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The International Journal
of Not-for-Profit Law

Volume 4, Issue 4, June 2002

A publication of the International Center for Not-for-Profit Law

Table of Contents

Articles

The Legal Framework for Civil Society in East and Southeast Asia
Barnett F. Baron

A Flaw in Comparative Studies of the Tax Benefits for NGOs in Latin America
Antonio Itriago M. and Miguel
Itriago M

The Principle of Subsidiarity in Italy: It's Meaning as a "Horizontal" Principle and It's Recent Constitutional Recognition
Andrea Maltoni

A Synopsis of Law Reform for Iranian NGOs
Zahra (Sahar) Maranlou

Tax Treatment of NPOs in Macedonia
Prof. Dr. Vesna Pendovska

Competition and Abuse of Association Membership
Assoc. Prof. Ivo Telec

Reviews

Working with the Non-Profit Sector in South Africa
Working with the Non-Profit Sector in Nigeria

By the Charities Aid Foundation / Allavida
Reviewed by Karla Simon

Legal and Organizational Practices in Nonprofit Management
By Pacquale Ferraro
Reviewed by Karla Simon

Promoting Legal and Institutional Frameworks for Corporate Social Responsibility in Peru
By Javier de Belaúnde L. de R., Beatriz Parodi L., and Delia Muñoz M.
Reviewed by ICNL Staff

Social Responsibility: 12 Case Studies from Chile
by Soledad Teixido, Reinalina Chavarri, and Andrea Castro
Reviewed by ICNL Staff

Case Notes

Asia Pacific:
Hong Kong

Newly Independent States: Russia

North Africa:
Egypt

North America:
Canada | United States

Sub-Saharan Africa:
Ethiopia

Western Europe:
United Kingdom

Country Reports

International:
FATF | World Bank

Asia Pacific:
Regional | Australia | Indonesia | Japan | New Zealand

Central and Eastern Europe: Bosnia and Herzegovina | Czech Republic | Hungary | Lithuania | Macedonia | Slovakia

Latin America & The Caribbean: Chile | Peru

Middle East and North Africa: Kuwait

Newly Independent States: Armenia | Azerbaijan | Kyrgyzstan

North America:
Canada | United States

South Asia:
India | Pakistan

Sub-Saharan Africa:
Nigeria | South Africa | Tanzania

Western Europe:
Regional | Belgium | Germany | Italy | United Kingdom

- - - - - - - - - -

Editorial Board

Country Reports: Central and Eastern europe

Bosnia and Herzegovina

New Implementing Regulations in Bosnia and Herzegovina, by Dragan Golubovic*

The Ministry of Civil Affairs and Communications of the Bosnia and Herzegovina (BiH) has recently enacted a regulation with the somewhat cumbersome name: Regulation on the Manner of Keeping and the Content of the Registry of Associations and Foundations of Bosnia and Herzegovina, Foreign and International Associations and Foundations and Other Not-for-Profit Organizations (Official Gazette of BiH, No 9/2002).

By introducing the Regulation, the Ministry completed the legal infrastructure necessary for the implementation of the state-level Law on Associations and Foundations of BiH (Official Gazette of BiH, no 32/2001).  The Regulations provide the rules for registration at the state-level. In addition to prescribing the manner of keeping the registry of associations and foundations, and the content of the registry, the Regulations further elaborate on the criteria and the procedure prescribed in the Law for granting the status of “public benefit organization.”

ICNL provided technical assistance to the Ministry in preparing the Regulations. It also co-hosted a seminar in Sarajevo where several issues regarding the Regulations were clarified. For example, the Regulations unlawfully extends conditions prescribed in the Law for the establishment of an association by requiring that the founders present evidence to the Ministry about the minimum founding capital. At the seminar, the representatives of the Ministry pointed out that such a provision was unintentionally incorporated in the Regulations and will not be implemented.   

The English version of the Regulations will soon be available on ICNL’s web site.   

* Dragan Golubovic is a Senior Legal Adviser in ICNL’s Budapest office and can be reached at dragan@icnl.org.hu .

Czech Republic

See also in this issue, Competition and Abuse of Association Membership by Assoc. Prof. Ivo Telec

Amendments to Legislation Affecting NGOs in the Czech Republic, by Petr Pajas*

In September 1995 the Czech Parliament adopted the Law No. 248/1995, on Public Benefit Companies, which introduced a new legal form of a non-membership, public services providing NGO; it may be considered parallel to the US “operating foundation.”  Two years later, in September 1997, the Law No. 227/1997, on Foundations and Funds followed, introducing two kinds of legal entities; these may considered parallel to US grant-making foundations, with or without a fixed endowment.  The latter law redefined the legal prerequisites for establishment, operation and termination of private foundations (in Czech "nadace").  It also created a new form of “foundation,” explicitly known in Czech as a “foundation-like fund” (in Czech "nadacni fond").  This may be called in English just a “fund,” being aware, however, of the fact that it is a special form of a legal entity, which differs from a foundation, as well as from a state fund.  In this parlance, a fund is a legal entity established by a special legal act to support specific activities or purposes and managing assets dedicated to public purposes.

This new legal framework restructured the spectrum of foundations in the Czech Republic. Out of more than 5,300 foundations, then in existence and which were established from 1990 to 1996, only some 250 foundations have been able to re-register.  They were required to provide evidence to the court of the existence of an endowment of a value higher than the required minimum of CZK 500,000 (currently about US $15,500). Another 300 to 400 foundations have used the option to become a fund (without an endowment).  About 400 others opted for converting themselves into the operating type of the foundation - a public benefit service providing organization.  This was all possible without the organizations losing their legal status, thanks to the transformation provision in the Law on Foundations and Fund that was in force during 1998.  However, even today about 1500 former foundations may still exist, which did not terminate their activities voluntarily. The District Administration, which has been authorized by the law to liquidate their property, has not found the resources to do so.

In the early days of 1996 and 1997 there was not much enthusiasm for establishing public benefit service providing organizations (also translated from the Czech “obecně prospěšná společnost” as public benefit corporations or companies).  Such organizations are required exclusively to provide commonly needed and commercially unattractive services. This new legal form was originally conceived as a tool for privatisation of the state-subsidised quasi-NGOs surviving from the previous regime. However, the enactment of the Law on Foundations and Funds brought about an important new rationale for using this special legal form, since it appeared to be a means of saving the operating foundations, by permitting their easy transformation. Since 1999, the number of these providers of public services has grown significantly, especially in the field of education (private schools and even universities), social care (residential homes or service centres for handicapped or aged persons) and culture (museums, libraries, galleries, theatres, cinemas, etc.).

In mid-2002, there are already more then 550 grant-making  foundations with endowment, about 720 funds without endowment, and about 780 operating foundations - public benefit corporations in the Czech Republic.  Moreover, about 70 foundations operate with endowments in amounts ranging from CZK 3,000,000 to CZK 50,000,000, which were given to them by the Government as a contribution from the privatisation scheme.

These changes in the legal environment have had positive effects: the three types of foundations form the most transparent part of the not-for-profit sector; their establishment is based on evidence thoroughly scrutinized by registering court; the general public and donors have full access to mandatory data in the foundation register open to public on the home page http://www.justice.cz of the Czech Ministry of Justice, as well as to the detailed information on activities of these legal entities in their mandatory annual reports. Combining these transparency requirements with strict regulations concerning the independent governance of such organizations by persons without a conflict of interest, has made these legal form of foundation type organizations a reliable tool for individual and corporate philanthropy.  They have also become a tool for municipalities and foreign government agencies to carry out their programs through contracting out or financing publicly beneficial projects.

Lessons from practice

Under the Act on Foundations and Funds, such organizations are defined as custodians of assets to be used solely for public benefit purposes. Their activities are, in general, limited to financial support of third persons acting in some public interest or to providing grants in public interest to third persons.  While they are allowed to be engaged in educational, cultural, social and sports activities, as well as to rent their property in order to generate income, their administration expenses must be limited in a transparent way.

From the outset, however, there have been investment and use restrictions with respect to the assets of foundations.  An endowment of a foundation must be explicitly registered and should consist of money kept in a special bank account, real estate, securities, works of art or other assets capable of generating income. Under the prior law, all these investments were required to be within the Czech Republic. Only the income from the endowment is permitted to be used for the activities of the foundation, not its principal amount, but the income is fully exempt from corporate income tax. Other income of foundations (and all income of funds) is taxed at a reduced rate. However, there is only a very limited possibility left to the board of directors of a foundation as regards any change in the composition of the assets in an established endowment.

Neither a foundation nor a fund may be involved in any commercial activity in its own name nor may it participate in such an activity as a partner. However, for foundations (not funds) one exception was allowed under prior law: they were entitled to buy and sell up to 20% of the shares in a company on any public stock exchange, but they could not use for this purpose more than 20% of their property, excluding the endowment.

In practice, these conditions, however interesting they may have looked to the parliamentarians at the time, have seriously constrained the ability of foundations to make proper use of their assets to generate substantial income.  In addition, the restrictions are in violation of the rules of prudent investment, which would allow for greater diversification.  Given the restrictions, foundations have had difficulty earning the income needed for their sustainability and purpose.

In the case of public benefit service providing organizations – public benefit companies, the most inconvenient restrictions on their activities include the strict requirement making the board of directors consist of a multiple of three natural persons, two of every three of whom must be citizens of the Czech Republic. Besides that, a public benefit company was strictly forbidden to establish a branch outside of the territory of the Czech Republic, which has seriously constrained the activities of several important internationally active operating foundations (e.g., the well-known People in Need Foundation, which is engaged in humanitarian relief to people affected by earthquake in Armenia, or civil war in Chechnya, Afghanistan and elsewhere.)

Amended laws

During its last session before the recent elections, the Czech Parliament adopted two laws, which amend the Act on Foundations and Funds and the Act on Public Benefit Corporations.

The most important amendments in the Act on Foundations and Funds broaden the possibility of efficient investment of both endowment assets and the use of other property of a foundation. The endowment composition may now be changed and optimally restructured, unless explicitly prohibited by the founder or donor.  It may also be invested in modern investment tools, such as a contract on investment with a bank whose rating is better or equal to that of the Czech Republic. It was clarified that a bank, which holds an endowment’s monetary assets and securities of a foundation must have a seat in the Czech Republic, but this may also be a seat of a branch of a foreign bank. Under the new legislation, investment assets, such as bonds, certificates of indebtedness and other securities may be issued or registered on a capital market within any country, as long as the country is a member of the Organization for Economic Cooperation and Development.  The monetary part of the foundation’ s endowment may now be also converted into a real estate, but it may not be lent to any person.

The amended law also promotes in a more direct way the concentration of endowed property into efficient foundations by requiring a merger of a weak and inefficient foundation with another foundation. Such a merger becomes a mandatory operation whenever the foundation is not able to stabilize the value of its endowment above the required minimum over a span of one year.

It is also important that now even the profit made from selling the securities placed in the endowment of a foundation is exempt from special income tax.  This may significantly enhance the possibility of using the collective investment instruments, otherwise limited to bonds and state guaranteed securities.

As regards the public benefit corporations, the amendments in the law governing their establishment, operation and termination are mostly of a technical nature. However, the discrimination against foreigners has been fully removed, so that now any natural or legal person may not only establish a public benefit corporation but may also serve on its board of directors or supervisory board. The amended law also allows the removal of a member of the board of directors if he or she in some way violates either the law or the statutes of the corporation, which was not the case under the prior legal environment.

Last but not least, the public benefit corporations may set up branches abroad, as long as the legal system of the country in which they wish to do so regulates the activities of operating foundations similarly to the Czech law.

The Senate – the upper chamber of the Czech Parliament –approved the amendments. After being signed by President Havel they became effective from July 1, 2002.

* Petr Pajas is Legal Consultant to ICNL for Central and Eastern Europe.  He is based in Prague and can be reached at prvni.poradenska@ecn.cz.

Hungary

Abuse of the Law Regulating Churches

During the last year it has come to light that various kinds of organizations – bordellos included – have been registering as churches under Hungarian law.  This abuse of the church law has been brought to the attention of Parliament, and legislation has been prepared to address the issues.

The history of the church law goes back to 1990, in the early days of the change, when it was thought important to create an environment in which people would feel free to establish faith-based organizations after years of their being repressed under Communism.  Thus, the 1990 legislation made it very easy to establish a church, so easy, in fact that the law has come to be abused.

Just exactly how to deal with the problems created is not clear, given the fact that any legislation that is enacted should not interfere with the freedom of religion.  Nor should it discriminate in favor of the older, more established religions and against some of the smaller and newer sects.  On the other hand, having a bordello called the Temple of Isis registered as a church does not in any way advance the purposes behind the legislation!   It is difficult to know how many pseudo-churches have been registered in Hungary up to this point.

One way to resolve the problem might be to require all churches to be registered in the court in Budapest, where expertise could be developed to oversee the registration documents.  Alternatively, it may be possible to create rules that would not automatically make churches tax-free and able to access the funds set up for compensation for losses of church property during the Communist period.  In any event, these are important issues and the situation bears watching as legislative proposals are developed to deal with it.

The Legal Environment for Endowments in Hungary, by Nilda Bullain*

Although nothing prohibits the establishment of an endowment in Hungary (and it is even encouraged by law as one possible form of creating a foundation) in practice endowments do not exist. “Endowment” is used here in the following sense:  an endowment exists within an organization and consists of money and/or property dedicated to a specific purpose. The principal of an endowment must be kept intact indefinitely and only the income from that principal may be used to fulfill the purposes of the organization.   

In analyzing the legal environment of such funds, this paper will look at investment opportunities for NGOs in general, even though it concentrates specifically on endowments.  Besides the current economic circumstances and limited organizational capabilities of such funds, the failure to establish them is probably due to the lack of adequate legal incentives, including unfavorable or unclear regulations in the areas of governance structures.  In addition, the Hungarian legal system lacks adequate risk-management concepts, clarity about liability for investment failures, and has insufficient incentives with respect to the taxation of investment returns. 

Establishment of an endowment

Interestingly, under Hungarian law the establishment of a foundation in itself involves the possibility of creating an endowment.  In the current law, there are two ways to dedicate the property of a foundation, through the so-called “closed foundation”, or through the “open foundation”. 

Art 74/A (1) of the Civil Code (Act IV of 1959) states that “the property required to realize the goals of the foundation must be designated to the foundation” (closed foundation).  This means that the fund must be so-dedicated in perpetuity and that the corpus may never be invaded to do the work of the foundation.  Art 74/B (4) states that if the founder allows others to join the foundation (open foundation), anyone may join [i.e. contribute to] the foundation, under the conditions laid down in the founding statutes. In this case, only “at least the amount of property that is essential to start its operations” needs to be designated to the foundation.

In the various excerpts from opinions by the Supreme Court (which are binding on the judiciary), the following are pointed out:

“In case of a closed foundation, its property can only be increased by the yield of the initial capital [and/i.e.] possibly by the income of the entrepreneurial activity.” (The wording here is not clear, and it is also not clear whether, for example, certain types of yields are by definition considered entrepreneurial activity or not.)

“The founding statutes need to determine the method of use of the property, including the stipulation of whether, in order to accomplish the goals of the foundation, all of its assets may be used [expended] or only the capital of the foundation or only the gains of that capital can be used.” The Supreme Court also determines that “in case of an open foundation, the founder cannot prohibit the use [expenditure] of the initial capital, because that would be contradictory to the requirement that the funds necessary to start the operation shall be available at the founding.” ( Supreme Court Public Administration College, Opinion #2, Section 1[c] )

While it is clear that the first statement (the case of a closed foundation) considers the initial capital as an investment to be harnessed, the latter ones (ways to use the property in the case of both a closed and an open foundation) contradict the notion of the initial capital as an endowment since they clearly allow the expenditure of all of the initial capital for the purposes of the foundation.

In practice, the number of closed foundations is minimal. Founders are not interested in designating large amounts of property to a foundation’s purpose in perpetuity.  The law has created insufficient incentives and too many barriers to the establishment of an endowment; some of these legal obstacles are detailed below.

Governance and principles of investing

One reason why there may be reluctance to endow foundations is that the governance principles of foundations in Hungary are not entirely clear. Although in principle the founder retains the right to appoint and dismiss board members throughout the life of the foundation (and is also the only person competent to modify the founding statutes), in practice the Hungarian court rulings show a tendency to restrict the founder from active involvement in decision-making about the organization. This is logical and understandable, given the fact that in most cases the founder has made only a minimal financial contribution to the organization. There is also a legal argument that a foundation is a separate legal entity, so the founder should be able to exercise only indirect control over a foundation. At the same time, grant-giving endowed foundations and grant-seeking, operating foundations (essentially NGOs) are not distinguished in Hungary. It is also not possible to set up self-perpetuating boards of directors. The controversies around rights and responsibilities of the founder probably impede those who want to dedicate a greater amount of their wealth to a public purpose by creating an endowment.

Art. 4. (1)(b) of Act CLVI of 1997 on Public Benefit Organizations (PBOs), which lists the criteria for a public benefit organization, provides overall guidance on prudence in financial matters when it states that a PBO “only undertakes entrepreneurial activity in order to further its public benefit purposes and without endangering them”.

A concrete example of what a PBO is not allowed to do because it would endanger the realization of its purposes is provided by Art. 16 of the PBO Act: “A public benefit organization shall not issue bills of exchange or other securities creating a debt obligation” and “a PBO, except a public benefit company, shall not draw credit with the aim of developing its business activity to an extent which jeopardizes its public benefit activity”.

Art. 17 of the PBO Act requires that “a public benefit organization pursuing investment activity shall prepare investment rules which are approvedby its highest body”. Apart from the above-mentioned, however, the law provides no further guidance as to what these policies should involve.  Thus, there is no clear guidance as to how a foundation endowment may be invested and the extent to which prudent investment policies govern such investments.

We should also note that the Civil Code and other laws are silent on regulating issues such as the above in the case of foundations that do not have a public benefit status, apart from stating that a foundation cannot be founded for primarily economic purposes (CC Art. 74/B (6)).However, the Hungarian system does have an instrument that could serve as a model.  Act XCVI of 1993 established Voluntary Mutual Insurance Funds, in which individuals are allowed to invest in various financial vehicles that provide for financial growth while ensuring prudence. The funds are obliged to maintain an operational and a liquidity fund besides the equity, and an approved financial manager must manage the funds.  At least in part, the investment management regulations of the Voluntary Mutual Insurance Funds could be applied – voluntarily by the NGOs as well as by legislation -- to endowment funds of NGOs.

Taxation

In Hungary there is a differentiation between "economic activity" and "entrepreneurial activity" (or, in another translation, "business activity"). Act LXXXI of 1996 on Corporate Tax and Dividend Tax (CTDT Law) defines in its first paragraph (Article 1.1.) "entrepreneurial activity"  as "economic activity aimed at or resulting in obtaining income and property". This type of economic activity -- and only this type -- is what a legal person is required to pay tax on, whether it is a for-profit or a not-for-profit entity.

Appendix 6 of the CTDT specifies that in applying Article 1.1 to foundations, public foundations, social organizations, and public societies (e.g., chambers in Hungarian law), from among their economic activities aimed at or resulting in obtaining income and property, the following is not considered entrepreneurial activity:

The difficulty in the interpretation is that while “securities” in legal terminology may mean income from both capital ownership (shares in stock and other ownership rights) and from debenture ownership (interest and other yields), the Hungarian Law on Accounting (Act C of 2000) explicitly differentiates between the two and later consistently refers to only the second group as “securities”.

On the one hand, the CTDT and other laws are not as consistent in using “securities” to mean only debt obligations. On the other hand, in the paragraph above, the CTDT refers to only “interest” received from the “securities,” and so it is not likely that it was the intent of the lawmakers to include shares under this heading. Under this interpretation, a foundation would not be able to invest in a perpetual (“open-ended”) investment fund free of tax, even if the specific portfolio would include only bonds, since such ownership is considered a form of shareholding.

All in all, if a PBO does not have commercial activity at all, its income from investments in credit-type securities (bonds, whether government or corporate-issued) will not be counted as entrepreneurial income.  On the other hand, income from investments in shares, limited partnerships, and perpetual investment funds will be tax exempt only as long as it is under 10% of its total revenue or less than 10,000,000 HUF (in other words, it will be treated as income from entrepreneurial activity.[1]

Liability

As pointed out by ICNL in its memorandum on the same issue for Poland (Legal Environment for Endowments in Poland, May 2001, by Dr. Leon E. Irish, President of ICNL), civil law countries do not have the concept of trust and fiduciary duty in the sense used in common law countries, such as the England or the United States.  In common law countries, issues of liability with respect to endowment funds have largely been derived from trust and fiduciary law. The issue of liability for bad investment decisions is not clear at the present time in Hungary, as the issue of liability of board members and management is not clear in general.

The most concrete reference to such liability is in Art.74/C (6) of the Civil Code that determines the liability of the foundation for damages to a third party caused by a board member or official of the foundation; and states that the board member or official is liable to the foundation according to the general tort rules of the Civil Code.

* Nilda Bullain is Senior Legal Advisor at the ICNL office in Budapest.  A version of this paper was prepared in connection with a project sponsored by the EastWest Institute in Prague and funded by the Charles Stewart Mott Foundation.  The original report “The Hungarian Environment for Endowments and Financial Sustainability” was written by Robert N. Thomas.

[1] Unfortunately, most PBOs are unaware of these issues and PBOs do not take advantage of these opportunities.

Lithuania

New Tax Designation Rule Enacted, by Vaidotas Ilgius*

The Parliament in Lithuania recently enacted a new law on Private Income Tax. This law contains a provision allowing Lithuanian taxpayers to dedicate 2 percent of their income tax to public benefit organizations (i.e., all public and private non-profit entities that are entitled to receive tax-free charitable donations).
 
It was quite a battle getting this bill through the Parliament.  We began talks with the government about the "2 percent" issue in 1999. In the original draft bill, the government proposed that 1 percent of taxes could be designated for NGOs, but only for the support of organizations that are on a special list established by the government. After emailing support letters from NGOs and a few supporting media events, the third vote in the Seimas – taken this year -- was positive and resulted in the rule described above.

On the other hand, we lost "in exchange" the traditional tax deduction for private philanthropists. But we will come back to this issue and hope to restore it fairly soon.

Special thanks are due to our Hungarian colleagues -- NIOK -- for sharing with us their
model and their know-how.  We hope the developments in Lithuania will encourage many more countries from CEE to explore this instrument of philanthropy development.

*Vaidotas Ilgius is Executive Director of the NGO Information and Support Centre in Vilnius.  He can be reached at ilgius@delfi.lt .   The Centre’s website is www.nisc.lt .

Macedonia

See also in this issue, Tax Treatment of NPOs in Macedonia  by Prof. Dr. Vesna Pendovska.

Slovakia

Impact of the April Amendment of the Act on Income Tax on NGOs, by Jana Kadlecova *

On 9 April 2002, the Parliament passed an amendment to the Act on Income Tax, which will enable legal entities to designate to Slovak NGOs 1 per cent of the income tax they have paid. The minimum amount that may be designated is 250 Sk (5 USD). A company may split its designation amount among several entities.

This amendment was prepared in co-operation with representatives of non-governmental organizations including the Slovak Non-profit Centre, the Fund for Support of Social Changes and the Donors’ Forum.  It was also supported by the Slovak Humanitarian Council, the Gremium of the Third Sector, the Rural Parliament and hundreds of local non-governmental organizations.  In addition, many citizens indicated their support for such a change in the tax laws by answering a questionnaire on this topic at www.rozhodni.sk (‘decide.sk’).

Similar to the provisions in the Personal Income Tax Act, the new amendment precisely determines who can be a recipient of the tax designation and how these funds may be used. The funding can be obtained by organisations that register with a notary public as recipients of the tax designations in the period from September to December 2002.

The Donors’ Forum welcomed the decision of parliamentary deputies to enact this legislation. “The deputies have supported the activities of non-governmental, non-profit organisations working for the citizens’ benefit in various fields, e.g. health, social services, education, culture and human rights. At the same time, this will assist the development of corporate philanthropy in Slovakia,” said Zuzana Franova, Executive Manager of the Donors’ Forum. She also added that in this case too, it is necessary to stick to ethical principles of “donorship.”

The amendment of the Act on Income Tax brings about a new source of funding for NGOs, as well as new principles of transparent use of funding obtained from the “One Per Cent” tax designations. Any NGO that receives more than 100,000 Sk (2,000 USD) is obliged to publish information about its use of the funding in the Commercial Gazette.  If an organization fails to do so, the Chamber of Notaries Public will not include it in the list of potential recipients for a period of three years.  The amendment also modified the Act on Accounting adding a requirement for not-for-profit organizations to have their accounts certified by an auditor and published it in Commercial Gazette if the funding received from the “One Per Cent” tax designation exceeds the amount of 1 million Sk (20,000 USD). 

The amendment will become law after being signed by the President and will come into effect on 1 January 2003.

*Jana Kadlecova is with SAIA in Bratislava .

Reform of the Legal Environment for Foundations and Public Benefit Service Organizations, by Petr Pajas*

As of March 1 st, 2002, the legal environment has changed for Foundations and for Not-for-Profit Organization Providing Public Benefit Services (non-membership establishments providing services of public benefit; hereinafter public benefit service organizations “PBSOs” [Editor’s note:  The author used the term “Center” to apply to these organizations, as that term corresponds with the term used in the Slovak language.  For purposes of better comprehension by an international audience, the term PBSO is being used in this article.  It should be noted that this is a term of art referring to a special type of legal person in Slovakia, and that it is not used generically.]  New laws were adopted by the Slovak National Council (Parliament of the Slovak Republic): 

What are the main changes made by the new laws?

  1. Both foundations and PBSOs must re-register and supply additional data to the newly created registering offices established at the Ministry of Interior for foundations and at regional offices for PBSOs and they must be included in a Central Register being maintained at the Ministry of Interior.  The two Registers are accessible to the general public and contain identification and other data, which are needed by third parties to conclude contracts with foundations and PBSOs, with full information about the persons acting on behalf of these organizations and about the public benefit statutory purposes or services to be provided, respectively.
  2. A foundation must maintain an endowment – whose principal value may not be decreased and may not be less then SK 200,000 (about US$ 4,500).
  3. Foundations are allowed to create trusts by their own decision or in agreement with a third person; the trusts are treated as a separate part of the property of a foundation, which is to be used under specified conditions for a specified public benefit purpose. The trusts do not acquire their own legal personality. The foundation is entitled to be remunerated for the costs incurred in the management of the trust.
  4. A foundation’s principal activity is to provide monetary and non-monetary grants to third parties to carry out public benefit purposes.  A PBSO’s principal activity consists in providing public benefit services under equal and defined conditions to all users. The lists of public benefit purposes and services are included in the laws – they are extensive and may be considered as open lists, but that may depend on the  interpretation of the registering office at the time a new purpose is proposed.
  5. A foundation may not conduct business, except for renting real estates, organizing cultural, educational, social or sport activities, if these activities contribute to more effective use of its property and if these activities comply with the public benefit purpose of the foundation. The foundation may not enter into agreement of limited partnership.
  6. PBSOs may be engaged in business activities according to a special regulation [1] provided that such activity allows for more effective use of their property and the quality, extent and availability of services for which they were established will not be endangered. A PBSO may not take part in the business of other persons or to conclude an agreement of limited partnership; its income is subject to income tax according to general tax laws. A PBSO may not condition the provision of its public benefit services on the receipt of donations from natural or legal persons.
  7. The endowment of a foundation or the assets of a PBSO may not be used for financing the activity of political parties or political movements or for the benefit of a candidate for an elected post.
  8. Both foundations and PBSOs have a “Board of Directors,” at a minimum composed of three members, as their governing body. They may also have a “Supervisory Board,” which is mandatory when the property exceeds a certain level. Otherwise, the oversight duties of the Supervisory Board rest with a single “Inspector.”  The operational executive powers in a foundation are conducted by its “Administrator,” and in a PBSO by its “Executive Manager;” both of these executive officers are elected and recalled by the Board of Directors.
  9. The Board of Directors decides in both foundations and PBSOs on the budget and particularly on the amount of income that may be used for administrative costs of the organization.
  10. Both foundations and PBSOs must publish Annual Reports, in which their activity is described and a detailed overview of the status and use of their assets is provided. Under specific conditions, and depending on the income and expenditures or on the acceptance of certain amount of donations from public budgets by a PBSO, the annual balance sheet of income and expenditures must be certified by an independent licensed auditor.
  11. Foreign organization branches may qualify as a foundation or a PBSO by providing to the Registering Office adequate evidence of being a branch of a legal entity under the laws of the foreign jurisdiction as well as having activities corresponding to the provisions of the respective Slovak law. .
  12. Either the Board of Directors or the court may initiate the termination of either form of  legal entity, under conditions set out in the respective Law.  Voluntary termination is initiated by the Board, while involuntary termination is initiated by a court. The laws regulate in detail the liquidation of property of the foundation or the PBSO in cases of involuntary termination or complete cessation of the existence of the organization.
  13. A PBSO may be endowed by receiving property from the State as its founder (as regulated by the Transition Law described below). This is the so-called “Priority Property” of the PBSO. The priority property must be used exclusively for securing the public benefit services, it may not be used as a security or otherwise used to secure the obligations of the PBSO or a third person and it must not be sold, donated, rented or lent. The priority property is not subject to liquidation. Real estate forming the priority property must be registered with lien in favor of the State in the Cadaster (Register of Real Estate).
  14. Upon a decision of the Board of Directors, a PBSO may split into several PBSOs, as well as merging with or combine with or into another PBSO or a foundation. This is done without liquidation and with full transfer of obligations and rights to the surviving PBSO or foundation.
  15. Upon a decision of the Board of Directors, a foundation may merge with another foundation. It may be also transformed into a Non-Investment Fund (regulated by the Act No. 147/1997, on Non-Investment Funds). This is done without liquidation and with full transfer of obligations and rights to the surviving foundation or Non-Investment Fund.  However the registered endowment of a foundation must be transferred to another foundation with similar purpose.
  16. For both a foundation and a PBSO the respective Law introduces state supervision through the registering office and the Ministry of Interior.
  17. The founder of an existing PBSO must submit necessary data to the regional Registering Office by no later than June 30 th, 2002; if this is not done or if the motion for re-registration is rejected, the Ministry of Interior may submit a motion to the court requiring the termination of the PBSO.
  18. The Administrator of an existing foundation must submit the necessary data to be registered in the Register of Foundations kept by the Ministry of Interior by no later than December 31 st, 2002. Alternatively, the Board must decide to transform the foundation into a PBSO by that time. Otherwise the existing foundation will be deemed to terminate and be liquidated as of January 1 st, 2003. 
  19. Beginning January 15 th, 2002, the Central Administration Bodies may decide to select budgetary or subsidiary organizations for transformation into PBSOs. For this purpose, a “Transformation Project” must be prepared and submitted to the Slovak Government through the Ministry of Management and Privatization of State Property. In the case of a positive Governmental decision, the Central Administrative Body, together with other interested parties (employees of the original governmental organization, medical or social care professionals and churches or other legal persons, who may prove that they are active in the field of health care, social care or humanitarian assistance on their own or through a PBSO established by them), may endow property to the newly founded PBSO.  All the rights, obligations and liabilities of the original governmental organization are transferred to the PBSO.

These and other more detailed changes in the laws make the Slovak legal environment on the one hand closer to, and, on the other side hand, more detailed than that of the Czech Republic. There may be equality of legal form between the notion of “foundation,” “PBSO,” and “fund” in both the Czech Republic and Slovakia (though slightly different terminology is used in each country).  However, by introducing the concept of trusts as a possible and negotiable part of a foundation’s property, as well as by providing more economic and governance freedoms, the Slovak laws surpass those of the Czech Republic equivalents. The Slovak Transformation Law has yet no equivalent in the Czech Republic, although similar procedural legislation has been planned since 1995, when the Czech Act No. 248/1995, on Public Benefit Corporations was drafted and discussed in the Czech Parliament. On the other hand, the state supervision, as introduced by the new Slovak laws, goes beyond the scope of public supervision provided by the Czech laws.  It is worthwhile to note these differences and similarities; comparative analysis of legal reform efforts brings attention to needs in the legal environment in various countries.

* Petr Pajas is Legal Consultant to ICNL for Central and Eastern Europe. 

[1] E.g. the Civil Code, the Act No.455/1991, on Trading, in the text of later amendments.

 

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