprises with profit motive yet.”
Anukriti's challenge is around funding, “Since there is no separate considerations for Social Enterprises  especially the ones registered as for-profit companies, huge challenges are faced in raising funds from CSR (law itself does not allow), foreign funds etc. There are no special tax exemptions given for carrying out the activities.”
Nisha similarly agrees, “Compliances with receiving and disbursing funds are a big issue. As a for-profit entity, my hands are tied and it is impossible for me to receive any money for philanthropic disbursal; everything has to show up as sales! Besides, overall compliances are too many, opaque and complex for small enterprises who cannot afford a Company Secretary to take care of all this.”
Many feel that laws in the country are not friendly for the social sector in general. For the longest time, non-government organisations that so far were dominant in this space have been struggling to not only understand the plethora of laws but also keep up with the demanding compliance. We asked if SEs find working within the current legal and regulatory framework inhibiting? Why?
Anukriti agrees, “Yes, it is inhibiting for companies registered under companies act but completely working for social good. They work at low margins, operations costs but need to adhere to all commercial company laws. Additionally, at times it becomes confusing on what is applicable and what is not. And proper legal advice/services are generally expensive.”
Nisha concurs, “If the law does not differentiate between me and any profit oriented enterprise without a social mission, then why label me 'social' at all? It is very complex to traverse the line between profit and mission without muddying both, and one is constantly torn in two directions depending on who is asking the questions. Funders say they want to see returns, but also with big impact. It is a double burden, and an unrealistic one.
Tilisa views it this way, “There are many factors, which may potentially inhibit the smoother operations and development of a SE in India. These include social attitudes, religious beliefs and prevailing cultural factors. In addition, legal, regulatory and taxation rules will also play an important role. The primary reason is the lack of standardized, identifiable and widely agreed definition for the term social enterprise.”

Is there a need to legally define a SE and what sort of legal and regulatory reliefs would SEs be looking out for under the current circumstances?
Tilisa has her list ready - “Social enterprises are categorized as part of the development/social sector. Which leads to a lot of disadvantages for business operations. A mega-regulatory body must be created that acts as a single window for incorporation, approval, monitoring and compliance. This body should have state-level centers to reach out to remote parts of the country. Also, there is a need for a robust policy environment to enable social entrepreneurship, especially a policy that grants concessions or incentives to create positive social outcomes. This is necessary, as it will become hard to legitimize concessions, provisions for SEs verses other businesses. Important interventions that social enterprises need: Structured financial space, regulatory operating guidelines, CSR funding and self-regulation.”
Nisha wants, “Allow me a special income class that is not sales, not taxable, but goes straight into impact delivery. Let it not show in the balance sheet against profit, but against fund raising or something. Allow foreign remittance for this. The FCRA constraints are not the friendliest!
Anukriti agrees there is definitely a need. “If we want to create the maximum social and environmental value out of the money being pumped currently in social sector through CSR, foreign foundations etc, we need to have institutions (SEs) which have well defined legal structure and are aiming to provide impact and scale. We also need smooth process for accessing foreign funds. Tax exemptions (benefits can be passed on to beneficiaries). Relaxation under Labour law, minimum wages act, PF act, for people being employed from informal/unorganised sectors, so that in addition to benefits under the act, they can also have more in hand salary.”

All around the world, social businesses with a mission to improve the lives of the poor and generate a profit are capturing increasing attention. One of the key decisions to be made is whether to be an NGO or SE. Once that is resolved key is to decide is the choice of legal structure for the SE.
Do more SEs choose the non-profit model over the for-profit model or vice versa? Why?
Anukriti's experience says, “Not necessarily. The choice of model depends mostly on the kind of activities, inherent revenue generating capacity and the intent of the people behind the SE. But there are increasing number of support entities which are supporting only for-profit model as it can scale and thereby have a larger impact. This might indirectly give boost for more for-profit models.  Since it is linked to the social sector making profit is not considered good, however the talks should be focused on how the SE is utilizing the profit.”
Tilisa sees a shift in the last decade, in the landscape of the not-for-profit and for-profit sectors due to the increased momentum of the social enterprise movement. “We have seen reshaping in both the not-for-profit and for-profit sectors - with many not-for-profit charitable organizations looking more and more like for-profit entities and vice versa. This has given birth to a new structure known as a hybrid model, which has joint ventures between the charitable and for-profit entities. Hybrid model based social enterprise has often been hyped as the model to embrace and practice as it provides an opportunity to serve two bottom lines simultaneously, reaping both financial and societal rewards. Moreover, it helps the organization self-sustain itself.”

Which model is preferred most by funders and why?
“I think there is greater acceptance of for-profits; even grant making organisations want to see a revenue model in place. Except government schemes, I have seldom come across funds that exclude private companies.” says Nisha.
Tilisa is positive with advent of social entrepreneurs, fund generation has not remained a major challenge anymore. “The lack of funding opportunities was one of the major disadvantages social enterprises faced in the past but that is changing. The funding was lopsided; it was either focused on for-profit business to generate higher returns or for non-profit charitable organization for social impact.
Investors are coming to realize that social enterprises of all sorts can also generate financial returns that will make them attractive to the right investors. Therefore, we see for-profit social enterprises being preferred organization for funders.”
Anukriti is certain there are both types of funders. “The purpose behind the funding differs.  For non-profit, the funders might have to keep changing as they will keep needing funds to run the regular operations and have a good part of the team dedicated to reach out to funders. Funders will be looking at impact.  For-profits will have the revenues taking care of the operational cost (partially or fully), but they might need funds for scaling. Here the funders look at impact, increase in impact with scale and also to get returns on investment (might not be as high as a commercial business).”

Ultimately, both SEs and NGOs exist for social good. Hence, do they need to be mutually exclusive?
Tilisa concludes, “Both social enterprises and NGOs are categorized as part of the development/social sector. A blended approach is the best strategy to succeed and to create social value that transforms the lives of those who lack the capacity to change the social and economic ecosystem.”
Nisha adds, “I firmly believe, not. All we need to do is build in legislation to tackle some key issues, such allowing some form of private ownership of assets and discretionary powers to allocate incoming funds as income vs fund raised for impact work. If we can demonstrate that the funds have indeed been used for development work, then why should it be treated as taxable sales income?”
We all have to agree with Anukriti's closing statement, “There is need for both to exist. But a stronger legal and tax framework can bring in more transparency and efficiency.”

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