Different approaches

Behind these many terms are, of course, different purposes. Definitions are neither true nor false, and they are ultimately judged by their usefulness in describing a part of reality of interest to us. Specifically, a definition must be simpler than the reality it seeks to describe. In the social sciences, we are particularly interested in definitions that facilitate communication, generate insights, and lead to better understanding. In this respect, we can either use existing definitions, such as the legal and functional definitions reviewed below, or propose new ones, as is the case for the structural–operational definition, which, … was inductively developed by comparing the terminologies used in a wide range of different countries (Salamon and Anheier 1997c; see the United Nations Handbook on Nonprofit Institutions 2002).

The legal definition

Perhaps the most certain and straightforward system for defining the nonprofit sector is the one provided in a country’s laws and regulations. In the US, for example, nonprofit organizations are defined in the Internal Revenue Code, and for the most part in sections 501.

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To qualify for 501(c)(3) status, an organization must pass three tests: the organizational test, the political test, and the asset test. While nonprofits can be established for any lawful purposes, the organizational test for 501(c)(3) status requires that they operate exclusively in one or more of eight functional purpose areas:

educational

religious

charitable

scientific

literary

testing for public safety

fostering certain national and international amateur sports competitions

prevention of cruelty to children and animals.

The political test requires organizations with 501(c)(3) status not to participate in the political electoral process of promoting any specific candidates for office. This prohibition includes the preparation and distribution of campaign literature. The political constraints imposed on 501(c)(3) organizations go beyond actual elections and campaigning and extend to lobbying as well, and such organizations are prohibited from making substantial contributions to lobbying activities by third parties. Accordingly, a 501(c)(3) organization can spend up to 20 percent of annual expenditure on lobbying activities relating to the organization’s mission. By contrast, 501(c)(4) organizations have no restrictions on their lobbying activities.

To pass the asset test, the nonprofit organization has to demonstrate procedures that prohibit assets or income being distributed to individuals as owners, managers, or their equivalents, except for fair compensation for services rendered. This also stipulates that the organization may not be used for the personal benefit of founders, board members, managers, staff, or associates.

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CIVIL LAW SYSTEMS

In contrast to common law countries such as the US, Australia, or the UK, civil law countries such as France, Germany, and Japan have a different starting point for defining nonprofit organizations. The civil law system is based on the fundamental distinction between private law, regulating the rights and responsibilities of individuals and private legal personalities, and public law (e.g. administrative, fiscal, and ecclesiastical law), dealing with the relations between individuals and the state, public agencies, and public law corporations. The central point is that the state is regarded as a legal actor sui generis and in possession of its own legal subjectivity that requires laws and regulations qualitatively different from those addressing private individuals.

The civil law systems have two principal types of organizations: private law associations and corporations. To achieve legal personality, an association must be registered in some association registry which, depending on the country’s administrative system, is typically maintained either locally at city or county courts or nationally at the Ministry of the Interior or an equivalent government department. To register, an association must pursue a non-commercial objective, have a specified minimum number of members, a charter, and a governing board. A non-registered association possesses no legal personality; the board legally represents it, and members are personally liable.

However, registration does not necessarily imply tax exemption for the organization. In most civil law countries, the distinction between public and private law equates the state with the public good and puts the burden of proof of public benefit on private law associations only. As a result, the law concerning public benefit is more complex than in common law countries and involves a legal act separate from registration. What is more, while many civil law countries have relatively simple registration procedures for associations and corporations, the achievement of public benefit status is much more demanding. In France and Japan, there are many more nonprofit organizations than tax-exempt nonprofit organizations.

The legal definition of what constitutes a nonprofit organization, however, makes clear the implicit assumptions about the purposes and objectives of nonprofit organizations. This points to the importance of what we call the functional definition, to which we now turn.

The functional definition

A second type of definition of the nonprofit sector emphasizes the functions or purposes that organizations in this sector carry out. Perhaps the most common type of function attributed to the nonprofit sector is the promotion of what is variously termed the “public interest,” or “public purposes.” Perhaps the most comprehensive statement of such a “public purpose” definition can be found, however, in the Preamble to England’s Statute of Charitable Uses of 1601:

... relief of aged, impotent and poor people... maintenance of sick and maimed soldiers and mariners, schools of learning, free schools, and scholars in universities... repair of bridges, ports, havens, causeways, churches, sea banks, and highways, education and preferment of orphans... relief, stock, or maintenance for houses of correction... marriages of poor maids... supportation, aid and help of young tradesmen, handicraftsmen... relief or redemption of prisoners or captives,... aid or ease of any poor inhabitant concerning payments of fifteens, setting out of soldiers, and other taxes.

(cited in Hopkins 1987: 56; see Picarda 1977)

The functional definition also dominates the notion of charity in Britain, as specified in the case Income Tax Special Purposes Commission v. Pemsel 1891:

Charity in its legal sense comprises four principal divisions: trusts for the relief of poverty; trusts for the advancement of education; trusts for the advancement of religion; and trusts for other purposes beneficial to the community, not falling under any of the preceding heads.

This now well over 110-years-old ruling and related legislation since then are to be modernized, according to a review conducted by the UK’s Cabinet Office in 2002, and are to be replaced by ten purpose categories:

A charity should be defined as an organization which provides public benefit and which has one or more of the following purposes:

1 The prevention and relief of poverty

2 The advancement of education

3 The advancement of religion

4 The advancement of health (including the prevention and relief of sickness, disease or of human suffering)

5 Social and community advancement (including the care, support, and protection of the aged, people with a disability, children and young people)

6 The advancement of culture, arts and heritage

7 The advancement of amateur sport

8 The promotion of human rights, conflict resolution and reconciliation

9 The advancement of environmental protection and improvement

10 Other purposes beneficial to the community.

(note – now the new Charity Act is passed by the Parliament of the UK. – N.Mishyna)

The notion of public benefit is critical to the definition of charity. The Charity Commission Guidelines in the UK offer a useful set of criteria indicative of public rather than private benefit of organizational purposes:

the organization benefits the public as a whole or a significant segment of it;

the beneficiaries are not defined in terms of a personal or contractual relationship;

membership and benefits should be available to all those who fall within the class of beneficiaries;

any private benefit arises directly out of the pursuit of the charity’s objects or is legitimately incidental to them;

the amount of private benefit should be reasonable;

charges should be reasonable and should not exclude a substantial proportion of the beneficiary class;

the service provided should not cater only to the financially well off. It should in principle be open to all potential beneficiaries.

(note – now the new Charity Act is passed by the Parliament of the UK. – N.Mishyna)

CIVIL LAW SYSTEMS

So far we have looked at the functional definition in the context of the common law countries, but what is the situation in civil law countries, where the state puts more onerous requirements on private actors that seek to work for the public good? In most civil law countries, the legal status of associations was at center stage in the emergence of civil society in the nineteenth century and became enshrined in the Civil Code, with the definition of what constitutes public benefit essentially defined by provisions in various tax laws.

Public benefit status today is foremost a fiscal term. Its definition and application serve to differentiate tax-exempt organizations from those liable to various forms of taxation. Using the German tax code as an example, the promotion of the following objectives are covered by the definition of public benefit:

public well-being in material, spiritual and moral spheres;

charitable and benevolent activities to support persons in need and unable to care for themselves;

Church-related activities including the construction, maintenance, and administration of churches and church property, religious instruction, religious services, and training of the clergy.

Against the background of these general headings, the tax code lists the following types of activities as examples of public benefit:

support of science and research, education and instruction, arts and culture, religion, international understanding and exchange, development aid, environmental protection, historical preservation, and local customs;

support of youth welfare, the elderly, public health, welfare, and sport;

the general support of a democratic state and community; and

the support of animal husbandry, plant cultivation, and gardening (all noncommercial), traditional customs, veterans’ affairs, amateur radios, model airplane clubs, and dog shows.

What is more, the tax code stipulates that private activities for public benefit must be carried out in a certain manner:

Selfless, in the sense of altruistic, whereby members of the organization are neither allowed to receive profits nor other profit-like compensations: this strict nondistribution constraint excludes many mutual membership associations, as well as business and professional associations. It also implies that the cost behavior of nonprofits must be “reasonable” in terms of salaries and fringe benefits.

Exclusive, in the sense that the organization pursues only purposes defined as public benefit: if an organization carries out other activities, it may lose the nonprofit tax status altogether. In practise, the organization may declare some of its activities as public benefit and others as “commercial.” This has the effect that those activities classified as public benefit receive preferential tax treatment, whereas commercial activities may be subject to taxation.

Direct, in the sense that the charitable purpose has to be served by the organization itself rather than through third parties. This provision contains many exceptions that basically relate to inter-organizational structures, financing, and special institutions, whereby a third party may provide services on behalf of a tax-exempt organization.

Timely, in the sense that the organization has to spend its resources for the specified purposes within a certain time period, usually a given fiscal year. This implies that many nonprofit organizations are not allowed to build up financial reserves or accumulate capital for investment. Again, there are many exceptions to this rule.

The functional definition, under both common law and civil law, has at its core the notion that nonprofit organizations are identifiable by their financial behavior, in particular their lack of a financial profit motive or restriction of profit distributions. This is also the starting point for the economic definition.

The economic definition

According to this definition, the key feature that sets the nonprofit sector apart from the others is the revenue structure of nonprofits. According to economic definition, nonprofit institutions (or NPIs) do not receive the bulk of their income from the sale of goods and services in the market, or through taxation, but from the voluntary dues and contributions of their members and supporters. Importantly, this basis for defining NPIs, which focuses on the common characteristic that they do not distribute their profits, is a central feature of most definitions of “the nonprofit sector” in legal … and social science literature …

The economic definition is laid down in the System of National Accounts (or SNA) (United Nations 1993), the international economic standard used for economic reporting and forecasting purposes of many kinds.

Within this structure, the 1993 SNA distinguishes nonprofit institutions from other institutional units principally in terms of what happens to any profit that they might generate. In particular:

Nonprofit institutions are legal or social entities created for the purpose of producing goods and services whose status does not permit them to be a source of income, profit, or other financial gain for the units that establish, control or finance them. In practise their productive activities are bound to generate either surpluses or deficits but any surpluses they happen to make cannot be appropriated by other institutional units.

(UN 1993, para. 4.54)

National accounting groups similar kinds of economic entities into institutional sectors.

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The structural–operational definition

This definition does not emphasize the purpose of the organization or its sources of income but its basic structure and operation. According to this definition, which was first introduced by Salamon and Anheier in 1992a, an organization is defined as a nonprofit entity if it shows the following five characteristics:

1 Organized, i.e. institutionalized to some extent

What is important is that the organization has some institutional reality. In some countries a formal charter of incorporation signifies this, but institutional reality can also be demonstrated in other ways where legal incorporation is either not chosen or not readily available, such as having regular meetings, officers, rules of procedure, or some degree of organizational permanence. By contrast, purely ad hoc and temporary gatherings of people are not considered part of the nonprofit sector under this definition. Otherwise the concept of the nonprofit sector becomes far too amorphous and ephemeral to grasp and examine.

This criterion also requires meaningful organizational boundaries, e.g. some recognized difference between members and non-members; an awareness of the distinction between organizational and individual responsibilities; and an understanding of the difference between the organization and other entities such as family, friendship circles, and loose networks among individuals.

2 Private, i.e. institutionally separate from government

Nonprofit organizations are not part of the apparatus of government. They are “nongovernmental” in the sense of being structurally separate from the instrumentalities of government. This does not mean that they may not receive government support in cash or in kind, or even that government officials cannot sit on their boards. What is important from the point of view of this criterion is that the organization has an institutional identity separate from that of the state, that it is not an instrumentality of any unit of government whether national or local, and that it therefore does not exercise governmental authority.

While such separate institutional identity is relatively easy to identify in most cases, there are numerous borderline cases. The most obvious of these are the many “quangos,” or quasi-nongovernmental organizations, found in a number of European countries as well as elsewhere. The critical point in all such borderline cases is the extent to which such organizations operate as extensions of government, exercising governmental authority, albeit through separate institutional structures.

3 Self-governing, i.e. equipped to control their own activities

Some organizations that are private and nongovernmental may nevertheless be so tightly controlled either by governmental agencies or private businesses that they essentially function as parts of these other institutions even though they are structurally separate. To eliminate such situations, Salamon and Anheier (1997b) add the further criterion that nonprofit organizations must be self-governing. To meet this criterion, organizations must be in a position to control their own activities to a significant extent. This implies that they must have their own internal governance procedures and enjoy a meaningful degree of autonomy.

Under this criterion, the presence of government or corporate representatives on the boards of nonprofit organizations does not disqualify the organizations from being nonprofit. The question is the degree of authority they wield and the degree of autonomy the organization retains.

4 Non-profit-distributing, i.e. not returning profits generated to their owners or directors

Nonprofit organizations may accumulate profits in a given year, but the profits must be plowed back into the basic mission of the agency, not distributed to the organizations’ owners, members, founders, or governing board. The fundamental question is: how does the organization handle profits? If profits are not distributed as income, what happens to them? If they are reinvested or otherwise applied to the stated purpose of the organization, the organization will qualify as a nonprofit institution, assuming the purpose is charitable or in the public benefit. In this sense, nonprofit organizations are private organizations that do not exist primarily to generate profits, either directly or indirectly, and that are not primarily guided by commercial goals and considerations. This differentiates nonprofit organizations from the other component of the private sector—private businesses.

5 Voluntary, i.e. involving some meaningful degree of voluntary participation

To be included within the nonprofit sector, organizations must embody the concept of voluntarism to a meaningful extent. This involves two different, but related, considerations:

First, the organization must engage volunteers in its operations and management, either on its board or through the use of volunteer staff and voluntary contributions. This does not mean that all or most of the income of an organization must come from voluntary contributions, or that most of its staff must be volunteers. The presence of some meaningful voluntary input, even if only a voluntary board of directors, suffices to qualify an organization as in some sense “voluntary.”

Second, “voluntary” also carries the meaning of “non-compulsory.” Organizations in which membership is required or otherwise stipulated by law would be excluded from the nonprofit sector. For example: some professions (e.g. medical or legal) may require compulsory membership in a particular professional association; owners of small-scale industries may be required to join the local chamber of commerce; or employees may be required to join a union. In such cases, the criterion of “voluntary” would not be met, and the associations consequently excluded from the nonprofit sector. Similarly, “voluntary” implies that contributions of time (volunteering) and money (donations) as well as contributions in kind may not be required or enforced by law, or otherwise be openly coerced.

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