Chapter 2
International Grantmaking by Public Charities
Chapters 2 and 3 focus on U.S. requirements that pertain to international grantmaking. In these chapters, we are dealing with 501(c)(3) organizations, formed under U.S. laws, that make grants directly to foreign recipients. If you are making grants to a U.S. intermediary you generally will not need to be concerned with these rules, although the U.S. intermediary will.
There are a number of good sources of information for international grantmakers, including the Council on Foundations (www.cof.org) and its U.S. International Grantmaking Project (www.usig.org). Additional resources are listed in Appendix B. By contrast, there is very little information available for U.S. organizations that directly conduct activities outside the United States. For this reason, the greater part of this book (Chapters 4 through 10) is aimed at organizations that are, or are contemplating, operating foreign programs directly. At the same time, most U.S. organizations that operate foreign programs also engage in some cross-border grantmaking, and therefore need to understand the basic rules discussed in this chapter or Chapter 3 (whichever applies).
For purposes of Chapters 2 and 3, the term grantmaking is used to refer to any contribution of funds or in-kind donation (books, clothing, medical supplies, technology, or anything else) made for charitable (that is, 501(c)(3)) purposes. The discussion contemplates that contributions are made to foreign organizations. As a general rule, a U.S. 501(c)(3) organization may also provide charitable aid directly to foreign individuals, subject to the rules discussed in Chapters 2 and 3.1
A 501(c)(3) organization is permitted to support foreign programs, and in doing so it may use tax-deductible contributions received from U.S. taxpayers.2 We will see in Chapter 7 that not all countries allow this kind of cross-border giving, and many impose significant restrictions. The United States does, however, impose certain restrictions on cross-border giving to ensure that funds are used for 501(c)(3) purposes. It is critical that your organization comply with these rules; failure to do so could jeopardize your donors' tax deductions, and possibly even jeopardize your organization's tax-exempt status.
2.1 Public Charity or Private Foundation: Why Does It Matter?
A 501(c)(3) organization is classified as either a public charity or a private foundation. All 501(c)(3) organizations are exempt from federal (and often state) income tax and, if established under U.S. laws, can attract tax-deductible funds. However, those 501(c)(3) organizations that are classified as private foundations are subject to a variety of additional restrictions. Contributions to private foundations also receive less generous tax deductions than contributions to public charities. There are many resources that explain all of the requirements and restrictions applicable to private foundations, some of which are listed in Appendix B.
The remainder of this chapter focuses on the U.S. rules applicable to cross-border grantmaking by public charities. Chapter 3 addresses the rules applicable to cross-border grantmaking by private foundations. As discussed in Chapter 3, if your organization is classified as a private foundation, you will face more burdensome requirements in making cross-border grants.
2.2 What is a Public Charity?
An organization may qualify for public charity status by satisfying any of several alternatives. In practice, each of these alternative tests is quite technical.3 With few exceptions, to avoid being treated as a private foundation an organization must apply to the IRS for recognition as a public charity, generally with its initial application for tax-exempt status. If your organization receives funding from a large number of individual donors, it may be easy to determine that you qualify for public charity status. In many cases, however, it will not be readily apparent whether the organization qualifies as a public charity. It is often advisable to work with an attorney or accountant to make that determination.
An organization can qualify as a public charity by satisfying any of the following alternatives:
Broad public support test. Mission-related revenue test. Automatic public charity status. Supporting organization.Each of these is described in the following paragraphs.
Broad Public Support Test
A broadly supported organization is one that receives at least one-third of its total revenue from gifts, grants, or other contributions from governmental units or the general public.4 This would include, for example, the charitable organization that receives donations from a broad base of individuals, does not receive fees for services, and does not rely substantially on a few large donors.
This test is quite technical in practice. An organization that relies on a small number of large donors may not meet the one-third requirement. However, some organizations can take advantage of a more flexible facts and circumstances test by showing that at least 10 percent of the organization's support comes from government units and the general public, and that the organization makes significant efforts toward reaching out to a broad base of donors.5
Mission-Related Revenue Test
Some organizations receive broad support, not just through contributions, but because they earn revenue, such as service fees and ticket sales proceeds, through the pursuit of their charitable purposes. Some examples of this type of organization are providers of health services, museums, and performing arts organizations. Of course, these organizations must qualify for 501(c)(3) status in the first place, but charging fees for services generally does not preclude that.
To meet this test, an organization must receive more than one-third of its support from a combination of gifts, grants, and contributions or membership fees from governmental units and the general public, plus revenue earned in furtherance of the organization's tax-exempt purposes.6 In addition, the organization must not earn more than one-third of its support from investment income. This second test prevents an organization from qualifying for public charity status by relying heavily on endowment funds for ongoing support.
Automatic Public Charity Status
Certain categories of 501(c)(3) organizations are automatically treated as public charities. These include schools (including colleges and universities), churches, and hospitals.7 It is critical to pay attention to technical definitions and requirements to be sure you qualify under any of these categories. For example, in order to qualify as a school for this purpose, an organization must satisfy certain criteria including maintaining formal instruction, regularly enrolled students, and regular faculty, and adopting certain nondiscrimination policies and procedures.
Supporting Organization
A 501(c)(3) organization that is supported by a small group of donors may be unable to qualify as a public charity under one of the previous three tests. Such an organization may nevertheless qualify for public charity status as a so-called supporting organization.8 A supporting organization is one that is formed to support one or more other public charities. It must meet certain specific criteria, establishing that the supporting organization has a close relationship with the organization or organizations it supports.
Prior to a 2006 change in the U.S. federal tax law, this was a common way of obtaining public charity status for a U.S. 501(c)(3) organization (a so-called American friends of organization, described in section 2.4) formed to support a foreign charity. Today, the primary use of a supporting organization in international grantmaking is to support a U.S. intermediary public charity, which in turn, supports one or more foreign organizations.
2.3 Basic Rules for Foreign Grantmaking
Any organization that makes cross-border grants must develop policies and procedures to ensure that funds are used for their intended purposes. The rules that will help shape your policies and procedures are predominantly federal tax requirements, some of which are written into the Internal Revenue Code, Treasury Regulations, written IRS rulings, and court opinions.
In addition, in recent years the U.S. government has become increasingly concerned about the possibility that cross-border grants may be diverted away from charitable purposes, and even into the hands of terrorists. Federal tax laws require that your grants be used solely for 501(c)(3) purposes. If you transfer funds that end up supporting terrorist activity, which, of course, is not a 501(c)(3) purpose, your organization may face severe penalties. See section 8.1.
Your application for federal income tax exemption may well be met with a list of questions, and even demands, aimed at assuring the IRS that the funds you send outside U.S. borders cannot be diverted for improper purposes. Once exempt, you may face similar questions if your organization is audited by the IRS. For these reasons, any organization that intends to engage in international grantmaking is well advised to seek legal advice in preparing and organizing documents, such as articles of incorporation and bylaws, developing written grantmaking policies, and preparing the application for tax-exempt status.
Establish Objective Selection Criteria
To ensure that all grants your organization makes are in furtherance of its 501(c)(3) purposes, the board of directors should adopt a policy that establishes criteria for selecting grantees. This is good governance practice, and it is also something the IRS will look for in your application for recognition of tax-exempt status.
Written selection criteria may be more or less detailed, depending on the nature of the grantmaking organization and the kinds of organizations it supports. Keep in mind that the primary reason for having such criteria is to ensure that your organization's funds are devoted to the proper purposes.
Selection criteria should, at the least, specify the purposes for which grants may be awarded, consistent with the 501(c)(3) purposes of the grantor. In addition, criteria should aim to determine that the grantee is capable of carrying out the purposes of the grant. Selection criteria should also include a process for vetting prospective grantees, described in the following paragraph.
Know Your Grantee
Before agreeing to make a grant, it is critical that your organization has vetted the prospective grantee sufficiently to determine that:
The grantee is capable of carrying out the purposes of the grant. The grantee will not, purposefully or inadvertently, use the funds to support terrorist activities or any other noncharitable purposes.The scope of the vetting process can vary greatly, and will depend on a variety of factors including your relationship with or knowledge of the prospective grantee, the grantee's geographical location, and the nature of the grantee's activities.
Confirm the Grantee's Ability to Carry Out the Purposes of the Grant
Here are some questions you should ask when assessing whether a prospective grantee is capable of carrying out the purposes of a grant:
Does the grantee have legal authority to engage in the contemplated activities? Review the grantee's legal registration and organizing documents. If the answer is unclear, you may want to seek local legal advice. Are there any restrictions on the grantee's ability to receive funds or goods-in-kind from foreign sources? Does the grantee have the practical ability to carry out the contemplated project, given the amount of the proposed grant and the grantee's existing resources? This inquiry can include confirmation that the grantee has adequate financial resources, staff, facilities, and access to utilities. Does the grantee have the ability to provide reports on the use of the grant? Look at whether financial systems are capable of tracking the use of grant funds, as well as whether the grantee has adequate communication technology and English language ability.Determine That Funds Will Not Be Diverted for Terrorist Purposes
Unfortunately, there is no procedure you can follow that will automatically protect your organization from potentially severe consequences should your grant funds end up in the hands of terrorists. Rather, you need to assess the risk and determine the appropriate scope of pre-grant inquiry. It is not always clear how much vetting of prospective grantees is required. For example, is it necessary to check potential grantees against official terrorist lists, even if you have a close, long-standing relationship? You need policies to ensure compliance with the law, and to protect your organization from misuse of resources, without imposing unnecessary burdens on your thinly stretched staff and/or volunteers.
Section 8.1 summarizes some helpful and important guidelines to help you avoid inadvertently supporting terrorism. These include voluntary guidelines issued by the U.S. Treasury Department, which should be considered in determining the appropriate scope of inquiry for any proposed grant.
Do Not Act as a Pass-Through for Contributions to Foreign Organizations
A U.S. taxpayer cannot (subject to very limited exceptions discussed in section 7.6) deduct a contribution made directly to a foreign organization, even if the recipient organization has obtained 501(c)(3) status. For this reason, the IRS has long disallowed deductions to a U.S. 501(c)(3) where the U.S. organization acts as a mere pass-through. That is, if an individual makes a contribution to a U.S. organization, subject to a restriction requiring that the funds be re-granted to a foreign charity, that contribution is not deductible because it is viewed as an individual contribution to a foreign organization.9
The IRS does, however, allow a U.S. organization to use tax-deductible contributions to fund foreign organizations, as long as the U.S. organization retains discretion and control over the funds. Simply stated, this means that the U.S. organization must take responsibility for evaluating whether and how the funds will be used by a foreign grantee to ensure that the funds are used for charitable purposes and are not diverted for any improper purposes.
If your organization intends to provide funding to foreign organizations, the IRS will generally require, when reviewing your application for tax-exempt status and upon audit, that your bylaws include:
A statement that your organization will retain discretion over funds contributed to it, and control over whether and how to disburse the funds. A statement that the board of directors has exclusive control over making foreign grants. A statement that a foreign grantee must agree to make periodic reports to ensure that the funds are used for their intended purposes, and to return any funds not spent.This does not always mean that the board has to review and approve each individual grant. In larger grantmaking organizations, the board may establish detailed criteria, and delegate to staff the authority to make grants that comply with the criteria up to a specified dollar threshold.
The IRS has provided two general models for cross-border grantmakers that are public charities (and not private foundations):10
U.S. Organization Solicits Funds for Its General Purposes, Then Selects Foreign Grantees and Projects
The U.S. organization receives contributions for its charitable purposes and decides to make grants to one or more foreign organizations to carry out the purposes of the U.S. organization. The U.S. organization can advise its donors that it makes grants to certain foreign organizations, but must not make any binding commitments to donors regarding foreign grants. That is, the U.S. organization must have control over the funds it receives, and must have discretion as to their use, so that it can determine how to ensure they are used for charitable purposes.
For example, consider a hypothetical U.S. organization, the purpose of which is to supply warm winter clothes to young children living in poverty. The organization might decide to devote some of its funds to supply coats for children in a foreign orphanage, and it might do that by making a grant to a foreign-based organization that provides assistance in the particular orphanage. Before making a foreign grant, the organization must vet the grantee, review the grantee's proposed use of funds, and enter into a written agreement regarding the use of grant funds.
U.S. Organization Solicits Funds after Vetting and Selecting a Specific Foreign Project
Your U.S. organization may decide to solicit funds from U.S. donors for a specific foreign project conducted by a specific foreign organization. As a variation on the example immediately above, the U.S. organization would identify and vet the foreign organization and its project, and would then solicit funds from U.S. donors for that project. In this case, additional requirements apply:
Prior to soliciting funds, the project must be carefully vetted to ensure that it will serve your organization's charitable purposes, and that the funds will not be diverted for any improper purposes. Donors must be clearly informed that the U.S. organization maintains discretion and control over the funds, such that your organization can redirect the funds to another project, or even to some other organization, if you determine that the contemplated project is not consistent with 501(c)(3) requirements.Funding through a Foreign Intermediary
Note that the rules discussed earlier apply regardless of whether your organization is funding an organization that directly conducts foreign projects, or is funding a foreign intermediary organization (described in section 1.3). If you are making grants to a foreign intermediary, you should:
Before disbursing funds, vet and approve the foreign project in which the funds will be used (identify the ultimate beneficiary and use of the funds). Disburse funds only as needed for the approved project. Require periodic reports so that you can monitor how the funds were used by the ultimate beneficiary for the approved project. Monitor the use of funds by the ultimate beneficiary.Use Written Grant Agreements
Any organization that engages in cross-border grantmaking should insist upon receiving written grant requests from prospective grantees, and entering into written agreements confirming the terms of a grant. Not only does the IRS ask about these procedures, but these procedures are also commonly recognized as best practices that help ensure that your organization's resources are being used in furtherance of its charitable purposes.
Items That Should Be Included in Written Grant Agreements
Every grant agreement should, at a minimum, include the following:
A description of the way grant funds will be used. The grant agreement may incorporate by reference the terms of the grant proposal, which may include a budget for the project to be funded. A requirement that any deviation from the agreed use of funds must be approved in advance, in writing, by the grantor. A prohibition against any use not permitted under 501(c)(3), including any use of grant funds for political activities.11 A prohibition against the use of grant funds for any lobbying activity, or a specific limitation to ensure that the grantee's lobbying activities do not cause the grantor to exceed its own lobbying limits (see section 8.5). A requirement that the grantee segregate and separately account for the use of grant funds. Periodic (at least annual) reporting by the grantee to demonstrate that the funds are used for the agreed purpose. The return of unused grant funds upon completion of the project, or as of a specified date. The grantor's right to withhold grant funds if it determines that the grantee is not in compliance with the grant agreement. The grantor's right to terminate the grant agreement, terminate funding, and receive a return of unused funds in the event funds are misused.Additional Items to Consider
You may wish to include the following, where appropriate:
The right of grantor to conduct periodic site visits. A certification that the grantee will not provide material support to terrorist activities.12 A description of each party's rights (if any) to publicize and/or use logos or other intellectual property of the other. A description of the ownership and rights to use any intellectual property created with the grant funds. The right of the grantor to withhold grant funds to comply with U.S. withholding tax requirements, if applicable. A right of the grantor to withhold taxes if required by law. A restriction against the use of grant funds for travel to, or activities in, the United States. The purpose of this is to avoid the possibility of triggering a requirement that the grantor withhold taxes from the grant funds. In the event U.S. tax withholding is required, a provision for grossing up grant funds, that is, adjusting the grant so that the grantee receives the entire grant amount and the grantor absorbs the cost of withholding.This list is not comprehensive. Any particular grantor-grantee relationship may include a host of additional provisions.
Monitor Your Grants
It is critical to monitor the use of grant funds. This doesn't necessarily mean that your organization must send staff, board members, or volunteers to visit the grantee, although that is always desirable. When feasible, site visits are an excellent way to confirm that a grantee is using funds for the intended purposes. At the least, you need to make sure that you receive financial and narrative reports that are adequate, given the level of resources and degree of risk, to assure your board that the funds are being used for the intended purposes.
The Critical Role of the Board of Directors
Regardless of where in the United States your organization is established, the board of directors is legally responsible, under state law, for ensuring that the organization devotes its resources in furtherance of its purposes. The board need not, and in all but the smallest organizations should not, participate in day-to-day management. However, to satisfy its oversight responsibility the board must see that the organization adopts and complies with appropriate policies and procedures to ensure against any misuse of funds.
The risk that funds may be diverted for improper purposes is, in general, greater when organizations make cross-border grants. It is more difficult to gather information about grantees, and once obtained, such information may be difficult to interpret due to legal, cultural, and language differences. Monitoring of remote activities can be challenging.
In addition to state law requirements, as discussed above, the IRS requires that the board have exclusive control over the making of cross-border grants.
To satisfy both state law and IRS requirements, boards need to assess the level of risk inherent in their organizations' grantmaking, and develop policies and procedures establishing selection criteria and monitoring procedures appropriate to the level of risk. As a general rule, the board, or a board committee, should review and approve individual grants. For larger organizations that make many grants, the board may authorize staff approval of grants, up to a specified dollar limit, based on objective, written criteria. Some organizations choose to set forth in bylaws the board's specific responsibilities in overseeing the grantmaking process, and this can be useful in obtaining IRS determination of exempt status.
2.4 American Friends of Organizations
A common structure for Americans who want to support a particular foreign organization is the so-called American friends of organization.13 This term was coined because often the name begins with American friends of, or friends of, and ends with the name of the foreign organization it supports (such as, for example, American Friends of the British Museum). While a friends of organization is typically formed primarily to support a single foreign organization, it should have some additional purposes or activities. For example, the bylaws may contemplate supporting additional foreign organizations, and/or the friends of organization may engage in some activities in the United States beyond fundraising.
While the IRS has approved many friends of organizations as 501(c)(3) public charities, all of the requirements described in this chapter with respect to cross-border grants apply. A friends of organization must be careful to act independently of the foreign organization it supports. It must review requests for funding, and make funding decisions, on a project-by-project basis. Funding a specific foreign project may include an allowance for administrative, so-called overhead, expenses of the foreign organization.
The U.S. organization may solicit funds for a specific project it has approved, but it must advise donors that it maintains discretion and control over the funds, as described in section 2.3. This means that the U.S. organization must advise donors that it has the right to withhold and redirect funding in the event that a project is not conducted in accordance with 501(c)(3) requirements.
In order to maintain its independence, and to avoid any perception that the American friends of organization is controlled by the foreign charity, a majority of the directors of the U.S. organization should not also be directors, officers, or employees of the foreign organization.14 It is also important to maintain a separate website for the friends of organization so that it's clear to visitors that they are being asked to contribute to a U.S. organization, not directly to a foreign organization, and that the U.S. organization does not directly operate the foreign projects being funded by U.S. donors. The U.S. organization's website may contain a link to that of the foreign organization, but visitors should know which organization's website they are visiting.
2.5 Special Rules for Donor-Advised Funds
One way to avoid the burden of complying with foreign grantmaking requirements is to contribute to a U.S. intermediary organization using a donor-advised fund. Simply stated, a donor-advised fund is an account that a donor creates with a so-called sponsoring organization.15 The sponsoring organization must be a public charity, and frequently is, but is not required to be, a community foundation or large financial institution. The donor makes an irrevocable contribution, which triggers a tax deduction (to the extent otherwise allowed by law). The donor can then make recommendations regarding the use of the contributed funds, but the sponsoring organization must maintain discretion and control over the funds, and therefore cannot have a legal obligation to comply with the donor's wishes.
Donor-advised funds that make cross-border grants are required to comply with the so-called expenditure responsibility requirements that apply to private foundations, described in Chapter 3. For this reason, many sponsoring organizations refuse to make cross-border grants. Those sponsoring organizations that do make cross-border grants typically need to charge relatively high fees to cover the costs of legal compliance.16
2.6 Other U.S. Intermediaries
You can greatly simplify your grantmaking process by contributing to a U.S. intermediary organization which itself is a public charity (and not a donor-advised fund). However, it's important to be aware that any U.S. intermediary is subject to the discretion and control requirements explained earlier. This means that, at best, you will be able to make recommendations regarding the ultimate recipients of your funds. The intermediary organization must have the ultimate authority to determine how the funds are disbursed. You need to decide how much control and involvement you want to have in the grantmaking process.
2.7 Review and Further Considerations
Before venturing into cross-border grantmaking, it's important to properly classify your 501(c)(3) organization as a public charity or private foundation. This chapter has focused on U.S. federal tax requirements related to cross-border grantmaking by public charities. The following chapter provides an overview of U.S. federal tax requirements for private foundations making cross-border grants.
Whether your organization is characterized as a public charity or private foundation, it's important to be aware that additional U.S. legal requirements and restrictions may come into play. Chapter 8 lists a number of additional legal and practical considerations that may apply to cross-border grantmakers.
In addition, you need to know whether the recipient's country imposes any restrictions on the receipt of funding or importation of goods in-kind. These considerations are addressed in Chapter 9.
Notes
1. A private foundation that wishes to provide scholarship assistance must obtain advance approval from the IRS. I.R.C. § 4945; Treas. Reg. § 53.4945-4.
2. As explained in Chapter 1, in order to be eligible to attract tax-deductible contributions, a 501(c)(3) organization must be formed under U.S. (not foreign) laws.
3. See IRS Publication 557, Tax-Exempt Status for Your Organization (December 2011), 33, available at www.irs.gov/app/picklist/list/publicationsNoticesPdf.html?value=557&criteria=formNumber&submitSearch=Find.
4. I.R.C §§ 509(a)(1) and 170(b)(1)(A)(vi); Treas. Reg. § 1.170A-9(f).
5. Treas. Reg. § 1.170A-9(f).
6. I.R.C. § 509(a)(2).
7. I.R.C. §§ 509(a)(1) and 170(b)(1)(A)(i)-(iv). Also included in this category are: organizations formed to hold and administer endowments for public colleges and universities, governmental units, and organizations organized and operated for purposes of testing for public safety.
8. I.R.C. section 509(a)(3).
9. The IRS has not clarified whether this would also jeopardize the U.S. organization's tax-exempt status. In any event, no organization wants to jeopardize a donor's tax deduction, and misleading donors about the tax-deductibility of contributions may cause further trouble for the organization.
10. See Rev. Rul. 63-252, 1963-2 C.B. 101 (Jan. 1, 1963), and Rev. Rul. 66-79, 1966-1 C.B. 48 (Jan. 1, 1966).
11. As a technical matter, the grant agreement would typically make reference to section 170(c)(2)(B) of the Internal Revenue Code.
12. For a discussion of the pros and cons of requiring such a certification of grantees, see Andrew Schulz, “The Debate Over Anti-Terrorism Certification,” International Dateline, a Publication of the Council on Foundations 74 (Third Quarter 2005), available at www.cof.org/templates/content.cfm?ItemNumber=2036&navItemNumber=2527.
13. For a detailed explanation of the rules and restrictions applicable to so-called American friends of organizations, see Lieber, Penina Kessler and Donald R. Levy, eds., Complete Guide to Nonprofit Organizations (Kingston, NJ: Civic Research Institute, 2005), ¶10.3[3], and Cumulative Supplements. See also Edie, John A., Jane C. Nober and Jacob T. Clauson, Beyond Our Borders: A Guide to Making Grants Outside the United States, Fourth Edition (Council on Foundations: Arlington VA, 2012).
14. The IRS has, on occasion, ruled that a U.S. 501(c)(3) organization may have a board that overlaps completely with that of a foreign organization. See PLR 200551024 (Sept. 30 2005), where the foreign organization met the requirements of 501(c)(3). IRS Private Letter Rulings such as this do not have legal precedential value, and cannot be relied on. Today, it is likely to be difficult, if not impossible, to obtain recognition of 501(c)(3) status where there is complete overlap among the boards of a domestic and foreign organization.
15. I.R.C. § 4966(d)(2) defines a donor-advised fund to mean a fund or account: (i) which is separately defined by reference to contributions by a donor or donors; (ii) which is owned and controlled by a sponsoring organization; and (iii) with respect to which a donor (or any person appointed or designated by such donor) has, or reasonably expects to have, advisory privileges with respect to the distribution or investment of amounts held in such fund or account by reason of the donor's status as a donor.
This definition, along with restrictions applicable to donor-advised funds, was enacted into law as part of the so-called Pension Protection Act of 2006, Pub. L. No. 109-280, 120 Stat. 780 (2006).
16. See, for example, Charities Aid Foundation America, available at www.cafamerica.org.