(By Attorney Dov Kivlovitch – Published in “”MISHPATI”-“Legal Magazine” – September 2024)
What is the difference between an Israeli Public Benefit Company, a Nonprofit Israeli Organization and an Israeli “Social Enterprise” Entity? How does this manifest in terms of objectives, control, and limitations?
Attorney Dov Kivlovitch believes that as long as the Israeli legislature has not yet advanced an amendment to the Companies Law- the combination of public benefit companies and business corporations is the direction and the next big thing that will advance public benefit projects in Israel.
What is an Israeli Public Benefit Company (“PBC”)?
The Israeli COMPANIES LAW 5759-1999 (“Companies Law“) defines a PBC as a company whose articles of association state: 1) public purposes only, 2) a prohibition on distributing profits or any other distribution to its shareholders.
In other words, it is:
- A corporation – a legal entity created by the law; a company that operates, registers, and is managed according to the Companies Law (under a special chapter designated for it, following special amendments).
- For public benefit – meaning that: its purposes, establishment, and management are “public” in nature: aimed for the benefit of defined interests of specific large groups or the public in general. These specific purposes are outlined in the schedule of the Companies Law, including: education, sports, welfare, science, health, religion, and more.
- Prohibition on profit distribution or any other assets distribution to its shareholders.
How is a PBC different from a nonprofit organization?
An Israeli nonprofit organization (“NPO“, or “Amuta“) is a legal entity created under the Nonprofit Organizations(“Amutot“) Law (1980), which defines an Amuta as:
- A corporation – established for any legal purpose.
- “…not intended for profit distribution among its members and…
- Its primary purpose is not to make profits (although some of its secondary purposes might involve profit-making).
Unlike a PBC, Amuta’s legal purposes are not restricted, as long as the primary purpose is not profit-making. The law under which an Amuta operates is older, dating back to 1980, and its legal management tools are outdated. Revisions have been made through several amendments that granted broad powers to the regulator–the Registrar of Associations. The basic governing body with overarching powers in an NPO is the general assembly of its members (in Hebrew: “Asefa Clalit“).
Amuta vs. Israeli PBC
In a company, the relationship between the organization and its member is through a legal element called a “share,” which represents ownership rights – the ownership of the share itself. A share embodies and contains a bundle of rights in the company incl. control rights. There can be different types of shares depending on the acquired rights. This concept applies theoretically even in an Israeli PBC, although its goals are not profit-making or the distribution of profits. In general-any personal gain is prohibited.
Difference in objectives – A NPO is fundamentally different from a “regular” (for personal benefit) company in that it is not for profit. An Israeli PBC[1] is also not for profit, but unlike an Israeli PBC, an Israeli NPO is not restricted in its objectives, which can be liberal and may include profit-making purposes in order to finance its activities. However, when entities seek approval as a “public institution” from the Israeli Tax Authorities, the difference in the objectives of them- narrows; the Tax Authority requires a “public institution” to have solely public objectives as defined in Section 9(2) of the Income Tax Ordinance.
Difference in control – In a company, the share allows control over the management through the owner’s right to appoint directors, who form the governing body that sets policy and often manages the company. Furthermore, the share cannot be taken from its owner (as it is a property right), and the owners cannot be deprived of their rights in the company based on their shares.
In contrast, in a NPO, control is exerted through personal influence via majority voting in the general assembly of the NPO’s members. As members change or new ones join, the majority in the general assembly will control the organization through its decisions, including the replacement of the governing board. Unlike a company, in a NPO, the founders or significant contributors can be ousted by a decision of the assembly, losing their rights and positions.
Key similarity – Despite the different structures and founding laws, Israeli NPOs and PBCs are very similar in their sole nonprofit purpose: to function as entities serving public interests, not for personal or group profit, and to be exempt from income tax and VAT.
Likewise, what unites or makes them similar is the tax law’s treatment of such entities and its requirements (whether as an NPO or a PBC). To achieve the status of a “public institution” exempt from taxes on its income from any source and not subject to VAT (as a nonprofit entity under the VAT Law), both must comply with the requirements of Section 9(2) of the Income Tax Ordinance as a “public institution”. This section mandates the entity to have at least seven members,the majority of whom are not related, and to ensure that its means (assets and income) are used solely for the public purpose. A “public purpose” is defined as one involving religion, culture, education, science, health, welfare, or sports, or another purpose approved by the Minister of Finance as “public”.
Although there are differences in the founding law and operational legal structure, when entrepreneurs approach the state – the Tax Authorities – for the approval of a nonprofit status, the tax authorities impose the same substantive requirements on both NPOs and PBCs. Therefore, in this essential aspect, they are identical. Likewise, recent amendments to the Amutot Law and the Companies Law have imposed identical regulatory requirements on both types of entities.
Israeli PBC vs. Israeli Business Company
A PBC differs from a business company in that it is prohibited from having profit-making purposes or distributing profits or any other personal gain. However, most of the rules and provisions of the modern Companies Law still apply to it, providing its shareholders with better management and finance tools, which are familiar to those experienced in for-profit companies.
How do a NPO and a PBC relate to a corporation that is a “social enterprise”?
For several years, there has been ongoing discussion and initiatives to grant special legal status to an entity recognized as a “social enterprise”. This refers to an entity that is a “hybrid” combination of a “for profit” company and a legal entity with public purposes[2].Such a hybrid entity is expected to operate for profits as a means to encourage entrepreneurs to contribute to society and the environment (i.e., to pursue public, mainly social, goals). Its uniqueness lies in the fact that its business activity is intended also to achieve social goals or fund them.
Indeed, international studies on the subject have shown that it is advisable and beneficial to promote specific legal frameworks for hybrid corporations in terms of their goals and activities (both business and social), but so far, a social enterprise has no legal definition and no defined corporate structure. Hence, in principal both an NPO and a PBC can be used as a corporate legal structure for a social enterprise.
Attempts have been made to define it legally through amendments to the Israeli Companies Law (in 2017 and again in 2019) adding to the PBCs part a special chapter which defines a new type of company: a “social business company”. But so far, no agreed-upon amendment has been reached.
Moreover, so far, the Israeli Tax Authorities have been reluctant to grant recognition and benefits to such social businesses operating through a NPO or a PBC.
As of the end of 2024, no such legal entity exists. However, in light of its proven advantages, it seems that its time will eventually come.”
The Impact of the Public Purpose Requirement on an Israeli PBC
In theory, a PBC can only be established based on public purposes detailed in the schedule of the Companies Law – a closed and seemingly restrictive list. This limitation also affects the future of the PBC- since if the management of the PBC wishes to update or change any of its objectives, and the change is deemed “substantial”, then a court approval is required. This can create difficulties with donors (who may have donated based on the company’s pre-change objectives) and with the regulator who intervenes on their behalf due to the “principal-agent problem” (donors and beneficiaries of the PBC’s services have no influence over its management or the alteration of its objectives).
In contrast to PBC, in an NPO, it is theoretically possible to anticipate future changes by specifying more objectives, not necessarily public ones, which may “capture” more possibilities for the future activities. However, this is only an apparent advantage because the limitations, definitions, and Tax Authorities requirements mentioned above- reduce the primary objectives to only public ones, narrowing the options and once again reducing the difference between an NPO and a PBC.
Why Establish an Israeli PBC?
An Israeli PBC is a unique legal entity with special abilities and rights. On the one hand, it enjoys advantages as a nonprofit organization, such as tax exemption and recognition as a public institution for grants and donations. On the other hand, it has an efficient and modern management structure. In addition, it preserves the ownership and control of the entrepreneurial shareholders who invested resources, money, time, and reputation into the entity, and they cannot be ousted from it. Control can even be transferred to another person -by the transfer of the company’s share/s, but only for a symbolic sum.
Another Advantage: The company’s structure and management methods are familiar to those experienced with for-profit companies. As a company, it also has better familiarity and accessibility in forming partnerships and collaborations with similar entities or business corporations, along with the advantages of cooperating with an entity that has resources and managerial and financial capabilities.
When to Prefer Establishing a NPO, and When a PBC? Pros and Cons
In favor of a PBC
When the entrepreneurs value management efficiency and control in the nonprofit organization, the ability to appoint professionals to the board of directors who are not shareholders, the importance of proximity to business corporations, and the willingness to meet the requirements and challenges of establishing and adhering to public objectives (from which deviation is theoretically prohibited in the future). Also, if there is an emphasis on gaining and maintaining control of the corporation, then relying solely on the drafting of articles of association, granting special rights and control to relevant parties in the articles may create difficulties with the Tax Authorities when applying for “public institution status” for donations.
Against a PBC and in favor of a NPO
If the organization’s future and activities are not entirely clear, or expected to change, including its objectives, and if a profit-making mechanism (even for the organization’s purposes) is planned. Also, if it’s important to establish the entity quickly and without complications, and if there is a desire to specify business and profit-making objectives in the articles, the tendency would be to prefer a NPO.
However, the well-known rule still applies: each case depends on its own circumstances.
What is Recommended at the Startup Stage?
The above is merely a basic and initial model for analysis and planning. There may be additional possibilities for combining nonprofit entities with other nonprofit organizations or with business entities they control, or in cooperative agreements with them.
As mentioned earlier, the process of establishing a PBC requires, already at the planning and entrepreneurial stage, a comprehensive discussion, thoughtful and precise planning for the future. Therefore, it is advisable to conduct brainstorming and present as much data, scenarios, and expected goals as possible in consultation with a legal advisor to make decisions and act accordingly, aiming to minimize substantial changes to the articles and objectives in the future. Hence, it is preferable that such a process be carried out with the guidance of lawyers who are well-versed in both the nonprofit and business worlds and can understand the complex relationship between the two.
Looking to the Future
As long as the suggested amendments to the Companies Law have not been enacted into legislation – combinations and cooperations between for-profit companies and nonprofit organizations- especially PBCs – are the near future in Israel.
“Today, we are beginning to see the first signs of the next stage, where corporate responsibility is seen as creating synergy with the business activities of the organization, as an activity that can yield business benefits and opportunities. This approach is particularly favored by management because, at its core, it contains the important understanding that corporate responsibility is not only a source of expense but can also be a source of income, with proper management and creativity. In professional jargon surrounding corporate responsibility, this approach is called ‘doing well by doing good’–doing good for the organization by doing good for its surroundings” (Wikipedia – August 2024).
Accordingly, the combination of a nonprofit organization specializing in a certain public activity with a business entity that may benefit from the connection to that public-oriented activity, where the business entity contributes its managerial and business assets—knowledge, business and managerial skills, technology, and capital—into the framework of the nonprofit corporation, can serve for the above approach and create a “win win situation”: Both the general public and the shareholders of the business entity will benefit from it .
As recognition of the potential benefits of such cooperations increases, so too will initiatives multiply, and eventually, mutual successes will emerge from these collaborations.
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[1] Unlike a Delaware PBC – which is formed for business purposes and retain profits and also for public purposes.
[2] A new legal entity which corresponds with the Delaware PBCs.
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