B-Corporation as Subsidiary for Non-Profits

Arizona’s Newest Business Entity, The Benefit Corporation

By | Articles, Business

In many markets, consumers and employees, alike, hunger for purpose-driven companies committed to socially and environmentally responsible business practices.

Prior to this year, however, Arizona did not offer a form of business entity that could fully accomplish a dual mission, producing both profit and social good. But now, the Benefit Corporation, or “B-Corporation,” exists as another option for Arizona entrepreneurs, enacted under A.R.S. § 10-2401, et seq.

B-Corporations are uncommon but up-and-coming. For example, in Fort Collins, Colorado, New Belgium Brewing Company, a one-hundred percent employee-owned B-Corporation, serves up an award-winning beverage, while making smart sourcing decisions and charitable partnership initiatives, including a strategy to purchase 10% of all hops from Salmon Safe Certified farms, ensuring healthy watersheds for native salmon. New Belgium also holds accountable the companies in its supply chain on issues such as manufacturing, transportation, waste, and company culture — and likewise, the beer-maker tracks its own statistics to reduce mega joules of energy, water, and greenhouse gas used in production. With these ingredients, this B-Corporation has disrupted the craft beer market.

Fundamentally, the question is whether the underlying state law that governs the company supports the entrepreneur’s mission-driven direction.

If not, then the company faces significant legal risk. The problem arises when one camp wants to use company assets to prosper a non-owner stakeholder, opposed by another group unwilling to subsidize that effort. These disagreements often surface when socially-conscious for-profit companies attempt to scale.

Consider an equity investment, a merger, or a liquidity event. In a larger corporate operation, governance and economic rights are spread out, allocated across tens or thousands of persons, including officers, directors, and shareholders. Historically, managers lean toward their traditional fiduciary responsibility to maximize returns to shareholders. The risk of litigation looms over their planned acts of generosity.

And so, the company’s social agenda will be trimmed back or cut.

On the other hand, the laws for the B-Corporation entity augment certain fiduciary duties, allowing or even requiring managers to pursue shared and enduring prosperity for all stakeholders. Further, tactically, B-Corporations offer market differentiation, broad legal protection to directors and officers, and expanded shareholder rights. Commitment to B-Corporation standards can also attract and retain talented employees.
At New Belgium Brewery, Jenn Vervier, Director of Strategy and Sustainability, agrees that the company’s legal commitments have, “signal[ed] to our stakeholders (coworkers, customers, suppliers, and community) that our values are truly at the core of our business.”

In upcoming articles, I’ll guide you through a few important topics, including fiduciary duties, corporate structure, and the logistics of operating a B-Corporation.

B-Corporation as Subsidiary for Non-Profits

B-Corporation as Subsidiary for Non-Profits

By | Articles, Business

A B-Corporation could nicely fit within the overall corporate structure of a tax-exempt organization, maintaining the tax exemption by limiting unrelated business income and, at the same time, aligning with the organization’s mission-driven standards.

For example, many churches are currently considering revenue-producing mixed-use real estate development projects. Those projects might include administrative and programming spaces for the congregation, along with retail space and condominiums or leasing to other commercial ventures. All in all, churches have pursued these opportunities to acquire better real estate and improve cash flow, allowing them to create spaces in expensive urban areas. Others simply need a way to save a distressed property from foreclosure.

Let’s review some fundamental concepts in connection with exempt organizations. Then, we can think about how the B-Corporation might be used.

Exempt Organizations and Unrelated Business Income Tax

The Internal Revenue Code specifies certain types of organizations that are exempt from federal income tax. The most common types are charitable, religious, and educational organizations. Others include: civic associations, labor organizations, business leagues, social clubs, fraternal organizations, and veterans’ organizations. The main benefit of exempt status is that the organization does not pay federal income tax on income related to its exempt purpose. More particularly, a 501(c)(3) organization must engage in activities that further its exempt purposes or it jeopardizes its tax-exempt status and its eligibility to receive tax-deductible contributions.

Nonetheless, a 501(c)(3) tax-exempt organization may engage in income-producing activities unrelated to its tax-exempt purposes as long as the unrelated activities are not a substantial part of the organization’s overall activities. Yet, the net income from such activities will be subject to the Unrelated Business Income Tax if three conditions are met:

  1. The activity constitutes a trade or business.
  2. The trade or business is regularly carried on.
  3. The trade or business is not substantially related to the exercise or performance of the organization’s exempt purpose.

In addition to tax liability on unrelated business income, a 501(c)(3) organization with substantial unrelated trade or business income jeopardizes its exempt status. There is no bright line test to define how much unrelated business income is “substantial,” but anecdotally, the generally held position is that it should not exceed 10-20% of the organization’s income.

An Example

Now, consider an Arizona nonprofit corporation, who received 501(c)(3) tax-exempt status, a corporation whose exempt purpose is to stimulate and foster public interest in the fine arts by promoting art exhibits, sponsoring cultural events, and furnishing information about fine arts. Suppose that this organization leases studio apartments to artist tenants and operates a dining hall primarily for these tenants. Under the current tax law, these two activities do not contribute importantly to accomplishing the organization’s exempt purpose. Therefore, they are unrelated trades or businesses.

This does not necessarily mean, however, that the organization should discard its idea to provide studio apartments and a dining hall. But it must thoughtfully plan how to implement the project without risking its hard-earned tax-exempt status.

Generally, a separate business entity might be formed to operate the new venture.

Then, the question is how the income received by the exempt organization, from the operation of the separate entity, will be characterized. The income could be unrelated business income. The answer will turn on the tax characterization of separate entity.

B-Corporation Subsidiary as a Solution

One strategy would be to form a subsidiary, a company that is partly or completely owned by the exempt organization, and have the exempt organization hold a controlling interest in the subsidiary company. They key is that dividends are excluded when computing an exempt organization’s unrelated business income.

Briefly, dividends are generally excluded from unrelated business income for two reasons. First, the exempt organization as shareholder is acting, generally, as an investor, not engaged in a trade or business, negating the first element of unrelated business income. Second, the subsidiary corporation who earned the income pays tax. And so, in this scenario, the IRS is ultimately able to receive its share.

Let’s return to our fine arts organization, from our example above. Applied there, the exempt organization could retain control of the studio apartment and dining hall project and receive dividends from its subsidiary who operates that project, without garnering any unrelated business income tax. As an aside, the subsidiary in this case would operate for-profit and pay income tax to the federal government, and the exempt organization would not pay tax in connection with dividends received. As a result, the primary goals would be met: [1] preserving the exempt organization’s tax-exempt status and [2] minimizing tax liability.

This strategy could be implemented with either a B-Corporation or a C-Corporation. On the other hand, an entity with partnership tax treatment such as certain limited liability companies, would not be a proper choice of entity for the subsidiary, as the unrelated business income would pass through from that company to the exempt organization, causing a tax liability and jeopardizing its exempt status.

The exempt organization may consider using a B-Corporation to convey the message that the subsidiary is transparent and accountable — and that it will produce benevolence for the community, just as the exempt organization does. And legally, the directors and officers of the B-Corporation subsidiary would owe fiduciary duties to pursue those benefits.

Both corporate forms can achieve the tax-minimization goal. But a B-Corporation might better align with the exempt organization’s story and values.

B-Corporation as Subsidiary for Non-Profits

Preview: Arizona Entity Restructuring Act

By | Articles, Business

Arizona will offer a more business-friendly legal framework next year, thanks to new law for entity restructuring transactions, law that will take effect on January 1, 2015. The result will be that these transactions will be more efficient and available at a lower cost.

Background: What is an Entity Restructuring Transaction?

Your company may reach a point in its life where it needs to undergo an “entity restructuring transaction,” a transaction to change its form or location. For instance, you might have started your family-owned business as a partnership, and now the business has attracted an angel investor, someone who may require your business to convert to a corporation to facilitate an outside investment. Or perhaps your real estate investment company needs to divide into one or more new limited liability companies, to settle a dispute among the owners. In total, there are five such entity-restructuring transactions.

To briefly catalog them: a merger occurs when two entities combine into one surviving entity; a conversion occurs when a single entity changes form — for example, when a limited liability company converts into a corporation; an interest exchange occurs when owners trade their ownership in one company for ownership in another company; a domestication occurs when an entity formed in one state changes its state of incorporation to another state; and a division occurs when one entity divides into two or more entities.

The Problem: Obsolete Law Governing Intricate, Multi-Step Transactions

Historically, entity-restructuring transactions have required multiple steps to accomplish, ratcheting up your risk and expense. Your business may have even needed to dissolve to change its form or location. In that case, you would have needed to wind down, satisfying creditors and interest holders, potentially incurring adverse tax consequences. Those consequences erode your profitability. And those consequences are counterproductive to a company that simply wants to continue in another form or location.

Compounding the problem, Arizona has not had a comprehensive statutory framework for these transactions. Our entity restructuring laws were hard to find, scattered throughout Titles 10 and 29 among the twenty-two types of Arizona business entities. And our entity restructuring laws were incomplete, leaving out domestications and divisions. And those laws were procedurally inconsistent, imposing different requirements for the same transaction on different entity forms.

The Solution: Arizona Entity Restructuring Act and its One-Step Transactions

The Arizona Bar and Arizona lawmakers recognized those issues and have been working over the last four years to implement a solution: the Arizona Entity Restructuring Act (“AERA”), which will take effect January 1, 2015.

In sum, AERA universally applies to all kinds of business entities. And the law will allow your company to change form or location, without dissolving and winding down. Cross-entity transactions are available. And the statute fits with our existing law for business entities, meaning that our current corporate and partnership statutes will remain intact. Moreover, these new procedures will not extinguish creditors’ interests as a debtor-entity changes form. Therefore, AERA allows for seamless, non-disruptive transitions between the old and new companies. Entity restructuring transactions will be more efficient and available at a lower cost.

Here is the simple process under AERA.

First, each kind of transaction requires a written plan, one approved by the company’s interest holders. The plan will describe the details and effect of the transaction. You approve that plan according to your company’s organizational documents, such as its bylaws or operating agreement, or AERA’s default rules. Second, once the plan is approved, a statement concerning the transaction must be filed with the appropriate filing authority, which is the Arizona Corporation Commission for corporations, business trusts, and limited liability companies, and the Arizona Secretary of State for limited partnerships and limited liability partnerships. That statement notifies the public of the transaction and identifies the surviving business entity.

To round out this discussion, AERA does not apply to government agencies, trusts, or estates — and does not displace relevant regulatory statutes, dissenters’ rights, or appraisal rights.


You wisely chose to form a business entity to limit your personal liability and to aggregate capital and assets, such as your residential or commercial real estate. Beginning next year, you will be better equipped to change your company’s form or state of incorporation. AERA is straightforward and comprehensive. Overall, it will encourage new businesses to incorporate or organize or in Arizona and will make it easier for existing out-of-state companies to relocate to Arizona.


  1. Terence W. Thompson and Raj Gangadean, “Coming Attractions for Arizona M&A Practitioners: Preview of the Arizona Entity Restructuring Act” (November 19, 2014).
  2. The National Conference of Commissioners on Uniform State Laws, ed., Entity Transactions Act Summary (available at: Transactions Act, accessed May 20, 2013).