Private foundations in the United States are often interested in funding promising organizations and projects that are based outside of the country. When doing so, these foundations are required to follow certain rules and procedures promulgated by the IRS to help ensure that the foreign grantees are properly using those funds for charitable purposes. Currently, when a private foundation engages in international grantmaking, it has two options for complying with these rules: exercising expenditure responsibility or conducting an equivalency determination.
Expenditure responsibility requires that a foundation follow a number of oversight and monitoring procedures throughout the grantmaking process. This includes making pre-grant investigations, entering into a written grant agreement with the grantee, receiving written periodic reports from the grantee, and notifying the IRS in some detail as to each grant. It must be proven that the grantee intends to, and eventually does, use the grant funds to carry out activities that further the charitable purpose of the grantor.
Alternatively, a foundation may conduct an equivalency determination to evaluate whether the foreign grantee is equivalent to a U.S. public charity. This involves a review of its organization (governing documents) and operations to ensure it meets the following requirements described in Section 501(c)(3) of the Internal Revenue Code (IRC):
- It is organized exclusively for a charitable, educational, or other 501(c)(3) exempt purpose;
- It is operated primarily for a qualified exempt purpose;
- It does not engage in any transactions that would result in private inurement or a prohibited private benefit;
- Its assets, upon dissolution, would be distributed to another nonprofit for a qualified exempt purpose or a government instrumentality;
- It does not engage in substantial lobbying; and
- It does not engage in prohibited political campaign intervention.
In addition, the review must ensure that the foreign grantee would qualify as a public charity (and not a private foundation) if it were to apply for IRS recognition of exemption under 501(c)(3). Most public charities qualify as such because they are “publicly-supported” (i.e., they receive a significant portion of their financial support from public sources). For such organizations that do not receive a significant amount of earned income, this may be proven using one of two tests referenced in IRC Sections 509(a)(1) and 170(b)(1)(A)(vi).
First, an organization can demonstrate that it receives at least 1/3 of its total support from governmental units or the public. If the organization cannot meet this first test, it may pass an alternative facts and circumstances test, which requires the organization to establish that, under all of the facts and circumstances, it normally receives a substantial part of its support from government units or the general public. (For more information about public support, see Adler and Colvin’s Qualifying For Public Charity Status).
The equivalency determination process, outlined in IRS Revenue Procedure 92-94, requires the grantmaker to collect comprehensive information about the foreign organization’s operations and finances to make a “good faith determination” of whether the grantee would be given tax-exempt, public charity status in the U.S., including whether it is publicly supported.
Often, these requirements can be difficult to satisfy because of differences in a foreign grantee’s accounting system, language, and sometimes governing legal system and reporting procedures in the grantee’s own country.
The equivalency determination may be done either by the grantor itself, based on information provided in an affidavit completed by the grantee, or by written opinion of legal counsel of the grantor or the grantee. The affidavit is meant to extract all the necessary information about the foreign grantee including financials for the current and previous years, governing documents (often a translated copy is required), details about the board of directors, and descriptions of program activities.
More specifically, in order for a grantee to be equivalent to a public charity based on its level of public support, it must provide the grantor with a financial support schedule for the current year as well as the four most recently completed years. The schedule must be detailed and include information such as grants and contributions received, net income from unrelated business activities, and gross receipts for services performed. Furthermore, the schedule must show contributions from donors that are in excess of 2% of the total support received (because such excess is not included as public support in the public support test).
In September of 2012, the IRS issued proposed regulations that allow private foundations to rely on a broader class of practitioners, not just legal counsel, in making the good faith determination. The person issuing the opinion may be a “qualified tax practitioner,” such as an attorney, a certified public accountant (CPA), or an enrolled agent. Foreign counsel is no longer included in this class unless they meet the requirements of a qualified tax practitioner. Although these changes are technically “proposed,” the regulations indicate that a private foundation may rely upon these changes for grants made on or after September 24, 2012.
While the regulations aim to simplify and expand equivalency determinations, the process is quite burdensome and costly. For many years, there was no mechanism for sharing information about foreign grantees among grantmakers, and no uniform standard for collecting and processing the equivalency determination information. Thus, grantees were, and many continue to be, asked to provide affidavits and supplemental materials to multiple grantmakers in various forms. The regulations required each grantmaker to use its own reasonable judgment and good faith determination based on the materials collected. Therefore, foundations were not permitted to rely upon each other’s determinations.
To address these issues, several leading organizations such as The Council on Foundations, InterAction, the Foundation Center, and Independent Sector, worked to create a centralized repository of information to improve the efficiency of international grantmaking. The product of this effort, NGOsource, recently launched an online equivalency determination service and repository . NGOsource members can easily access which projects and organizations are approved for grantmaking purposes, thus eliminating redundant determinations and lowering costs for both the grantmaker and the foreign grantee.
For information about how NGOsource’s equivalency determination service works, click here.