Taking Stock of Impact Investing in Canada

Impact investing has become an increasingly important way for registered charities and non-profit organizations (“NPOs”) to advance their values and missions. As interest in impact investing continues to grow, however, so too does the confusion about what impact investing actually means—a concept that, for many, remains something of a mystery.

To help address that confusion, this article is intended for readers seeking a clearer understanding of impact investing or considering whether their organization should enter this space.

Who are the Impact Investors?

Both registered charities and NPOs have a role to play in impact investing, although each is subject to a distinct legal framework. This article focuses on how charities and NPOs may participate in impact investing and the legal considerations that arise in each case.

The impact investing landscape extends well beyond charities and NPOs. Private investors, businesses, governments, philanthropic families, and individuals may all engage in impact investing, whether acting alone or alongside others. Identifying this broad range of participants is helpful because it shows that impact investing is not tied to a single type of actor or structure.

At the same time, the fact that so many different participants use the term “impact investing” helps explain why the concept is often misunderstood. In some cases, an “impact investment” may simply refer to a commercial investment made with social or environmental goals in mind. In others, the term carries a more specific legal meaning and may have important consequences, particularly when the investment is made by a charity or NPO.

Impact Investing Vehicles

At a high level, impact investing refers to investments made with the intention of generating a social or environmental benefit alongside a financial return. The terms, structure, and expected returns of these investments can vary significantly. Some investors seek market-rate returns and simply want their portfolios to include investments with positive social or environmental effects.

Others may be prepared to accept greater risk or below-market returns in order to support a particular outcome. In that sense, impact investing is not a single investment model, but a broad category of approaches united by an intention to achieve both impact and investment exposure.

When registered charities engage in impact investing, however, the analysis cannot remain at that general level. The term must be considered against the specific legal rules that apply to charities. In some cases, a charity’s impact investment may take the form of an equity investment in, or a loan to, an organization carrying on a socially beneficial activity.

 In others, it may involve investments within the charity’s broader portfolio that are intended to align with its mission or values. Some of these investments may yield below-market returns, although that is not always the case. As discussed below, the legal treatment of an investment will depend not on the label attached to it, but on its purpose, structure, and terms.

Before turning to those issues in more detail, it is worth briefly noting some of the vehicles currently discussed in the Canadian market. Community bonds, for example, are receiving increasing attention and, in some respects, appear to have supplanted social impact bonds as the latest trend.

Impact investing also continues to be discussed in connection with decentralized autonomous organizations (“DAOs”) and blockchain-based structures. These vehicles and structures may be useful in the right circumstances, but they also raise their own legal and practical considerations.

As in any developing area, certain structures may gain popularity quickly, and some of that interest may be warranted, while some may reflect more enthusiasm than substance. For that reason, the focus should remain on the underlying arrangement—its purpose, terms, and legal consequences—rather than on the label used to describe it.

Impact Investing by Registered Charities

Traditional Investment Portfolios

As noted above, some charities describe mission-aligned investments within their ordinary portfolios as a form of impact investing. In practice, these investments are often made through traditional investment advisors and may consist of conventional portfolios that emphasize companies or funds with positive social or environmental characteristics. Where the expected returns are prudent and commercially reasonable, these investments are generally treated as part of the charity’s regular investment portfolio, subject to the usual investment rules and the fiduciary duties of directors to invest prudently.

“Social Investments” in Ontario

As if the terminology were not already confusing enough, Ontario has its own concept of “social investments.” That said, the term has a specific legal meaning under Ontario law, which is distinct from the broader way in which “impact investing” is often used in practice. In other words, when participants at an industry event refer generally to impact investing, they are not necessarily referring to this particular Ontario regime. It is nevertheless an important concept for Ontario charities to keep in mind. Charities formed under the laws of Ontario are subject to the Charities Accounting Act (Ontario), which deems charitable corporations to be trusts. As a result, the Trustee Act (Ontario) applies to charitable corporations and requires investments to meet a prudent investor standard, such that investments by the charity are generally restricted to commercial investments. The Charities Accounting Act (Ontario) recognizes that charities may make non-commercial investments to further their charitable purposes and therefore provides a limited exception to the prudent investor standard for social investments. In summary, these rules effectively give Ontario charities somewhat greater flexibility in how they invest through their traditional portfolios.

Program Related Investments (“PRIs”)

In our view, the principal way in which registered charities participate in impact investing remains through investments that align with and directly further their charitable purposes, where the investment is not fully commercial because it involves greater risk or below-market returns. For example, a charity established to protect the environment may wish to invest in a green energy project that offers a below-market return. CRA policy permits this type of arrangement, provided that the investment, referred to as a PRI, directly furthers the investor charity’s charitable purposes.

The conditions for a PRI depend in part on whether the investment is made in a qualified donee or another grantee organization, and on whether the investor charity is a public foundation, private foundation, or charitable organization. Private foundations may need to take particular care in structuring these arrangements, including in light of rules relating to business activities and excess business holdings. Even so, private foundations are actively using PRIs in Canada, and their growing engagement in this area reflects the flexibility of the PRI framework when applied thoughtfully and in accordance with the relevant rules.

Many legal issues may arise in relation to PRIs. Two recurring challenges, however, continue to affect PRI structuring and planning. First, CRA has not confirmed whether a PRI made to a grantee organization that is not a qualified donee may constitute a qualifying disbursement.

Second, questions often arise about how PRIs are treated for purposes of the disbursement quota. Under CRA guidance, PRIs are treated as investments rather than expenditures and therefore do not, in themselves, count toward a charity’s disbursement quota. Consistent with that approach, PRIs are generally excluded from the calculation of the charity’s asset base for disbursement quota purposes because they are assets used in charitable activities. There are, however, exceptions to this treatment, including where a charity is unable to recover all or part of the principal advanced under a PRI.

Impact Investing by NPOs

NPOs are also part of the broader impact investing discussion, but the legal framework that applies to them differs in important respects from the framework governing registered charities. To qualify for tax-exempt status, an NPO must be organized and operated exclusively for social welfare, civic improvement, pleasure or recreation, or for any other purpose except profit. Although incidental profit arising from activities directly connected to an NPO’s not-for-profit objectives will generally not be problematic, profit from commercial investments may jeopardize that status.

Overall, the rules applicable to NPOs make impact investing less straightforward, not because structuring impact investments through charities is necessarily simple, but because the NPO regime is less clearly developed and is the subject of more limited published guidance. While we do not wish to be alarmist, it is important to get the structuring right. An NPO may engage in impact investing only where the purpose of the investment is not to generate a financial return; if a return does arise, it must be incidental and derived from an activity directly connected to the NPO’s not-for-profit purposes.

For example, an NPO may invest capital with the expectation that it will be returned without generating additional revenue, or it may make interest-free loans in support of projects that align with its values and mission. The PRI regime available to registered charities does not apply to NPOs. If these requirements are not met, the consequence may be that the organization becomes taxable.

Conclusion

Impact investing in Canada offers meaningful opportunities for charities and NPOs to advance their missions in thoughtful and creative ways. As this article has sought to illustrate, the term “impact investing” is often used broadly and is sometimes treated as elusive, but the legal analysis depends on the nature of the organization involved and the structure and purpose of the investment itself.

For charities and NPOs alike, the key is to look beyond labels and focus instead on the applicable legal framework, the organization’s objectives, and the practical consequences of the proposed arrangement. We hope this article has contributed to a clearer understanding of that landscape.