by Milton Cerny and Beth Sellers

Foundations making grants in foreign countries sometimes work with local grantmaking organizations for a number of programmatic reasons. Local groups often have better access to information about which projects are most likely to be helpful or effective. In addition, a close relationship with an experienced U.S. foundation can strengthen and educate a local charity or coordinating body. Foundations may consider such institution-building an important goal of their foreign philanthropy, particularly in developing countries. Thus, under this structure, a donor foundation makes grants to a local group (the initial grantee) which in turn regrants the funds to other local organizations or individuals (the secondary grantees).

When a foundation exercises expenditure responsibility in connection with a foreign grant, regranting can raise a number of questions. A recent IRS private letter ruling (LTR 9717024, January 23, 1997) takes a pragmatic approach to a few of the issues that can arise in this context. Without making any major departures from existing law, this ruling signifies a realistic and enabling approach on the part of the Service to international regranting.

In general, a private foundation cannot make a grant to an organization (domestic or foreign) which is not a section 501(c)(3) public charity unless it exercises expenditure responsibility with respect to the grant. Without expenditure responsibility a grant may be a taxable expenditure and may not be a qualifying distribution. Expenditure responsibility requires: (1) a pre-grant inquiry sufficient to satisfy a reasonable person that the grantee will use grant funds for proper purposes; (2) a contemporaneous, written, signed, and counter-signed grant agreement containing a series of commitments designed to assure the use of grant funds for proper purposes; (3) timely and adequate grantee reports on the use of the funds, compliance with the terms of the grant, and progress made toward the purposes of the grant; and (4) grantor reporting to the IRS detailing certain required information about each expenditure responsibility grant.

Although compliance with expenditure responsibility imposes some administrative burdens, it generally is not substantively difficult in the context of grants to domestic organizations. Grantees that have received grants from U.S. private foundations in the past tend to be familiar with these requirements and well-equipped to comply with them. Foreign organizations, on the other hand, are less familiar with various requirements, and therefore present a compliance challenge to the donor foundation.

Furthermore, private foundation grants to individuals for travel, study, or similar purposes must follow certain guidelines to avoid being treated as taxable expenditures. Such grants must be awarded on an objective and nondiscriminatory basis and must be made pursuant to a procedure approved in advance by the Internal Revenue Service.

Finally, the regulations require expenditure responsibility grant agreements to prohibit regranting of grant funds unless the secondary grant complies with the requirements applicable to grants made by private foundations. That is, if the secondary grant is made to an individual, it must be made on an objective and nondiscriminatory basis, and must be made according to a procedure pre-approved by the IRS. If the secondary grant is made to an organization that is not a section 501(c)(3) public charity, expenditure responsibility must be exercised. These conditions may place a significant burden on an initial grantee that lacks experience with such requirements. Furthermore, the situation may give the donor private foundation cause for concern, particularly if the private foundation believes it must somehow guarantee the initial grantee's compliance with the private foundation rules. This can usually be avoided by the foundation securing an opinion of counsel that the initial grantee is an equivalent to a U.S. public charity.

In LTR 9717024, a private foundation (the "grantor") made grants to a number of initial grantees, who then made grants either to individuals or to organizations that were not section 501(c)(3) public charities. The initial grantees were foreign organizations, and the grantor was required to exercise expenditure responsibility with respect to grants to these initial grantees.

The Service first held that the grantor's expenditure responsibility requirements relating to the regrants were satisfied by binding the initial grantees to meeting the applicable requirements with respect to the secondary grants, provided the initial grantees furnish satisfactory reports and the grantor has no reason to doubt the reliability and accuracy of these reports, provided the grantor reports the grants properly on its Form 990-PF. The Service did not attempt to hold the grantor responsible for any imperfect exercise of expenditure responsibility on the part of the initial grantees. Instead, the grantor was held responsible only for actions within its control, such as the content of the grant agreements, its efforts to secure reports from the initial grantees, and its own Form 990-PF reporting.

Second, the Service held that where the initial grantee makes a secondary grant to an individual, it may do so according to procedures for which the grantor has received IRS pre-approval. The ruling indicated that the grantor should submit a procedure to the relevant IRS District Director which specifies that it may be applied by the grantor's initial grantees in making regrants to individuals. The ruling leaves actual approval of such a procedure to the discretion of the District Director.

Third, the initial grantees need not make reports to the IRS regarding the regrants. Technically, the initial grantees' pledge to exercise expenditure responsibility with respect to the regrants includes proper reporting to the IRS. However, because foreign initial grantees are not otherwise required to file IRS information returns, the ruling held that the grantor's Form 990-PF reporting (assuming it is accurate and complete) would suffice.

Although only the foundation which obtained this ruling may rely upon it, the ruling provides helpful guidance to similarly situated foundations. The ruling is significant because it takes a pragmatic approach to foreign regranting. It is clear that foundations involved in foreign regranting must take substantial care in order to ensure technical compliance. However, it is also clear that the IRS will take a practical approach, provided that care has been taken. Under these circumstances, foundations should not be deterred from working closely with foreign grantmakers; they should, however, take care when doing so.

About the Authors

Milton Cerny is a partner at the law offices of Caplin & Drysdale in Washington DC. Mr. Cerny, a tax expert, has over 35 years experience in law, business and international philanthropy. Beth Sellers is an associate.

For copies of this article with citations to legal authority, please contact Mr. Cerny at 202/862-5075. "Legal Dimensions" articles are edited by an editorial board in which the following firms are represented: International Center for Not-for-Profit Law; Silk, Adler & Colvin; Day, Berry & Howard; and Caplin & Drysdale.