by Karla W. Simon

As previous Legal Dimensions discussions have pointed out, a U.S. private foundation making a grant to a foreign charity will often need to determine whether that organization is the equivalent of a U.S. charity. In some cases, the U.S. foundation wishes to demonstrate that the foreign organization is the equivalent of U.S. public charity so that no further special procedures are required in connection with the grant; in other cases the U.S. foundation seeks to treat the foreign organization as the equivalent of a U.S. private foundation and exercise expenditure responsibility in connection with the grant as discussed in International Dateline, November 1998, Issue 49. In either case, one of the determinations the U.S. foundation will need to make is whether the assets of the foreign organization must, upon its dissolution, be distributed in a fashion that meets the requirements of Section 501(c)(3) of the Internal Revenue Code.

Dissolution and U.S. Law

The underlying public policy rationale for the "dissolution" requirement is that the assets and income of a Section 501(c)(3) public charity must be dedicated to the charitable purposes for which the organization was established. Section 501(c)(3) of the Code requires that a public charity be organized and operated so that no private person receives a distribution of its earnings. This means that no distributions may be made of dividends or the like while the organization is in existence. It also means that neither accumulations of income nor any of the organization's assets may be distributed to private persons when the organization is dissolved, merged, or otherwise wound up. Assets that are charitable must remain dedicated to charitable purposes in perpetuity.

Under U.S. law, the assets of a dissolving charity must be distributed for a charitable purpose (including a distribution to one or more tax-exempt charitable groups) or to the federal government or a state or local government for a public purpose. In addition, some states have laws that provide rules for the distribution of a dissolving charity's assets. Many U.S. charities provide in their organizing documents for a dissolution distribution that will be in accordance with the federal rules; others do not include such provisions but rely on state law to supply the required procedures by default.

Dissolution Rules and Foreign Charities

When it comes to equivalency determinations for foreign charities, the same rules apply because those organizations must meet all the specific requirements of U.S. law. Thus, in making an equivalency determination for a foreign charity, a U.S. foundation must seek to determine whether the "dissolution" rule stated above is met. This may not be as easy to do as it is in the United States simply because the laws of foreign countries are obviously not attuned to the U.S. tax laws. As a consequence, when the organizing documents of a foreign charity do not include a specific qualifying provision regarding the distribution of assets on dissolution, there may be no comparable default provisions in the foreign jurisdiction's laws.

At least two problems may arise with respect to the laws of a foreign jurisdiction or with their application that could make it difficult to determine whether a foreign charity meets the "dissolution" requirement:

the laws of the foreign jurisdiction do not recognize the concept of public charity or public benefit in any way, or

although the laws of the foreign jurisdiction recognize the concept of public charity or public benefit, that concept in the laws of the foreign jurisdiction is not identical to the concept in U.S. law.

Failure to provide for the concept of public charity or public benefit. In some jurisdictions the laws simply provide for the establishment of certain forms of organization (e.g., associations, foundations, societies, companies, etc.) without providing for a separate qualification as a charity or public benefit organization. These laws generally deal with the destination of assets of an organization upon dissolution, but they may permit them to be returned to founders or members. Laws such as these would not by themselves assist a U.S. foundation when it seeks to qualify a foreign organization as the equivalent of a U.S. public charity. On the other hand, such laws generally allow an organization to provide in its governing documents for what it considers to be appropriate recipients of its assets on dissolution.

Laws recognizing a concept of public benefit which is not consistent with the U.S. law of public charity. Many jurisdictions in the world recognize the concept of public charity, public benefit, public utility or a similar concept (utilité publique in French, or Gemeinnützigkeit in German). In some cases there is a separate law that permits special qualification as a "public benefit" organization (with a special set of qualifying procedures). In others, the tax laws govern the distinction between the more generally qualifying legal entities and those of "public benefit."

Nevertheless, the issue of whether a foreign organization that meets the "public benefit" requirements of the laws of the jurisdiction in which it is organized also qualifies as a U.S. public charity is not so easily resolved. Although the "public benefit" laws of foreign jurisdictions aim to achieve public policy results similar to those underlying U.S. law, the legal requirements are frequently not in complete agreement with U.S. law. For example, the purposes for which a foreign law "public benefit" organization may be formed may include political activities inconsistent with U.S. law. As a result, even if the dissolving organization is itself prohibited from engaging in such disqualifying activities by its governing documents, a permissible distributee under the law of such a jurisdiction would not necessarily be operating with such a limitation (unless the dissolving organization's governing documents specifically made distribution to an organization with such a limitation a necessity). Even if the jurisdiction's law provides that a distribution in dissolution must be to a similar "public benefit" organization or to the government, the law by itself cannot guarantee that a distributee organization is the equivalent of a U.S. public charity. Thus, laws such as these, while facially similar to U.S. law, may not wholly resolve the "dissolution" requirement.

How to Deal with the "Dissolution" Requirement

First and foremost it is necessary to determine whether the foreign laws do in fact help a foreign charity meet the U.S. law "dissolution" requirement. If the foreign laws do not help, the general method of dealing with possible issues of lack of congruity with U.S. law in this regard is to have the foreign charity adopt in its governing documents appropriately limiting language that requires assets to be distributed only for one or more charitable purposes, including (1) to a corporation or other legal entity created for charitable purposes, none of the earnings of which inure to the benefit of any shareholder or individual and which does not as a substantial part of its activities attempt to influence legislation or otherwise engage in political activity; or (2) to a government or governmental entity, provided that such distribution is for an exclusively public purpose. This is generally permissible under the laws of all foreign jurisdictions. If such a requirement is included in the governing documents it is highly likely that it will be respected by a court overseeing the eventual dissolution, and thus the requirements of U.S. law would be met. Although there is some possibility that a registration organ in the foreign jurisdiction would be reluctant to permit an organization to include the appropriate language to meet the Section 501(c)(3)'s requirements in its governing documents, that issue can be dealt with only on an organization-by-organization basis.

About the Author

Karla W. Simon is Professor of Law at the Columbus School of Law, Catholic University of America. Simon holds a J.D. from Duke University and an LL.M. in Taxation from New York University. She has also studied law, including international law, at the University of Heidelberg, Germany. Simon has taught courses in federal income taxation, international and comparative taxation, administrative law, and the law of not-for-profit organizations.

For copies of this article with citations to legal authority, contact Simon at ksimon@icnl.org  or call 202/624-0766.