by Timothy R. Lyman
Day, Berry & Howard
More and more, U.S. corporations and private foundations are seeking out or responding to opportunities to make charitable expenditures abroad. More and more, foreign charitable organizations are looking to these types of U.S. donors for financial support. A collaboration with a domestic public charity may offer U.S. corporations and private foundations a way to accomplish their foreign funding objectives that is simpler than direct foreign giving.
The Necessary Ingredient. In order to work properly, such collaborations must involve a domestic 501(c)(3) corporation, organized and operated as a public charity. This organization accepts funding from corporations and private foundations. In turn, and in keeping with its own charitable objectives, it donates funds to foreign charities or to other foreign organizations engaged in charitable activities, or expends the funds itself on charitable work abroad.
How Can a Collaboration Serve U.S. Corporate Donors? U.S. corporations want to ensure that their charitable contributions are tax deductible. Donations by U.S. corporations that are destined for use outside the United States may only be deducted from U.S. income if they are made to a corporation formed in the United States. Because a proper collaborative partner is a domestically formed corporation, U.S. corporate grants to it can be tax deductible, even if ultimately used abroad.
How Can a Collaboration Serve Private Foundations? A private foundation must periodically distribute, in the form of "qualifying distributions," a certain minimum amount of cash or property in furtherance of its charitable purposes. A grant to a domestic public charity generally will be a qualifying distribution, while a grant to a similar foreign organization will generally only be a qualifying distribution if it can be established that the foreign donee is equivalent to a domestic public charity. Despite efforts to simplify the process of establishing equivalency, it remains a potentially significant investment of time and money. A grant to a domestic collaborative partner, even if the funds are used abroad, will not generally require an equivalency determination to be considered a qualifying distribution.
Private foundations also face restrictions on any "taxable expenditures." In general, all grants made to organizations that are not public charities or exempt operating foundations are taxable expenditures unless the private foundation exercises oversight known as "expenditure responsibility." If the grantor cannot make an equivalency determination with respect to a foreign grantee, expenditure responsibility will be required. A domestic collaboration can avoid both expenditure responsibility and equivalency determinations.
Types of Collaborations. A well-recognized type of cross-border charitable collaboration involves a so-called "friends of" organization. "Friends of" organizations are usually affiliated with a specific foreign organization, but have a separate U.S. presence in the form of an independent domestic 501(c)(3) corporation. While a much used model, this has the obvious limitation that it restricts funding options to those groups that have a viable "friends of" affiliate.
Established, broad-based, internationally active, U.S.-based charitable organizations also provide a potential model for simple cross-border collaborations. The choice among such potential collaborative partners is ample, particularly in humanitarian and development fields. A particular organization may conduct its foreign programs directly, by setting up a local affiliate, by funding already existing foreign programs and organizations, or by some combination of these methods. This type of collaboration works particularly well where the donor is interested in supporting a particular kind of charitable activity in a specific region, but does not care to support a particular foreign organization. Frequently, a foreign organization that a U.S. donor wishes to support may already be working with one or more suitable U.S.-based charitable organizations with which the potential donor could collaborate.
Recently, a new model of collaboration—the "advised fund"—has been borrowed from well-established domestic practice. This model aims to overcome the tax-related impediments to direct foreign giving while maximizing the donor’s input into the choice of the ultimate recipient of the gift. Under this approach, the donor relinquishes the legal right to determine the ultimate beneficiary of the charitable donation, but retains a legally unenforceable right to advise the initial recipient what to do with the funds. For instance, the donor may make a donation to the collaborating domestic public charity and request (but not require) that the gift be used to support a particular foreign charitable organization. The donor might instead request an "advised fund" to be set up by the collaborating domestic public charity, and at a later point suggest organizations that the fund should support.
Getting the Models Right. All collaborative models, in order to achieve the desired tax effect, require care in structuring. The success of each model depends on the legal independence of the collaborating domestic public charity, which must avoid being simply a legal extension of a foreign organization or a "puppet" of a domestic donor. Collaborations can be properly structured and administered a number of ways. For example, collaborative partners may accept non-"earmarked" donations and then distribute them to foreign charities or expend them for foreign charitable purposes; they may approve specific foreign charitable projects and then solicit funds for the projects; or they may conduct charitable activities in a foreign country through a subsidiary and accept funds to support these activities.
Although all of the foregoing approaches have been accepted by the I.R.S., and there are numerous such collaborations in existence, the collaborative partners must always take care to exercise sufficient "discretion and control" over the funds they receive, rather than simply turning them over to a foreign affiliate. If the collaborating charity serves as a mere "conduit," the I.R.S. will ignore its existence and treat donations as if they were given directly to the foreign organization. Although perhaps best recognized in the context of "friends of" organizations, this concern extends potentially to any type of collaborating domestic charity.
Another important concern is the potential for inappropriate "earmarking" of funds. "Earmarking" is any agreement, oral or written, that funds will be used for a particular beneficiary selected by the grantor. To avoid earmarking, a donor’s recommendations must be truly only suggestions and not legally binding, or else the I.R.S. will ignore the collaborating charity’s existence and treat donations as if they were given directly to the foreign organization.
If a contribution is treated as having been made to an ultimate foreign beneficiary, either because the collaborating charity is held to be a mere conduit or because the funding in question is held to be legally earmarked by the donor for the particular foreign beneficiary, a corporate donor will be denied a charitable deduction and a private foundation grantmaker risks denial of a qualifying distribution and possible liability for making a taxable expenditure.
About the Author
Timothy R. Lyman is a partner in the Hartford, Connecticut, office of Day, Berry & Howard. For copies of this article with citations to legal authority, please contact Mr. Lyman at 860/275-0329 or firstname.lastname@example.org. "Legal Dimensions" feature articles are edited by an editorial board in which the following firms are represented: Caplin & Drysdale, Chartered; Day, Berry & Howard; the International Center for Not-for-Profit Law; and Silk, Adler & Colvin. Additional members of the editorial board come from the Council on Foundations’ U.S. Giving Abroad Initiative.