Establishing a foundation: how to choose what’s best

Corporate foundations are independent entities set up for philanthropic purposes. Many companies choose to manage their corporate social investment (CSI) through a separate legal entity, either a trust or a non-profit company (NPC). Setting up a foundation can be beneficial, but it is not appropriate for every company. What are the pros and cons, and how can companies choose what is best for them?

Trialogue research indicates that in 2022, 43% of the companies surveyed managed some or all their CSI through a separate legal entity, 28% through trusts and 15% through NPCs. This is an increase from 2020, when 35% of companies managed their CSI programmes through a separate legal entity, 25% through trusts and 10% through NPCs.

What motivates companies to set up these separate entities, and which are best for a company’s purposes?

Which legal entity is best?

Nicole Copley, the founder of ngoLAW, explains that foundations are not a type of legal structure in South Africa and although the term ‘foundation’ is common, it has no legal meaning. In the context of CSI, a foundation can
either be run as an internal CSI division of a company, or as a separate legal entity. There are three possible legal vehicles a company can consider for a foundation:

1. A voluntary association
2. A charitable trust
3. A non-profit company (NPC)

All three of these legal entities can apply to be registered as non-profit organisations (NPOs) with the NPO Directorate, located in the Department of Social Development under the Non-Profit Organisations Act, 1997 (Act No. 71 of 1997) (due to be amended through the NPO Amendment Bill).

A voluntary association is far from ideal for a CSI foundation as it suits a grassroots or community-based organisation, run on a democratic basis by its members, with a new committee voted in every year. Copley says some companies inadvertently set up voluntary associations in the process of obtaining an NPO number, but the structure is inappropriate if there is no wider voting electorate of members.

It is more appropriate for companies to set up a charitable trust or an NPC for a CSI foundation.

A charitable trust is set up for charitable purposes and can be registered as a public benefit organisation (PBO) with the South African Revenue Service (SARS) Tax Exemption Unit. Once it has PBO status, donations to the trust are exempt from donations tax. PBO status also confers exemption from tax on some income and may, if the activities are the appropriate ones, be linked to Section 18A status (tax deductions for donors).

Aside from CSI foundations, companies also set up trusts as broad-based ownership schemes under the broad-based black economic empowerment (BBBEE) legislation. Such trusts own shares in the company, with the benefits accruing to beneficiaries who are members of a ‘defined class of natural persons’, for example black community members in a specified geographic area.

One of the disadvantages of setting up a trust is the fact that trust registration is still paper-based, which means filing original documents signed by hand by all trustees for every change made. Copley says the trust option is thus not recommended for organisations with board members who live overseas or in remote geographical
locations.

Trusts are administered by trustees and it can be a laborious process to change any of the trustees as the Master of the High Court has jurisdiction over trusts and is struggling with backlogs. It is impossible to act as a trustee without receiving Letters of Authority from the Master of the High Court, which may delay or hamper trust activities.

Trusts are more flexible organisations than companies, with a less detailed regulatory framework, but for this reason they are also more open to being used for fraudulent activities.

For the purposes of CSI, it is easier and quicker for companies to set up an NPC, which is recognised as a separate category of company in terms of the South African Companies Act, 2008 (Act No. 71 of 2008). Copley points out that companies require greater compliance, but they have the advantage of greater credibility and a more robust regulatory environment.

As with a trust, an NPC can register voluntarily as an NPO and as a PBO. An NPC can be set up with or without
members – a no-member NPC is for those entities that do not have voting members. Registration is quick and easy as it can be done via email and any changes to directors can be made online, which streamlines processes.

Both a trust and an NPC can have diverse boards from within and outside of the corporate founder, and can be structured to allow for independence. Alternatively, if companies would rather not appoint external board members, they can include independent views by setting up advisory committees from which they can request
advice and specialist expertise. The SARS rule is that no single person controls decision-making within a PBO, which should be kept in mind when appointing board members.

The advantages and disadvantages of separate legal entities for CSI

Advantages

• Foundations enjoy credibility, which confers reputational benefits and helps to maintain structured and
  consistent giving.
• Separate legal entities can maintain a degree of independence from the company, including guarding against undue influence by marketing departments.
• Trusts and NPCs are empowered to appoint external board members and staff who have specific expertise in a relevant area.
• Partners can be represented on the board of a foundation and provide input in this way.
• Foundations can commit to longer term strategies than companies might otherwise be able to do.
• If the founding company no longer wishes to fund a particular focus area, continuity can be maintained through other funding streams.
• A sustainable funding model can be set up that will allow the foundation to fund its activities independently of the founding company where there is possibly less funding flowing from the company.
• Separate legal entities can also build up reserves that can be redeployed by the foundation.
• Foundations can manage their own costs, including paying staff out of the foundation’s budget.
• Activities are not hamstrung by a company’s poor results, because donated funds are protected.
• If a foundation is recognised as a PBO, donors receive an exemption from donations tax and a tax deduction,
  subject to the foundation receiving approval in terms of Section 18A of the Income Tax Act, 1962 (Act No. 58
  of 1962).
• Third-party donors have the comfort of knowing they are contributing to a separate, accountable structure.

Disadvantages

• The foundation may not be closely aligned with the company’s business and sustainability agenda, or with its broader mandate.
• There may be fewer opportunities to market the company’s achievements.
• Companies may wish to exert more control than a foundation will allow, particularly if external independent
  board members are appointed.
• Setting up and running a foundation can be administratively complex, costly and time consuming, and may require legal, financial and tax experts, as well as annual reporting.
• Bureaucracy may slow activities down, particularly if all decisions are deferred to trustees and board members.
• It is possible that not all the activities currently being funded can be housed within the foundation
  without compromising the ability of the foundation to obtain various tax approvals and benefits.

The advantages and disadvantages of internal divisions for CSI

Advantages

• Corporate giving can be more strategic, as it is often better aligned with the competencies, products and services of the company.
• Easy integration between the core business of the company and departmental activities, including easier
  access to support functions.
• Better alignment with marketing objectives.
• Access to staff and systems to help achieve goals.
• Potentially more freedom regarding the choice of activities.
• Less bureaucracy and the ability to move faster as there is no need to defer to trustees or board members.
• Compliance requirements are less onerous.
• Less administrative complexity, which can be costly and time consuming.

Disadvantages

• Blurred boundaries between the business and the CSI department.
• Less opportunity to establish a separate brand and profile for work undertaken.
• Partnerships are restricted due to company or brand association.
• Inability to attract external funding.
• A lack of developmental credibility.
• Third-party donors do not have the comfort of a separate, accountable structure.

In summary, unless there are compelling reasons for a separate legal entity (such as third-party funding or tax reasons), Trialogue recommends that CSI is run as an internal function within the company. We believe that this allows for CSI to be better integrated into the core business and more strategic, delivering both social and business benefits.

Source: The Trialogue Business In Society Handbook 2022 (25th edition)