NESsT Ecuador Country Assessment Executive Summary

NESsT Learning Series

Executive Summary

CSO Self-financing Activities in Ecuador:

A National Assessment Written by Paola Estupiñán Edited by Nicole Etchart

NESsT

Nonprofit Enterprise and Self-sustainability Team - NESsT

NESsT Learning Series

1: RESEARCH METHODOLOGY

Published by:

Jose Arrieta 89 Providencia, Santiago, CHILE Phone: + (56 2) 222 5190 Fax: + (56 2) 634 2599 E-mail: nesst@nesst.org www.nesst.org NESsT promotes the social, political, economic, and religious rights of all people and does not discriminate on the basis of gender, race, age, national origin, mental or physical disability, sexual orientation and political or religious opinion or affiliation.

Copyright ©2009. All rights reserved.

This document contains information prepared by sources outside NESsT as well as opinions based on this information. NESsT strives to provide accurate information and well-founded opinions, but this does not mean that the content of this publication is error-free.

The laws and regulations cited herein may change. NESsT does not undertake to update this publication.

This document is a translation of the original written in Spanish and is an executive summary of the full-length version available only in Spanish, which is part of a learning series published by NESsT. It was researched and written by Paola Estupiñán, Enterprise Development Manager for Ecuador, with content and editorial input from Nicole Etchart. Additional editorial support was provided by Carola Delgado, Alejandra Díaz, Kerry Dudman and Gonzalo San Martín, and designer Jorge Moraga was responsible for the layout. This version was translated to English by Shamrock Idiomas.

Tinker Foundation 2

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Index Introduction............................................................................................... 5 1. Research methodology......................................................................... 7 2. Civil society in Ecuador........................................................................ 9 3. Self-financing trends among CSOs with

a social mission.................................................................................... 13

4. Nine CSO experiences with self-financing

activities............................................................................................... 15

5. Limitations and potential of self-financing activities,

based on CSO experiences................................................................. 19

6. Perspectives of CSO support organizations and donor

organizations on self-financing activities........................................... 21

6.1 The donors perspective............................................................... 21

6.2 Perspectives of CSO support organizations............................... 22

7. Basic information on the legal and taxation framework.................. 25 8. Conclusions......................................................................................... 31

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Introduction This document summarizes the National Assessment published by NESsT to provide insight into civil society organizations (CSOs)1 in Ecuador and specifically to describe their actions and attitudes towards self-financing activities.2 It provides an overview of Ecuadorian CSOs and the options for self-financing activities and analyzes nine self-financing experiences in Ecuador.

This document also includes opinions from different stakeholders, such as donors and CSO support organizations. The assessment is complemented by a brief analysis of the legal and taxation environment that applies to these activities.

This study lays the groundwork for a more in-depth study to identify existing needs in the country and to design instruments of support and training for CSOs interested in implementing or expanding selffinancing activities.

This research was made possible by the cooperation of 46 CSOs, nine of which provided detailed information about their experiences: Fundación Hermano Miguel, FUNDAMYF, Fundación Mariana de Jesús, Camari, Quito Eterno, CEBYCAM, CEMOPLAF, Fundación Futuro Latinoamericano, and Red Financiera Rural.

1 NESsT uses the term civil society organization (CSO) to refer to a wide range of formally registered nonprofit, non-state organizations or community-based associations and groups that fall outside the realm of the government and business sectors. In Ecuador, this definition includes the legal classifications of corporation, foundation, and international NGO. 2 NESsT uses the term self-financing to refer to diverse strategies used by civil society organizations to generate revenue, including service fees, sale of products, use of hard or soft assets, membership dues, and investment dividends. NESsT uses the term social enterprise activity to refer to self-financing activities that are designed by a CSO to significantly strengthen its financial sustainability and further its mission.

The following 12 donor organizations and seven CSO support organizations also participated: Belgian Technical Cooperation (BTC), CARE: Cooperative for American Relief Everywhere, UNIFEM, SWISSCONTACT, La Agencia Española de Cooperación Internacional para el Desarrollo (Spanish Agency for International Cooperation, or AECID), ACDI VOCA, United States Agency for International Development (USAID), the European Commission, the Inter-American Foundation (IAF), Corporación Andina de Fomento (Andean Development Corporation, or CAF), the InterAmerican Institute for Cooperation on Agriculture (IICA), Fondo Ecuatoriano de Cooperación al Desarrollo (Ecuadorian Development Cooperation Fund, or FECD), Agrónomos y Veterinarios sin Fronteras, GTZ (German technical cooperation), United Nations Development Program (UNDP), Inter-American Development Bank (IDB)/Multilateral Investment Fund (MIF), United Nations Development Fund for Women (UNIFEM), Food and Agriculture Organization of the United Nations (FAO), UBV (Swedish cooperation) and Corporación de Promoción de Exportaciones e Inversiones (Center for the Promotion of Exports and Investment, or CORPEI).

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NESsT is also grateful for legal input from three legal experts, María Fernanda Garcés, Marco Albán, and Edgar Acosta who generously shared their knowledge, experience and time for the development of this document.

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1. Research methodology Primary and secondary information was analyzed in order to understand civil society organizations and the activities that generate untied income for them in Ecuador. A range of stakeholders shared their vision with respect to self-financing and CSO sustainability, trends, and challenges in Ecuador.

The secondary information addressed aspects such as the history and evolution of civil society in Ecuador. The research revealed that there is practically no statistical information about this sector in the country.3 NESsT assessed the financing mechanisms available and analyzed the trends in international development cooperation or assistance.

3 For example, Fundaci贸n Alternativa developed a CSO database that has not been updated since 2005.

4 In Latin America, NESsT has carried out similar research in Chile, Colombia, Peru, and Argentina.

5 The following organizations were chosen to present in-depth case studies of their self-financing activities: Fundaci贸n Hermano Miguel and FUNDAMYF.

Leaders of 46 CSOs and 17 representatives of CSO support and donor organizations that operate in Ecuador were interviewed and/or surveyed to gather information about initiatives being used to strengthen CSO self-financing. Three experts in Ecuadorian legal issues were also interviewed about the legal and regulatory environment for CSO self-financing.

To gather more specific information about the implementation of self-financing activities, a smaller group of CSOs was asked to complete a questionnaire developed by NESsT.4 NESsT selected the organizations by their areas of work and included both traditional, long-standing CSOs and more recently established ones with a greater entrepreneurial focus. Eleven in-depth interviews were conducted, and nine organizations were selected as case studies. Once this process concluded, the self-financing experiences of two CSOs were chosen as detailed case studies.5

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2. Civil society in Ecuador Historically, there have been a variety of reasons for setting up and strengthening CSOs in Ecuador. They have been set up to meet the needs of and to carry out social policies in favor of marginal sectors when the state lacks the capacity to do so; to increase civil society representation in various development issues and to define social policy; and to implement programs addressing the interests of international cooperation agencies. Furthermore, CSOs also emerged in response to consulting opportunities offered by the state.6 More recently, in the 1970s and 1980s, some businesses created foundations and nonprofit corporations in order to reduce their income tax liability, transferring revenues from the business to the nonprofit entity in the form of donations in order to take a tax deduction. A number of these organizations, however, did not necessarily seek to fulfill a social purpose.

6 Consulting is defined as the provision of specialized, professional services for identifying, planning, developing or assessing development projects in the pre-feasibility, feasibility, design, or implementation stages. It also includes oversight, inspection, and assessment of projects, as well as advising and technical assistance services and development of economic, financial, organizational, administrative, audit, and research studies.

7 World Bank, Social Development Document. Participation and Civil Society, Document Nยบ 105, September 2007.

In the 1980s and 1990s, CSOs were mainly concerned about establishing their legitimacy, becoming more representative and professional (particularly through a large number of volunteers), and they focused on social and political issues. Social movements gained recognition, especially those organizing indigenous people, women, and environmentalists. CSOs took on the role of political mediators and the need to strengthen these organizations became quite evident.

Research conducted by the World Bank7 in 2007 concluded that CSOs in Ecuador are most influential in issues of governability, democracy, and transparency. The fact that social movements have caused three presidents in the last decade to be deposed clearly shows the antagonistic relationship that can exist between the state and civil society.

There are approximately 35,000 CSOs in Ecuador. The sector is varied, with a diversity of goals and issues, differing legal forms, and different ideas about what constitutes the public benefit, which is reflected in their institutional missions. Of these organizations, only 10,000 report to the Servicio de Rentas Internas (Internal Revenue Service, known as SRI), which shows that a high percentage of them still operate informally.

Not all CSOs have been viewed as representative of civil society. CSO have a variety of objectives, which are not always related to the public benefit. As a result, the work of some CSOs has created suspicion Executive Summary - CSO Self-financing Activities in Ecuador: A National Assessment Copyright @2009

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8 There are eight strategies, 12 objectives, 118 policies, 600 government strategies and 94 government goals in the Plan Nacional de Desarrollo for 2007-2010.

Source: http://www.senplades.gov.ec/ web/guest/estrategias/plannacional.

9 The goals defined are: to eradicate extreme poverty and hunger; achieve universal elementary school education; promote gender equality and women’s autonomy; reduce mortality rates in children under five; improve maternal health and fight HIV/AIDS, malaria and tuberculosis; achieve environmental sustainability; and promote an Asociación Mundial para el Desarrollo (World Development Association).

10 Information obtained from the web site of Ecuador’s Ministry of Finance, www. mef.gov.ec.

and has lead to stricter regulations affecting those CSOs that do have a social purpose. For this reason, the sector itself wants to improve transparency and demonstrate that many are working hard to develop good management practices.

There is a need to improve interaction and synergy with other sectors such as the government, international cooperation agencies, support organizations, and the business sector, to create cooperation and joint responsibility in promoting social development in a unified way.

However, many CSOs have had a significant social impact. They have filled gaps overlooked by the state and by other stakeholders in society, and they have made methodological and practical contributions toward resolving problems through their experience in carrying out comprehensive development projects and programs. Their contributions are the result of their proximity to the beneficiaries at the grassroots level and their knowledge of the local communities in which they work.

They have also successfully participated in defining public policy and regulations regarding human rights; gender equality; rights of indigenous peoples, children and adolescents; disadvantaged groups; certain environmental rights; and in building public participation and democracy.

The government is currently defining mechanisms for coordinating a collaborative policy between the central and local governments and international cooperation agencies, so that all efforts converge in the 2007-2010 National Development Plan,8 a program that includes the Millennium Development Goals.9 This plan proposes that international cooperation agencies support social objectives declared to be state priorities through the Secretaría Nacional de Planificación y Desarrollo (National Secretariat for Planning and Development, known as SENPLADES). Given this scenario, CSOs need to specialize and form networks that will enable them to act and interact with the state and international cooperation agencies in fulfilling this national plan.

With respect to CSO financing, there are no statistics regarding resources mobilized by civil society. Public investment in Ecuador in 2008 was estimated to be US$ 4 billion (10% of the country’s GDP).

About 75.11%10 of central government investment was allocated to five sectors: communications, urban development and housing, education, health and the agricultural sector.

International cooperation, on the other hand, gave US$ 290 million in 2006. Official figures for 2008 are still not available, but the estimate

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is that there was moderate growth, a trend that will be affected by the gradual withdrawal and reduction of cooperation resources from some countries including the Netherlands, Germany, Italy, Belgium, Switzerland, and Canada. The principal donor countries are the United States, Japan, and Spain.

The priority sectors among international cooperation agencies in Ecuador have been social welfare and local development, followed by the environment and education and, thirdly, agricultural and housing.

In addition to contributing to social development and policies, CSOs have generated their own funds to enable them to continue their social programs. However, there are no statistics available to assess the impact of these self-financing activities.

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3: Self-financing tRENDs among CSOs with a social mission

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3. Self-financing trends among CSOs with a social mission The information provided by 46 CSOs has demonstrated the diversity of these organizations. The organizations’ annual budgets range from less than US$ 50,000 to more than US$ 1 million. 40% of the CSOs in the sample received 90% of the total income, while the other 60% shared just 10% of the total.

All of the organizations carry out some kind of self-financing activity, although few do it as part of a structured and planned strategy that has developed over time. The major challenge for these organizations is covering their administrative expenses. For 33% of the CSOs, administrative costs account for between 20% and 40% of their total expenses; for 35% the figure is 40% of total expenses; and the rest spend a smaller amount or did not provide this information on the questionnaire.

With respect to financial results, 57% of the CSOs have financial difficulties, some of which are severe. Only 26% of the CSOs generate a small surplus, equivalent to 8% of their income. This indicates that there is a constant need for funding, regardless of the size of the CSO. The results also indicate that 42% of CSOs rely mostly on international donations and 58% obtain more than 50% of their budget from selffinancing activities. In quantitative terms, total donations received by the CSOs in the sample amount to US$ 9.7 million while self-financing totals US$ 18.9 million.

The most frequent self-financing activities are: product sales (24%); fees for services (20%); consulting (19%); membership fees (15%); and training (9%). Very few CSOs have experience with investment dividends, rental of physical infrastructure or charging royalties for use of their intellectual property.

In identifying the organizations’ focal areas, the study observed that 65% of them operate in one to four categories. Another 30% carry out activities in five to eight different categories and the remaining 5% in more than eight. The most frequently addressed issues are: community development, poverty, education, and support for other organizations.

In the other category, productive projects and microfinance appeared several times.

There are 1,606 people working in the 46 organizations. Of these, 1,091 people work full-time (68%); 134 people work part-time (8%); Executive Summary - CSO Self-financing Activities in Ecuador: A National Assessment Copyright @2009

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and 381 people work as volunteers (24%). The average number of people working in these organizations is 35.

In this group of organizations, self-financing is the main source of funding. However, these funds are not sufficient to cover normal operating expenses. Although self-financing activities are a common practice, they are developed rather spontaneously and are not always managed as ongoing income-generating activities. The organizations do not typically use strategic planning or financial planning tools, nor do they conduct prior studies or develop business plans that would enable them to manage the risks of undertaking activities of this nature.

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4: NINE CSO experiences with self-financing activities

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4. Nine CSO experiences with self-financing activities The experience of self-financing among the CSOs in the study varies: product sales, fees for services, membership fees, use of tangible assets and investment dividends (see Table 1).

Table 1: Different types of self-financing activities Case studies

Mission:

Self-financing activity

Annual income from selffinancing

% that selffinancing contributes to organizational budget

Fundaci贸n Hermano Miguel

Provides integral rehabilitation services to communities and specifically to people with disabilities. Programs range from providing medical services and implementing technical aids through the Centro de Atenci贸n Integral y Desarrollo (Comprehensive Assistance and Development Center, or CAID) to social and employment integration. Also advocates for the civil rights of people with disabilities.

Product sales: orthosis and prosthesis Sale of services: rehabilitation and medical services Use of tangible assets: rental of physical space Investment dividends: short-term investments, return on investment through partnership with Proyecci贸n Futura (collection of scrap material and furniture) and from partnership with Prot茅us (orthosis and prosthesis laboratory serving the middleand upper-income segments).

US$ 476,000

95%

FUNDAMYF

Contributes to reducing poverty levels through sustainable development that includes activities addressing integration, equity and diversity.

RANDIMPAK: processing and sales of Andean grains and cereals produced by women (approx. 5,000 women) from 180 communities in the Sierra Centro region. Domestic and export sales.

US$ 390,000

23%

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Case studies

Mission:

Self-financing activity

Annual income from selffinancing

% that selffinancing contributes to organizational budget

CAMARI

Improves living conditions of small farmers and rural artisans, through guides that help them determine what to produce and through domestic and international sales of their products. Works with a sustainability model based on fair trade principles.

CAMARI is a fair trade partner of Grupo FEPP (Fondo Ecuatoriano Populorum Progressio), which connects small producers to their markets, reducing or eliminating intermediaries.

US$ 3,000,000

93%

FundaciĂłn Mariana de JesĂşs (FMdJ)

Promotes development of works of charity and cultural and moral orientation for the disadvantaged. Belongs to the Company of Jesus.

Product sales: Construction of low-income housing.

Investment dividends: Interest from financing lowincome housing; interest from shares owned in the cement company HORMASA. Fees for services: Health programs

Not available

100%

CEBYCAMCES

Works for and with people with disabilities and people living in poverty in Penipe, helping them achieve their potential and develop their self-esteem so that they can integrate into and participate in society.

CEBYCAM has stimulated the creation of several community businesses, (shoes, meat, dairy and silk products)— which constitute a selffinancing activity for the area.

US$ 20,000

12%

Contributes to improving the quality of life of low-income people through providing health products and services with an emphasis on sexual and reproductive health.

It has 27 Health Centers in 11 provinces throughout Ecuador that sell medical services at differentiated prices and contraceptives.

US$ 4,884,000

96%, but there is a 20% deficit

CEMOPLAF

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It also has two of its own activities that generate income for the organization: the health center and the printing and card workshop.

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Case studies

Mission:

Self-financing activity

Annual income from selffinancing

% that selffinancing contributes to organizational budget

Quito Eterno

Fosters appreciation and support for Quito’s art, history and traditions. Develops teaching and theatrical tools to contribute to the educational system and community development in Ecuador.

It offers various services: “Legendary Routes” night tours through places that are representative of the heritage of Quito’s Historical Central District. The tours are conducted by guides dressed as historical characters from Quito.

US$ 165,000

92%

The organization also organizes events and theatrical productions related to the tours.

Fundación Futuro Latinoamericano

Promotes constructive multisectoral dialogue and conflict management through public policies for sustainable environmental development in the political, economic and social realms. The objective is to strengthen civic, political and institutional capacities and to promote and foster sustainable development processes in Latin America.

Training and consulting in conflict prevention and management.

US$ 140,000

20%

Red Financiera Rural

Contributes to expanding and deepening microfinance systems as a development instrument that is useful and adapts to market needs. These systems effectively help to reduce poverty, unemployment and inequality.

Membership fees. Training in management tools for financial institutions specializing in microfinance.

Consulting services and management tools for financial institutions.

US$ 659,000

66%

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5: Limitations and potential of self-financing activities, based on CSO experiences

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5. Limitations and potential of selffinancing activities, based on CSO experiences The nine cases presented in the National Assessment offer challenges, lessons, and valid experiences that can be shared with other CSOs that plan to engage in self-financing activities as well as other stakeholders interested in strengthening the sustainability and impact of this sector in Ecuador.

Among the lessons learned, CSOs have identified the need to: a) plan for the medium and long-term, maintaining a clear, realistic vision and thus reduce the amount of learning through trial and error; b)assess the potential for working in partnership or forging alliances with other stakeholders, as a strategy to increase opportunities for sustainability; c) generate information that shows the sources and designation of their financial resources in order to increase transparency and allow for more informed decision-making in terms of their self-financing activities; and d) develop strategies that strengthen the links between the organization’s mission and self-financing activities.

Some common challenges are related to: a) overcoming weaknesses in financial and marketing processes, such as avoiding projections that underestimate growing expenses (which can exceed income); b) understanding the organization’s liquidity needs in order to avoid a cash flow crisis and enable sustained growth of the self-financing activity, with proper management of budgeted cash flow; c) avoiding the overuse of subsidies and evaluating carefully the tendency to charge below-market prices rather than the use of differentiated pricing; d) considering diversification into market niches which are able to pay higher prices or diversification of products and services; and e) ensuring sufficient access to capital, above all working capital to cover operating costs and capital to expand self-financing activities.

In summary, in some of the cases analyzed, self-financing contributes only a small amount to the organizations’ income. Performance varies, depending on the development stage of the self-financing activity (start-up, growth, maturity, and decline). As some CSOs gain experience and better understand their self-financing activities, they begin to adopt a more entrepreneurial strategy with greater financial impact.

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5: Limitations and potential of self-financing activities, based on CSO experiences

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6: Perspectives of CSO support organizations and donor organizations on self-financing activities

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6. Perspectives of CSO support organizations and donor organizations on self-financing activities The opinions of organisms that donate to and support CSOs in relation to self-financing were also included in the research. Financial and technical support in Ecuador depends in part on how the sustainability of projects or proposed initiatives is defined. Sometimes sustainability emphasizes financial aspects, while in other cases its focus is on social development and connection to networks to develop joint efforts to leverage resources for future development.

6.1 The donor perspective In Ecuador, international cooperation or development assistance is still quite important; most donor organizations are bilateral, multilateral, or international NGOs that channel funds from their home countries.

Generally, bilateral organizations donate government to government technical cooperation and funding. Governments also channel funds through multilateral organizations, and to a lesser extent they occasionally provide funding to support civil society initiatives. Some cooperation organizations involve NGOs from their own countries as counterparts to local NGOs. In short, donor organizations work in a well-defined way, so that initiatives presented to them must fit within their guidelines.

The way to obtain such funds tends to be through public tenders, which may be regional or local. Donors seek to finance the best initiative in terms of medium-term results. This leads to less funding available for projects that address local initiatives, since more of the funding is allocated at the regional level. As a consequence, the social and economic impact of these tenders has been limited.

For this reason, the government came up with a proposal to organize and align the action plans of donors with the National Development Plan, which includes the Millennium Development Goals. Bilateral and international cooperation agencies have formed the so-called Donor Working Groups to address issues such as: the economic development, environment, governance and food security, in order to unify their criteria and join forces to generate a greater impact and contribution to social change.

Against this background, the organizations we interviewed indicated their concern about the sustainability of CSOs, although this is not Executive Summary - CSO Self-financing Activities in Ecuador: A National Assessment Copyright @2009

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reflected in their specific support guidelines. These organizations, especially the bilateral ones, focus on programs and projects that incorporate multiple issues, primarily overcoming poverty, local development, environment, health, education, human rights, and governability but not necessarily in the sustainability and long term impact of these efforts.

When asked about their interest in supporting and stimulating self-financing activities that contribute to CSO sustainability, the donors responded positively, as long as such proposals fit within the framework of their programs, have transparent financial accounting, and the income generated is used to further the mission of the CSOs. However, one of the limiting factors described by the donor organisms regarding supporting CSO sustainability is that most organizations don’t have the required entrepreneurial capacity needed neither for themselves nor to teach and generate this capacity among their project beneficiaries.

6.2 Perspectives of CSO support organizations Generally, CSO support organizations in Ecuador play a more active role than donors in mentoring their beneficiaries when they carry out projects and contribute to defining public policies.

These organizations usually promote self-financing by fostering the development of productive projects and look for opportunities to replicate successful models, especially if they are self-sustainable.

In terms of business management, some prioritize the formation of associations and use technical assistance to strengthen business and local capacities, teaching beneficiaries to develop market studies, obtain health department permits, as well as promotion and communication techniques.

While some organizations support projects focused on topics related to market access, promotion and marketing, improving and controlling quality and increasing productivity, there is no specialization in aspects related to financial sustainability, and even less focus on self-financing.

Furthermore Ecuadorian support organizations interviewed all indicated that they believe that it is not possible for all CSOs to generate resources to further their own sustainability. There are geographic areas and groups which are so vulnerable that it would be difficult to start up an activity that generates income by charging these target groups, even if the price of a product or service were heavily subsidized. According to some donors, no project is totally 22

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sustainable; nevertheless, they believe that it is necessary to support those initiatives that demonstrate high potential for sustainable social impact.

Finally, a difference was observed between European and North American organizations. European organizations prioritize support for projects that generate employment as a way to prevent migration and through this, to influence public policy in the area of social development. By contrast, the North American organizations place greater emphasis on supporting projects that stimulate production and market access, in order to improve people’s income levels and reduce the dependence of vulnerable communities or groups on social assistance.

In summary, both donor and support organizations understand the importance of contributing to organizational sustainability in order to strengthen the social impact of CSOs. They value the focus of NESsT’s work as a positive contribution because of the knowledge transfer that occurs and because the NESsT methodology includes “learning by doing”, thus complementing the work of the support organizations, the organizations that carry out the projects, and their beneficiaries.

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7: Basic information on the legal and taxation framework

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7. Basic information on the legal and taxation framework To complete the assessment, a summary of the legal framework with respect to CSO self-financing activities is included.11 There is no organic or special law in Ecuador regarding CSOs. The basis of their legal treatment is the Civil Code and they have largely been governed by Executive Decrees, which have been issued to address issues of operations, organization, and oversight.

The Civil Code recognizes public benefit corporations and foundations. The law indicates that these organizations must meet requirements regarding social purpose, non-profit status, legal capacity, and legal authority. Outside of the Civil Code, the regulations in force define NGOs as foreign non-governmental organizations and define some differences among them.

The articles of incorporation represent the main difference between foundations and associations. Foundations are established by one or more founders who contribute their own assets toward a social purpose and their projects promote the public benefit; the organization’s bylaws must provide for the existence of a board of directors consisting of at least three people.

11 The complete analysis of the regulatory framework is available in NESsT’s recent publication “The Legal and Regulatory Framework for CSO Self-financing in Ecuador“, available on our web site at http://www.nesst.org/Espanol/serieguiaslegalessp.asp.

12 First-tier organizations. Consist of individuals, with a minimum of five members. These may be associations, clubs, committees, professional associations and centers. Second-tier organizations: These are groups of first-tier organizations or are comprised of legal entities, such as federations and chambers.

Third-tier organizations: These are umbrella groups such as confederations and national unions.

Corporations, on the other hand, are formed with the contributions of at least five members and are for their own benefit, and thus their social impact will depend on the area they address and the number of members they have. In fact, corporations are divided into subcategories, such as associations, clubs, committees, centers, and others, which can cause confusion as they are not necessarily working toward a social mission. In addition, corporations can be organized to represent groups or institutions at the local, regional, and national levels, and are thus classified into three groups:12 first-tier, secondtier and third-tier.

To set up these organizations, they must not only have articles of incorporation but also register their assets and bylaws. For their operations, they must: a) obtain a civil society organization identification number (Registro Único de Organizaciones de la Sociedad Civil, or RUOSC) or the equivalent, the supplier identification number (Registro Único de Proveedores, or RUP); b) possess a taxpayer identification number (Registro Único de Contribuyentes, or RUC); c) be accredited in order to get access to public funds; d) keep accounting records and submit reports to Executive Summary - CSO Self-financing Activities in Ecuador: A National Assessment Copyright @2009

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13 These may include: volunteer work or provision of services by members, founders or other people. The value of these contributions must be recorded in the accounts and does not generate income tax for the volunteers (although some SRI officials still dispute this point).

oversight authorities; e) comply with all labor laws; and f) have an annual budget with a minimum percentage from donations.

This last point is quite important, because the law requires that CSOs must receive contributions or donations that are equal to or higher than a specific percentage of their annual income (see Table 2).

Table 2: % of contributions or donations Annual income in US dollars

% of income from donations and contributions

From 0 to 50,000

5%

From 50,001 to 500,000

10%

500,001 and higher

15%

This means that if an organization has higher projected income for a certain year, it will need more donations to make up its budget, although these donations can include both financial and in-kind donations.13 The positive aspect of this regulation is that since it recognizes that organizations receive income from activities other than donations, it implicitly allows the use of self-financing. The negative aspect, however, is that the law does not allow those who want to make donations to deduct such cash donations from the income tax they owe, so there is no incentive for people and organizations to make such contributions.

Self-financing activities are one way for a CSO to generate its own funds. Although Ecuador does not have a law addressing CSOs nor specific regulations with respect to self-financing, there are diverse laws and regulations that affect both CSOs and their self-financing activities, particularly those related to taxation system.

With regard to the tax framework, the two relevant national taxes are income tax (25%) and value-added tax (12%), although there can also be applicable tariffs when an enterprise activity engages in foreign trade transactions. Among the municipal taxes, there is the License Tax (applied to all commercial businesses).

The tax framework indicates that only the income of private, nonprofit, legally constituted institutions, as defined in the Regulation, is exempt from income tax. Such institutions must use their goods and income for specific purposes and may only invest directly in fulfilling those purposes. They must comply with all formal obligations in the 26

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Tax Code, the Internal Tax Regime Law, the Regulation and other laws and regulations of the Republic of Ecuador.

14 ICNL is an international organization whose mission is to facilitate and support the development of civil society and the freedom of association on a global basis. ICNL, in cooperation with other international, national, and local organizations, provides technical assistance for the creation and improvement of laws and regulatory systems that permit, encourage, and regulate the not-for-profit, non-governmental sector in several countries around the world.

Chapter 2 of the Legal Guide explains the framework used for analyzing the regulations that govern CSO self-financing activities. It describes four areas that are essential for understanding the legal structure for CSO self-financing before assessing the specifics of Ecuador: 1) the legal characteristics of CSOs; 2) the legal definition of selffinancing; 3) the criteria for permitting self-financing; and 4) the taxation of self-financing activities. See http://www. icnl.org.

Generally, CSOs are exempt from income tax, although they are sometimes subject to income withholding when providing a service.

Only when there are explicit exemptions are they permitted to invoice without VAT. However, in most cases they encounter difficulties with the authorities when implementing these exemptions.

The organizations in charge of regulatory oversight of CSOs are the various government ministries (CSO creation and operations), the Internal Revenue Service (taxation) and the Contraloría General del Estado (Comptroller General of the State, which oversees management of public funds).

Thus, while CSOs are not explicitly prohibited from engaging in commercial activities, there are no clear regulations, nor is there debate or discussion on the subject. For this reason, there needs to be formal recognition in the regulatory mechanisms that commercial activities may be undertaken by CSOs and that such activities are a legitimate alternative for CSO sustainability, as they enable them to fulfill their social mission, cover administrative and operating costs and, in some cases, generate a surplus that can be reinvested in the organization’s objectives. This would enable CSOs to generate funds that will help them guarantee their sustainability over time.

Because commercial activities are not explicitly prohibited and given current regulations, from the theoretical framework of the ICNL,14 in Ecuador the destination-of-income test is applied, which requires an organization to reinvest any surplus toward mission fulfillment. This prevents misuse of the legal status of a nonprofit entity.

For a CSO to use a self-financing activity, it must be included in the CSO’s bylaws, as the SRI has the authority to require proof of fulfillment of the statutory objectives of the organization. When a CSO has a surplus, it must ensure that any such earnings are used for the purposes for which the organization was established.

It is here that conflict arises, because the SRI verifies what each ministry approves. This means that if an organization wants to engage in self-financing activities, such activities must be defined along with the organization’s mission. Moreover, according to the opinions of some officials who were interviewed, the mission itself should state that the organization will engage in self-financing activities.

As a result, three types of situations can occur, depending on the interpretation of the law by ministerial officials and depending on Executive Summary - CSO Self-financing Activities in Ecuador: A National Assessment Copyright @2009

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the way in which they believe the social mission and bylaws should be approved: 1. The bylaws must include language that states that for the fulfillment of the mission, the organization will engage in self-financing activities, the output of which will be used to reinvest in the organization’s objectives and guarantee its sustainability -- thus, the destination-ofincome tax policy would apply, without any restrictions on the type of self-financing activity the organization chooses.

2. The bylaws must state that the organization may only engage in selffinancing activities that are mission-related, in which case, in addition to the destination-of-income test, the principal-purpose test would apply.

In other words, self-financing activities are permitted as long as their purpose is to further the mission itself, and thus all of its efforts and earnings must be used to this end.

3. The third scenario is that self-financing activities are simply prohibited.

Table 3 demonstrates the type of self-financing strategy that an organization can use, depending on the decision made by each ministry. The recommendations column includes a compromise strategy that could be used when there is no clear interpretation.

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Table 3: Applying the law in the regulation of self-financing activities Â

Ministry

SRI (Servicio de Rentas Internas)

Enterprise

Strategies that can be used

Recommendation

1

Allows self-financing activities, regardless of whether they are related to the CSO’s mission.

Destination-ofincome approach.

Sales of products and services that may or may not be related to the mission of the organization.

Sales of products and services to beneficiaries (CSO target group) at affordable prices.

If the authorities were concerned about abuses, it could impose a limit on the amount of income from self-financing activities which are not related to the mission.

Other strategies, such as: - Diversification of market niches.

- Diversification of activities: selling products or services not related to the mission to various groups.

2

3

Allows self-financing activities, but only those related to the mission and objectives of the organization.

Destinationof-income and principal-purpose approach.

Inclusion of selffinancing activity in the bylaws and social mission of the organization is not allowed.

The destination-ofincome approach would apply.

Only products and services related to the mission may be sold.

Sales of products and services to beneficiaries (CSO target group) at affordable prices.

Other strategies would be: -Diverse market niches and differentiated pricing.

-Diversification of products and/or services related to the mission.

Form an independent legal entity with a social focus, which would be subject to all regular taxes.

The only alternatives are: - Training and consulting in areas related to the mission.

-If a legal entity with a social focus is established, any surpluses can be given as donations to the CSO that owns the entity.

For some CSOs, this can be a very restrictive option.

In that case, the organization’s mission can be reformulated with a broader focus in terms of the specific objectives of the CSO (not just the overall objective).

- Create incentives for donations.

The government has a limited capacity to address the specialized areas of CSOs and the disadvantaged groups they serve.

-Some kind of incentive should be created for the private business sector to donate resources to the nonprofit sector.

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15 The social costs are those that a CSO incurs to reach its target group: remote geographical areas, subsidized or below-market prices, training and education for the community and for disadvantaged groups to assist them in obtaining employment. When a workshop is established for disadvantaged persons or persons with disabilities, typically the productivity level of the workshop is not high. It is difficult for these activities to engage in large-scale production and when they do, there are usually a very large number of beneficiaries involved.

The table illustrates that, depending on the stance taken by the ministerial authority acceptable strategies will either include diversification of market segments (for activities that must be related to the mission) or diversification of products and services (for activities which may or may not be related to the mission). Both elements diversification of niches and products or services - may be combined, especially when there is more freedom to engage in activities that are not necessarily related to the mission but where the income from them is used towards fulfilling the mission.

The fact that the legal framework is favorable in terms of taxation does not create unfair competition towards for-profit activities in the private sector. Because of the high social costs15 that these organizations incur, any additional benefits derived from tax exemptions are reinvested in the organization in order to cover these social costs and to contribute to achieving its social goals of the organization.

Indeed the work of civil society organizations complements the work of the public sector, lowering the cost of delivering certain services in difficult to reach locations far from urban centers. In addition, sometimes the work of CSOs replaces public sector efforts.

As self-financing activities become more transparent, and there is greater clarity regarding how the funds generated are used, and greater understanding that these activities represent a way to produce social impact and sustainability for CSOs, the need to implement provisions that limit or restrict these activities will decrease.

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8. Conclusions A legal and regulatory framework for CSOs should be created in order to clarify and recognize their role in society. Policies that specifically address CSO activity would go far in helping them to establish alliances with international cooperation agencies, the business sector and the public sector, building on the strengths of each group to resolve important social problems in Ecuador.

Ongoing, impartial oversight of the sector could ensure that CSOs working for the common good will improve their performance and those that do not will disappear from the marketplace.

The research shows that although the financial results of selffinancing have been limited to date, it has contributed to the social mission of CSOs by broadening the groups of people served by these organizations and increasing access to employment and markets for their beneficiaries. Strong teams, clear objectives and the capacity for rapid decision-making have enabled some CSOs to implement these activities, although there is no doubt room for improvement. Many of the organizations do not track information regarding these activities and tend to under price their products and services. Many have not diversified their markets and very few have developed business plans with clear financial projections, or well-defined marketing, operational or financial plans.

Civil society organizations still face restrictions, both legal and in terms of access to assistance in several areas, such as: taxation, finance, business and marketing. Organizations often have very specific and specialized knowledge in the area in which they work but lack the necessary complementary management tools.

Given the results of this assessment, NESsT believes that there is a clear need to support the development of self-financing and social enterprise activities in Ecuador. For this reason, in 2008 NESsT launched its Venture Fund in Ecuador. The Fund offers training and financial support to a select portfolio of CSOs with high social impact to develop social enterprise activities that strengthen these organizations’ financial sustainability, thus maximizing their social impact.

The NESsT Venture Fund works with organizations in an early stage, in which they prepare for self-financing and develop the ability to assess self-financing activities to determine if they are aligned with the Executive Summary - CSO Self-financing Activities in Ecuador: A National Assessment Copyright @2009

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CSOs’ financial goals and mission. The final product of this stage is an installed capacity within the CSO to manage the activity and a business plan that enables it to implement the self-financing activity. There is also a later stage, where the organization implements its business plan with financial and technical support from the NESsT Venture Fund, developing a system to monitor its plans for marketing, sales, finance, operations, and also its plans for mitigating any risks.

Finally, there is also an opportunity to combine the efforts of donors and NESsT. Most donor organizations have expressed concern about the sustainability of organizations but have yet to implement any administrative or management tools. The NESsT Venture Fund offers an opportunity for donors and NESsT to cooperate in their efforts to strengthen CSO sustainability and impact in the country.

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