By David S. Chernoff
Charitable activities know no international bounds.
It has long been established that activities that are considered charitable when carried on within the United States are similarly charitable when carried on abroad. Just as private foundations use program-related investments (PRIs) to invest money in domestic ventures that help achieve the foundation's charitable purposes, they may also commit resources to international projects that serve the foundation's charitable mission but do not otherwise meet the criteria to be a permissible business investment.
This article reviews the rules for PRIs generally, provides examples of innovative investing and sets out the special issues that may arise when foundations make international PRIs.
To be a PRI, and thus not a jeopardizing investment, an investment must possess the following three characteristics:
The primary purpose of the investment is to accomplish one or more of the charitable, religious, scientific, literary, educational and other exempt purposes described in the Internal Revenue Code (the "Code")
No significant purpose of the investment is the production of income or the appreciation of property
No purpose of the investment is to lobby, support or oppose candidates for public office or to accomplish any of the other political purposes forbidden to private foundations by the Code.
An investment will be considered as made primarily to accomplish one or more charitable or other exempt purposes if it significantly furthers the accomplishment of the private foundation's exempt activities and if the investment would not have been made but for the relationship between the investment and the accomplishment of the foundation's exempt activities.
In determining whether a significant purpose of an investment is the production of income or the appreciation of property, the applicable Treasury Regulations provide that it is relevant to consider whether investors solely engaged in investment for profit would be likely to make that investment on the same terms as the private foundation. However, the fact that an investment produces significant income or capital appreciation will not, in the absence of other factors, be conclusive evidence of a significant purpose involving the production of income or the appreciation of property.
It does not matter (except for purposes of expenditure responsibility, discussed further below) whether or not the recipient is tax-exempt or even if it is a for-profit business. The recipients of program-related investments in such cases are merely the instruments by which the charitable purposes are sought to be accomplished. What is crucial is that the activity being financed is clearly for a charitable or other exempt purpose (and the other two tests are met as well). PRIs often take one of the following forms:
interest-free or below-market-rate loan (most common)
letter of credit
low-interest-rate deposit with a bank or other financial institution linked to lending for charitable or other exempt purposes.
PRIs may take other forms as well, provided they comply with relevant provisions of the Code and Regulations.
The amount loaned or otherwise invested constitutes a qualifying distribution and thus is not a taxable expenditure; rather, it is credited against the private foundation's required annual distribution. Note that grant distribution credit cannot be taken on a loan guaranty or letter of credit furnished by a foundation unless and until such instrument is called or drawn upon and a payment is made by the foundation.
As an added inducement for foundations to make program-related investments, the Code provides that the amount of the program-related investment reduces the asset base upon which the 5-percent annual distribution requirement is applied. On the other side of the equation, any principal repayment of a program-related investment increases the foundation's minimum distribution requirement for the year in which the repayment is received.
Program-related investments are also exempted from the excess business holdings provisions of the Code; for this purpose PRIs are considered functionally related businesses.
Subject to applicable embargoes, currency restrictions and local law, program-related investments may be made to organizations anywhere in the world. For example, in a recent private letter ruling, the IRS approved as a program-related investment a private foundation's initiatives in a country that had only recently become a sovereign state and whose economy was plagued by resource shortages, trade blockades and natural disasters. The IRS approved both the foundation's plan to make loans to businesses to induce them to operate in this economically disadvantaged area and its plan to make loans to the country's central bank for regranting as business-development loans.
Indeed, many of the microfinancing initiatives discussed in Timothy Lyman's "Supporting Microfinance Abroad: Introductory Legal Issues for U.S. Grantmakers" (International Dateline, April 2000) could reasonably be structured as PRIs. Loans or equity investments in foreign entities that provide capital and financial services to populations that lack access to conventional sources of market support may serve a private foundation's mission but not meet its standards for business investments.
In another situation, the IRS has permitted a private foundation to treat as a PRI loans to newspapers and television and radio stations in Central and Eastern Europe and in the former Soviet Union to assist in the development of nongovernmental, nonpartisan, pluralistic, tolerant and nonextremist media in societies that have historically been "closed" (i.e., nondemocratic).
To the extent that a PRI is made to a foreign organization that is not the equivalent of a U.S. public charity, a foundation will generally be required to exercise expenditure responsibility in connection with the investment. Thomas Chomicz's "Grantmaking by Private Foundations in the International Arena" (International Dateline, November 1998) covers this subject generally, but it is important to note that the expenditure responsibility requirements for PRIs are slightly different from those that apply to grants.
The other two parts of the test for qualifying an expenditure as a PRI are usually easy to satisfy. Given that most program-related investments take the form of loans, a below-market interest rate is within the control of the foundation. Of course, the typical foundation's finance committee and financial officers must first be made to realize that program-related investments are alternatives to outright grants, not to investments of the foundation's endowment. Unlike a grant, not only will the money be returned, it may bear interest.
The remaining test—no lobbying or political purposes—may be satisfied by including appropriate language in the loan documents prohibiting the use of any of the proceeds of the investment for any such activities.
Making loans to or other forms of investments in foreign organizations may involve translating documents or complying with some local legal requirements, such as filing documents with a local official. There may also be local stamp taxes to pay. I have not found these aspects of the process—or the time and expenses required to close an international deal—excessive. In short, if your foundation wants to expand its charitable activities beyond U.S. borders, foreign PRIs provide an attractive complement to traditional grantmaking.
About the Author and Editors
Mr. Chernoff is an associate general counsel at the Chicago-based John D. and Catherine T. MacArthur Foundation. The views and opinions expressed are solely those of the author and do not necessarily reflect those of the MacArthur Foundation. For copies of this article with citations to legal authority, contact Mr. Chernoff.
This article was edited by Timothy R. Lyman, a partner in the Hartford, Connecticut, office of Day, Berry & Howard LLP, and Jane Nober, special counsel at the Council on Foundations.
The Council on Foundations coordinates the "Legal Dimensions" series with assistance from the Day, Berry & Howard Foundation ("promoting positive developments in the law, legal scholarship and legal education"). Inquiries may be addressed to the Council's International Programs department at 703/879-0600 or to Timothy R. Lyman, president of the Day, Berry & Howard Foundation, at 860/275-0329.