Challenges to Implementing Social Finance Policy in Canada

SUMMARY : Aggressive spending-reduction policies at the federal level beg for new types of financing such as social finance and social impact bonds to fund socially beneficial projects. But the implementation of social finance tools, in particular social impact bonds, could significantly change or even increase accountability requirements by, for example, bringing third-party private sector investors into the traditional government/nonprofit relationship, or demanding stricter accountability and reporting in order to determine whether a payout is warranted at the end of the project. Social finance tools could also run afoul of the Income Tax Act or create inter-governmental tensions. Without a larger federal policy framework that considers and resolves these challenges, the expansion of social finance in Canada may be slow-moving or languish.

RÉSUMÉ : Des politiques fédérales vigoureuses en matière de réduction des dépenses appellent de nouveaux types de financement, comme le financement social et les contrats d’impact social en vue de financer des projets avantageux d’un point de vue social. Mais la mise en place d’outils de financement social, en particulier les contrats d’impact social, pourrait changer considérablement ou même accroître les exigences sur le plan de la reddition de comptes — par exemple, en faisant participer des investisseurs tiers du secteur privé aux rapports qui unissent traditionnellement le gouvernement et le secteur sans but lucratif; ou encore, en imposant des exigences plus strictes en ce qui a trait à la reddition de comptes et aux rapports afin de déterminer si le recouvrement des coûts est garanti à la fin du projet. Les outils de financement social pourraient aussi transgresser la Loi de l’impôt sur le revenu, ou créer des tensions intergouvernementales. Sans un cadre de politiques fédérales plus vaste pour tenir compte de ces défis et les résoudre, au Canada le financement social pourrait stagner ou se développer lentement.

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of the Federal or Ontario government or any agency thereof.

In November 2012, former Human Resources Minister Diane Finley asked Canadians to propose innovative ideas to the federal government on tackling social issues such as homelessness, literacy, and unemployment. Human Resources and Skills Development Canada (now Employment and Social Development Canada) simultaneously launched a ‘National Call for Concepts for Social Finance’ and gave until December 31, 2012, to submit ideas online. The invitation was part of the federal government’s undertaking in the Economic Action Plan 2012to examine social finance opportunities. In her announcement, former Minister Finley stated: “My hope is that Canadians submit new and exciting ideas that can possibly shape future social policy in Canada or identify new partners with whom we can work or learn” (Ministry of Human Resources and Skills Development, November 30, 2012).

Social finance refers to an alternative means of investing capital, which differs from traditional investing in that the financier seeks to enhance society and/or the environment in addition to receiving a return comparable to financial markets (Shah & Costa, 2013). Social finance investors are generally private sector individuals and businesses with a social conscience, although some private and charitable foundations also invest in social finance initiatives. Facilitating the private sector to fund socially beneficial services has high potential to produce innovative ideas and open up new sources of revenue. As deliverers of numerous social services, nonprofit organizations have much to gain from the promotion of social finance. Please note that in this article, the term nonprofit organization includes registered charitable organizations, unless otherwise specified.

Former Minister Finley’s November announcement provoked interest and debate within and outside the nonprofit sector regarding the features and potential impact of social finance. Some welcomed the federal government’s initiative while others criticized it as a plan to download public services or commercialize social values (Clancy, 2013; Shapcott, 2012). There are many concerns, especially with respect to how social finance might shape public service delivery and funding, yet commentary has been sparse on how social finance may influence nonprofit accountability and performance measurement as a result of bringing in the private sector. Of greater concern are the continuing regulatory and administrative challenges that have been recognized by the federal government as barriers to developing social finance tools. In an October 2012 document, Human Resources and Skills Development Canada (HRSDC) noted four distinct legal and administrative issues that “need to be addressed before a made-in-Canada [social finance mechanism] can be established” (HRSDC, 2012). The barriers included: (1) treatment of social finance tools under the Income Tax Act, (2) creation of appropriate financial instruments to reimburse successful social finance projects, (3) formulation of accounting procedures to monitor reimbursement, and (4) management of intellectual property developed during social finance pilot projects. The document did not specify how the federal government planned to address these barriers.

Another challenge noted by HRSDC was its own limitation, as the lead department, to explore social impact bonds only within its mandate. Jurisdiction for the bulk of Canada’s human and social service areas falls to the provinces, making them better placed to develop new financing tools for social programs. Former Minister Finley’s announcement did not indicate whether the federal government would work with provinces to promote or support social finance in areas of provincial responsibility.

This article explores the tension between the federal government championing social finance at the same time as concerns around nonprofit accountability, and regulatory and intergovernmental ambiguity persist. Without a larger federal policy framework that considers and resolves these challenges, the expansion of social finance in Canada may be slow-moving or languish.

Social finance
Social finance has become of interest to a variety of stakeholders in recent years. Governments are leveraging social finance tools in light of the continuing sluggish economy and resulting pressure to cut spending and balance budgets. Investors are becoming inclined to seek both a financial and social return on their investments due to increasing emphasis on social and environmental degradation. Nonprofit organizations are eager to use social finance to augment revenue from non-traditional sources and potentially gain more control over project management and associated costs than exists under current finance models (Aptowitzer & Dachis, 2012).

There are three main types of social finance tools: (1) social investment funds, (2) social enterprises or social purpose businesses, and (3) social impact bonds. A social investment fund is an institution or fund that provides financing for small-scale public investments for social or environmental projects either through capital expenditure or a loan with specified terms. Such funds aim to generate social capital and build communities. By contrast, social enterprises and social purpose businesses generate revenue by producing goods and services for the marketplace. Investing in or buying from social enterprises or social purpose businesses directly supports their social missions (Mulholland, Mendelsohn, & Shamshiri, 2011). Finally, social impact bonds, the approach favoured by the federal government in the Economic Action Plan 2012, are bonds funded by financial investors and secured by government. Social impact bonds operate over a set period of time and offer a fixed rate of return to investors that is contingent upon the achievement of agreed upon outcomes. The return is realized through cost savings to government due to financing the service upfront and steering the client group away from using other, more costly, public services later on. Interventions best suited to social impact bonds are those that use a preventive approach to generate cost savings by tackling root causes, and have quantifiable outcomes (So&Jagelewski, 2013). To date, the more experimental aspects of social impact bonds, for instance those around pay-for-performance and suitable outcome metrics, are yet to be tested.

Benefits of social finance tools include: (1) providing incentive for private investors to get involved in the social sector, (2) making funding available for early/preventive interventions, (3) creating more organizations using market principles to attain social goals, (4) fostering more effective and results-oriented social projects, (5) enhancing responses to new challenges, (6) assuring reliable sources of funding for the entire length of a project, and (7) encouraging organizations to enter into collaborative partnerships with similar service providers because financing is not competitive (Jagelewski, 2011).

Potential risks that come with social finance include: (1) blurred lines of accountability and tax status, (2) overstepping of jurisdictional boundaries,(3) interference by private investors, (4) loss of reputation if the social project fails to achieve targeted outcomes, (5) funding being channeled to outcome-oriented projects rather than those that are needed, (6) discouraging valuable but hard-to-evaluate services, and (7) reducing the use of government grants(Social Finance, n.d.).

Federal government social finance initiative
Former Minister Finley’s November announcement came out of the federal government’s undertaking in the Economic Action Plan 2012,“to support the momentum building around social finance initiatives and…explore social finance instruments” (p. 173).In the Plan, the federal government stated it was in the process of examining ways to maximize its impact of spending on community-level partnerships through supporting social finance initiatives, including pay-for-performance agreements, and capitalizing on private sector resources. Continuing to explore social finance instruments was also recommended by the (federal) Standing Committee on Finance in February 2013 as part of a longer set of recommendations to boost charitable giving in Canada (Standing Committee on Finance, February 2013).

In May 2013, the federal government published the results of the National Call in Harnessing the Power of Social Finance: Canadians Respond to the National Call for Concepts for Social Finance. The report noted that citizens, businesses, charities, and other groups had submitted a total of 154 responses, which encompassed using social impact bonds, social investment funds, and social enterprises, as well as restructuring current funding streams to incorporate a social finance element. The report highlighted 15 concepts to illustrate the wide range of ideas put forward. It also described ongoing social finance activities across Canada and internationally.

As a next step, Harnessing the Power of Social Finance stated the federal government would seek to bring social finance players together, encourage new partnerships, and stimulate innovative ideas for addressing social and economic challenges. Ideas from the social finance submissions would be used to support research and policy development as well as identify partners with whom the federal government could work.

In its budget, Economic Action Plan 2015, the federal government stated it will “implement a social finance accelerator initiative to help promising social finance proposals become investment ready, attract private investment and turn social entrepreneurs’ proposals into action (p. 271).” The initiative aims to help “fast-track promising social finance ventures” to become more investment ready through supporting workshops, advisory services, mentorship, and networking/connection opportunities. (p. 271). This initiative indicates the federal government is continuing to take an active role in supporting social finance activities.

In October 2013, the federal government announced two literacy and essential skills pilot programs to be funded by employers and investors, who would be reimbursed up to 50% of costs if training participants achieved certain test scores (Curry, 2013). Employment and Social Development Canada’s accompanying news release stated: “The Government is now testing cutting-edge projects to help community organizations develop and implement innovative ideas for social problems and achieve greater, lasting impacts for Canadians” (Ministry of Employment and Social Development, 2013).Although appearing to be social impact bonds, it is not clear if these programs were developed as part of a social finance strategy or are a separate initiative.

By facilitating social finance ideas, the federal government has taken a bold step that can invigorate nonprofit organizations at a time when financial uncertainty and government funding cuts persist even as demand for social services increases. Canada’s social finance initiative follows similar approaches readily being used in other jurisdictions including the United Kingdom, the United States, and Australia. Notably, all three are further ahead than Canada in developing unique tax and business models for social enterprises and other social finance tools (Aptowitzer&Dachis, 2012).

However, since embarking on its social finance agenda, the federal government has not addressed how it plans to deal with barriers to implementing social finance or how social finance fits into wider federal policy on funding for social programs. Accountability for funds and outcomes within a social finance project is one area to consider. Tax concerns, arguably the largest of the regulatory and administrative challenges, are another matter. Finally, there may be federal-provincial jurisdictional issues regarding development/implementation of social finance projects. Each will be considered in turn.

Accountability is an overarching term to describe a set of tools at a government’s disposal to provide assurance that public money is being spent appropriately when social programs are contracted to nonprofit organizations and third parties (Lavasseur & Phillips, 2004). The main external accountability tools are program and financial reports, as well as performance and impact assessments (Shienfield, 2012). Program and financial reports typically provide an overview of short-term accomplishments and account for money spent. Performance and impact assessments measure medium to long-term program results. Both types of accountability instruments need resources and capacity to accurately account for the state of the public program or service and its impact on the community and/or client.

In Canada, accountability came to the forefront in the 1980s and 1990swhen federal policy became focused on ideas associated with the marketplace such as efficiency, value for money, and tangible results, following the global economic slowdown. It was at this point that the federal government began to contract out the delivery of public services to nonprofit organizations and third parties in an attempt to be more efficient and reduce costs (Lavasseur & Phillips, 2004).At the same time, the federal government shifted support for nonprofits from long-term, core grants to short-term, project-based funding. This shift was significant in introducing more rigorous reporting and accountability procedures than had existed previously (Hall, Barr, Easwaramoorthy, Sokolowski&Salamon2005).

Not long after, a 2006 federal government report on Canada’s social economy recounted that nonprofit organizations were experiencing difficulty in devoting enough time and resources to meeting accountability requirements (Human Resources and Social Development, 2006). In the same year, an independent panel looking at federal grants and contributions programs made a similar observation, and recommended that the federal government simplify its reporting and accountability regime (Lankin & Clark, 2006). The federal government has since taken steps in this direction (Auditor General, 2012).

The implementation of social finance tools, in particular social impact bonds, may significantly change or even augment accountability requirements for a number of reasons. In any contract to deliver public services, the accountability requirements are clearly set out between the principal (government) and agent (nonprofit provider), thus allowing the former to maintain control over the products and services. The structure of social impact bonds brings in a third-party private sector investor who may participate in determining a project’s activities and outcomes, thereby changing the principal-agent relationship. Nonprofits may no longer work directly with government to develop a project, which could complicate how projects are designed and whom they are to serve. In order to ascertain whether a payout is warranted at the end of the project, investors may generate an even stricter accountability and reporting regime than already exists with respect to federal grants. As a report on lessons learned from a United Kingdom social impact bond project pointed out: “There is a balance to be achieved between the robustness of the outcome measure and time, simplicity, resources, and data availability” (Disley et al., 2011, p. iii). The federal government has not addressed how the use of social finance tools may affect nonprofit accountability.

Tax considerations
A large concern of nonprofit organizations, next to meeting accountability/reporting requirements, is operating within Canadian tax rules so that their tax exempt nonprofit and/or charitable) status is not jeopardized. Nonprofits that intend to use social finance tools, in particular social enterprises and social purpose businesses, must continue to adhere to the requirements set out in the Income Tax Act (Canada). The application of income tax rules to nonprofit organizations and registered charities has received a fair amount of attention from the CRA, tax planners, accountants, and nonprofits. Over the years, the CRA has provided guidance by issuing guidelines and bulletins.

Under the Income Tax Act, nonprofit organizations are prohibited from intentionally generating profit. Any profit that is generated “must be incidental and arise from activities that support the organization’s not-for-profit activities” (CRA, August 2012). This is the case, regardless of whether that profit is reinvested in the organization. Organizations not abiding by the no-profit rule may lose their tax exemption status (Mulholland, Mendelsohn, & Shamshiri, 2011).

The rules pertaining to charities and profit generation have been more specifically set out by the CRA. Registered charities are permitted to generate profits but only to the extent they arise from “related business activities” or are substantially (90%) run by volunteers. According to the CRA, a related activity is one that is: (1) necessary for effective operations of the charity, (2) a by-product of the charity, (3) an offshoot of the charity, or (4) a use of excess capacity. Linkage is not demonstrated by profits flowing back into the charity. If a charity is operating a social finance activity that is deemed an unrelated activity, its charitable registration could be revoked.

In cases where a nonprofit organization is not certain whether profit is incidental or whether a potential or ongoing social enterprise or social purpose business is related to its activities, it may choose to discontinue or refrain from engaging in the initiative. For example, the BC Centre for Social Enterprise, a nonprofit organization in British Columbia, recently relinquished its tax-exempt status due to fears of no longer qualifying for that status because it provides nonprofit services and runs a social enterprise. As a result, the BC Centre for Social Enterprise pays corporate taxes on all its services (Corriveau, 2012). Alternatively, a nonprofit may choose to use a for profit entity to pursue the activity in question. For example, Free the Children is described as the charity partner to Me to We, a social enterprise operated as a for profit business. These types of solutions may not be the most efficient and effective use of dollars, but are alternatives that an organization could take when confronted with a choice between using social finance tools and staying within tax rules.

In reviewing the Income Tax Act and CRA interpretations of provisions relevant to nonprofits and charities, the CRA “takes a very conservative view of [nonprofit and] charitable activity, which discourages innovation in financial instruments and tools to leverage the full range of foundation assets towards achieving their mission” (Harji, Kjorven, Geobey, & Weisz, 2012, p.34). While acknowledging the existence of tax (and other regulatory) barriers to the use of social finance instruments, the federal government has not indicated how these barriers could be eliminated.

Intergovernmental issues
Provinces are constitutionally responsible for many of the subject areas that lend themselves to social finance instruments such as employment, immigrant settlement, healthcare, childcare, foster care, elderly care, home care, and some housing programs. The Economic Action Plan 2013 specifically mentions three areas in which the federal government received ideas as a result of the National Call: (1) supporting youth at risk, (2) reducing homelessness, and (3) improving employment outcomes for persons with disabilities. Programs supporting initiatives in these three areas would generally be formulated at the provincial level. The federal government may overstep its jurisdiction in trying to turn these social finance ideas into projects. Further, it is provinces that have the expertise and knowledge base to design effective social programs. Practically speaking, it may be more beneficial for the federal government to focus on setting up a regulatory framework supportive of social finance than creating social finance projects.

Aggressive spending-reduction policies at the federal level beg for new types of financing such as social finance and social impact bonds to fund socially beneficial projects. Most Canadians would agree that new, innovative tools and partnerships have become necessary to develop long-lasting solutions to intractable social problems. While ideas and projects using social finance tools have been floating around Canada for the past decade, it is only recently that the federal government has taken a direct interest.

Potential benefits of widespread use of social finance tools in Canada are manifold. Innovative approaches to financing social programs can improve community and social well-being, and lead to economic growth. Social finance tools can enable nonprofits to fund activities that might otherwise not be carried out, and the federal government can shift initial program costs to private investors or members of the public. Social finance can also invigorate the nonprofit sector and create better conditions for innovation and creativity in developing socially beneficial projects.

However, there are clear tensions between the federal government’s push for social finance ideas and obstacles that impede the fluid use of social finance tools. Prior to the National Call, HRSDC acknowledged a number of legal and administrative barriers to the development and implementation of social finance instruments that needed to be addressed before unrolling a social finance scheme. In addition, using social finance tools over traditional financing methods may create more stringent accountability and performance measures for nonprofit organizations. To date, the federal government has not indicated how it will tackle these issues. Not only could this detract from the widespread use of social finance, but is indicative of a policy initiative that may need more analysis before moving forward.

The federal government’s support for social finance may be more effective if embedded within a larger policy framework that is working to remove regulatory barriers as well as address issues around nonprofit accountability and performance measurement when using social finance tools. The role of the federal government in social finance appears to be better suited to developing an environment conducive to social finance opportunities than creating social finance projects, especially considering that many social finance subject areas fall under provincial prerogative. To truly support social finance tools in Canada, the federal government should reconcile its encouragement of social finance with the noted barriers. Already a latecomer to the use of social finance instruments, now is the time for the federal government to develop a comprehensive vision of social finance and a robust policy framework.


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