Chapter 5
Forming and Operating through a Foreign Legal Entity
Once you have decided to operate a program in a foreign country, there are a number of reasons you may need or want to have more than just a branch or office. You may end up establishing a separate organization, or so-called legal entity, in that country rather than operating through a foreign registered office or branch.
5.1 Establishing a Foreign Legal Entity
This chapter explains the concept of a legal entity and the reasons you may need or want to form one. We also explore possible ways to structure the relationship between a U.S. organization and one or more separate foreign legal entities so as to achieve an appropriate balance between central control and local autonomy.
What is a Legal Entity?
When we refer to a legal entity, we mean a local country nonprofit corporation or trust, or something roughly similar, established under a particular country's law. Unlike a branch or registered office, a foreign legal entity has its own organizational documents (such as articles or a charter), board of directors or other governing body, and members if it's a membership organization.
If you form a legal entity to provide services or conduct other activities in a foreign country, it is likely that you will want to maintain a separate 501(c)(3) organization, formed under U.S. laws, so that your U.S. donors can receive a tax deduction. That U.S. organization becomes a grantmaker when it contributes funds to a separate foreign legal entity, and it must comply with the U.S. cross-border grantmaking rules discussed in Chapter 2 or 3, depending on whether the U.S. organization is a public charity or private foundation. By contrast, if your U.S. organization operates in a foreign country through an office or branch (discussed in Chapter 4), it is treated for U.S. tax and legal purposes as operating the foreign program directly, and therefore it is not treated as a grantmaker.
If your U.S. organization is creating a foreign legal entity to help carry out its mission in a foreign country, the U.S. organization may want to maintain a certain degree of control over the foreign entity to ensure that the latter's purposes and policies are consistent with those of the U.S. organization. At the same time, there may be practical reasons, or even legal requirements, for vesting a foreign entity with local control. Later in this chapter we consider ways to achieve the relationship that's right for your organization.
Why Form a Separate Legal Entity?
Here are some reasons to form a separate legal entity:
You are required to do so. This may be a condition to hiring local residents, or to their eligibility for social benefits, or it may be a condition to engaging in particular activities. You want to allow for local governance. Operating through a local entity may facilitate relationships with government officials, or make it possible to obtain funding from local country sources. For example, in the European Union (EU), some funding is available only for organizations incorporated in an EU country. Forming a separate legal entity may avoid subjecting the U.S. nonprofit organization to liabilities, including taxes, in the foreign country. Forming a separate legal entity may avoid disclosing the financial statements of your U.S. operations to foreign authorities. If you want to solicit contributions in a foreign country, it is likely that you'll be required to form a separate legal entity in that country. You may want to engage in substantial foreign business activity, or in lobbying or political activity, or in other activities that are not in furtherance of the U.S. 501(c)(3) organization's tax-exempt purposes. If your foreign operations are likely to grow significantly, you may need a separate legal entity down the road. It may be more efficient to structure the foreign operation through a separate legal entity from the outset.Here, on the other hand, are some reasons to operate through a foreign office or branch, rather than forming a separate legal entity:
You want the U.S. 501(c)(3) organization to have maximum control over the foreign operations. You want to solicit funds for your foreign projects without having to comply with the discretion and control requirement (see section 2.3). Note that if you choose to operate a foreign program through a foreign legal entity, while funding that program through a U.S. 501(c)(3) organization, you may be creating a friends of structure, discussed in Chapter 2. You want to avoid the administrative burdens of maintaining a separate legal entity. You want to facilitate government relations. In some countries, a U.S. organization operating through a local branch may find it easier to work with local government officials than would a locally incorporated entity. You want to minimize the burden of financial and other reporting requirements, which may be less cumbersome for branches or registered offices than for legal entities.In determining whether and how to form a foreign legal entity, you will need to consult with a lawyer in the foreign country, and that lawyer should be physically in, or knowledgeable about, the locality in which you are operating. In addition, it is important to talk with other international NGOs to better understand the practical issues you will face. For example, you may want to consult other NGOs and question them about whether government interference is greater for a legal entity or for a branch, and whether one is preferable for purposes of government relationships.
Converting a Foreign Branch into a Legal Entity
As foreign operations expand or become more complex, it becomes more likely that a separate legal entity will become necessary and/or useful. It is often more cumbersome and expensive to transfer operations into a separate legal entity after you have been operating for some time as a branch. To do so, you will need to identify all assets, employees, and contracts so that you can transfer legal ownership, most likely with the help of a local attorney. In addition, transferring employees can create traps for the unwary. For example, in some countries this type of transfer triggers employees' rights to severance payments.
If you anticipate maintaining a presence, such as an office and staff, in a foreign country on a long-term basis, you may be better off creating a separate legal entity from the outset. While this may take more effort up-front, you will avoid the cost of having to transfer your operations down the road. This is a question to raise with your attorney in the foreign country.
5.2 How Hard Will It Be to Form a Foreign Legal Entity?
If you conclude that you want or need to operate through a separate foreign legal entity, here are two initial questions you should explore:
Some countries prohibit foreign organizations or individuals from forming nonprofit organizations. These include Malaysia, Thailand, and Qatar.1 Others restrict the purposes for which foreigners can form nonprofits, for example by prohibiting foreign organizations and individuals from involvement in human rights issues. Under Ethiopian law, any organization that receives more than 10 percent of its funding from outside Ethiopia is prohibited from advancing human rights among other issue areas.2
In some countries, procedural barriers make it impossible, as a practical matter, for foreign organizations or individuals to establish an organization. Procedural barriers can also take the form of periodic, even annual, reregistration requirements that add to the cost, burden, and uncertainty of operating. These kinds of procedural barriers may be written into the law (national or local), or they may exist only as a matter of practice.
In Angola, the registration process requires going back and forth among several governmental bodies at various levels (national and local) such that the process can drag on for years.3 Mexico, among other countries, requires that a majority of members be Mexican citizens, and imposes additional procedural hurdles when an organization has non-Mexican members.4
Other countries make formation of a nonprofit organization difficult by requiring large numbers of founders or members. For example, Turkmenistan requires a minimum of 500 founding members, while Yemen requires 41, and Sudan requires 30.5
Some countries, including Egypt, effectively exclude or limit foreign participation in their nonprofit sector by prohibiting or restricting local country nonprofit organizations from collaborating with foreign organizations.6 Many countries throughout the Middle East and Northern Africa (the so-called MENA region) require prior government approval of an NGO's affiliation with any foreign organization.7
Still other countries vest government officials with broad, or even complete, discretion to approve or reject the establishment of nonprofit organizations. This kind of discretion can be used to preclude nonprofit organizations with noncitizen founders or members, as well as to bar organizations that have purposes the government does not sanction. China, Bahrain, Russia, Egypt, and Malaysia are examples of countries with laws that afford this kind of broad administrative discretion. In Uganda, the process of registering an organization requires the submission of many letters of recommendation from government officials and others, while the law provides no objective criteria for government officials to approve or deny registration.8
As a matter of local country law, once you create a legal entity you may be required to have local representation among your membership and/or board. Or, government officials may have the right to involve themselves in the internal affairs of the organization, as in Russia and China. In Senegal, the government has the right to appoint voting representatives to an organization's governing body.9
The foregoing are examples of the wide range of restrictive laws and practices that may impede or inhibit your ability to form and operate a legal entity in a foreign country. Do consult a lawyer, but also talk to organizations that have established operations where you want to operate to find out about their experiences. Finally, keep in mind that laws are continually changing.
The mere fact that you can get permission to establish and operate an entity in a country today doesn't guarantee that you'll be able to stay, or to continue pursuing your purposes tomorrow. Of course, some countries' political and legal regimes are more stable than others, and some kinds of nonprofit activities are more likely to be targeted when there is hostility to foreigners. The key point is, do your homework and assess the risks before investing resources.
5.3 What Kind of Legal Entity Should You Create, and Why Should You Care?
Isn't This Something Just the Lawyers Should Care About?
There are a number of reasons that you need to care about the kind of legal entity you are creating in a foreign country. The form of legal entity you choose may determine any or all of the following:
The nature of permitted activities. Whether or not there are members. Whether there is a required minimum number of members. Whether, and the extent to which, members and/or board members may be foreign (including U.S.) nationals. Whether the entity is permitted to engage in fundraising.The form of legal entity may affect the degree to which members and/or directors or trustees could be held liable for the organization's actions; for example, if someone is injured due to an employee's or volunteer's negligence while providing services.
In addition, you need to be concerned about the relationship between the foreign entity you are creating and other entities you have created, or will create in the United States and perhaps other countries. For example, if you are raising funds in the United States through a U.S.-based 501(c)(3) organization (remembering from Chapter 1 that U.S. taxpayers can only deduct contributions to U.S. 501(c)(3) organizations), and providing services through a foreign entity, you need to consider whether, and the extent to which, the U.S. organization should control or influence the activities of the foreign service provider. The alternatives for achieving the relationship you desire, or getting as close as possible given the legal constraints, will depend on the kind of foreign legal entity you form.
No distribution of profits to members. A key feature distinguishing nonprofit corporations from for-profit corporations is that the former are prohibited from distributing profits (such as dividends) to their members. Nonprofit corporations typically are not permitted to issue stock.c Many people prefer the term not-for-profit over nonprofit because the defining characteristic of the not-for-profit corporation is the purpose for which the corporation exists. While a for-profit, or business, corporation exists to make money for its shareholders, a nonprofit, or not-for-profit corporation exists for a purpose other than to make money for its members. As such, it is typically not prohibited from earning a profit, but is required to devote any profit toward the pursuit of its purposes. May choose whether or not to have members. A nonprofit corporation typically may choose to be a membership corporation or a nonmembership corporation. If it has members, the members may have the right to vote on certain matters, such as the selection of officers, but members typically do not have the right or responsibility to oversee the corporation's affairs. State laws vary as to whether, and the extent to which, they grant rights to members. Some states' laws provide for different categories of nonprofit corporations, some of which are membership corporations. Limited liability for members. This means that members, if any, are generally not liable for the debts of the corporation, although they can be held liable under certain circumstances for their own acts or negligence. For example, if your organization is operating a childcare center and a child is injured, generally the individual members cannot be held personally liable.d Centralized management through directors and officers. A board of directors (sometimes referred to as a board of trustees, although these are not the same as trustees of a trust, described below) is responsible for overseeing the affairs of the corporation, and ensuring that the organization serves its mission and uses its funds appropriately. The board may be self-perpetuating (that is, the board elects successor members), elected by members, appointed by designated parties, or some combination of these. Officers of the corporation, paid or volunteer, may have responsibility for day-to-day management, reporting to the board. Perpetual existence. A corporation typically continues to exist indefinitely until it is dissolved by action of the board or members; dissolved by the government if the organization fails to maintain its legal registration; or until it is merged out of existence.Some Common Forms of Foreign Nonprofit Organizations
The number of different types of foreign legal entities is too numerous to describe here, and foreign laws are constantly changing. We will look at a few categories of legal entities, each of which is used in a number of countries. This will allow us to explore how you might structure the relationship between a U.S. and a foreign legal entity, or even among multiple legal entities, to achieve the optimal balance for your organization between central control and local autonomy.
While there are numerous variations in legal entity forms among countries, here are some notable themes:
Many countries have laws that provide for something similar to a U.S. nonprofit corporation, and something akin to a trust. Membership and nonmembership organizations are, in some legal regimes, distinct types of legal entities. In some countries, the form of entity is dictated by whether the nonprofit organization is a grantmaking organization or a direct service provider. In some countries, national laws govern the formation and registration of legal entities, while in others local laws apply. The form of legal entity dictates its tax status in some countries, while in others, obtaining tax-exempt status involves a separate process.In the United States, state laws determine the form of legal entity, while federal (and sometimes state) tax law imposes additional requirements for tax-exempt status. Many countries, including England and Wales, Canada, and India have a similar two-step process whereby a legal entity, once formed, must apply for a particular status, often called charity or public benefit status.10 This affords the organization an income tax exemption, and in some cases exemption from VAT and other taxes. Yet, an additional step may be required to obtain permission to solicit contributions from the public, and/or to qualify for the receipt of tax-deductible contributions. In addition, the governmental body that confers this special status may or may not be the tax office. For example, a charitable organization established under the laws of England or Wales must register with the Charity Commission of England and Wales, an entity separate from the taxing authority. The organization then must apply to the tax authorities to obtain tax-exempt status and authorization to attract tax-favored contributions.
A word of caution is in order regarding terms used to designate legal entities. It is critical to look behind the term used in any country, and to understand the characteristics of that entity. For example, the term foundation is used in many countries, throughout Europe and elsewhere, to designate a form of legal entity that bears some similarities to a nonmembership nonprofit corporation. In China, the term foundation designates a form of legal entity that is rather unique (see section 10.2). In the United States this term does not designate a form of legal entity, but rather the term private foundation is used in federal tax law to designate a type of 501(c)(3) organization (see Chapters 2 and 3). To add further confusion, many U.S. organizations that qualify as public charities, rather than private foundations, have names that include the term foundation.
Membership Nonprofit Company or Association
Many countries have laws that provide for a form of legal entity that has certain key features in common with a U.S. nonprofit membership corporation, such as:
Limited liability for members. Prohibition against distributions of profits to members. Centralized management through a board of directors or trustees.Some terms commonly used to designate this type of entity are company limited by guarantee and association.
Among other individual country variations, the minimum required membership can vary from one to many. This can be an important factor when you are considering how to structure the relationship between the U.S. and foreign (and perhaps multiple) entities. For example, if you want your U.S. entity to have control over setting the strategies of the foreign entity, you can achieve that by designating the U.S. entity as the sole member, assuming the organization is permitted to have a single member. If many members are required, that can be more challenging. If there is a requirement that all or a certain number of members must be nationals of the foreign organization's country, you will need to find other ways of achieving control, such as through contractual arrangements.
Members may have legal rights that cannot be altered, such as the right to elect and remove directors. It's important to know what those rights are before you form a membership organization.
The company limited by guarantee is commonly used by charitable organizations in England and Wales, and in other Commonwealth countries (whose laws were influenced by the British legal system), such as Ghana, Kenya, and Uganda, to name just a few. In a company limited by guarantee, typically members cannot be held liable for obligations of the company in excess of a nominal amount. A newer form of organization, the charitable incorporated organization (CIO), became available in Scotland as of 2011, and as of this book's publication, it was pending in England and Wales. This form is similar to the company limited by guarantee, but with streamlined registration and reporting requirements.
Associations are another common form of legal entity that also have key features in common with a U.S. membership nonprofit corporation. Associations exist throughout much of Europe, including most of the Central and Eastern European (CEE) countries.11
In Mexico the most commonly used form of nonprofit organization is the associación civil (A.C.), which is a membership organization bearing similarities to a U.S. nonprofit corporation.12
In South Africa, the so-called section 21 company bears similarity to the company limited by guarantee. It is required to have a minimum of seven members.13
As another example, in India the section 25 company has similarities to a nonprofit corporation formed under state law in the United States, and is eligible for Indian tax benefits when formed for charitable purposes, assuming additional requirements are satisfied.14
It is important to note that countries vary widely in the degree to which they restrict nonprofit activity. The formation and operation of a company limited by guarantee may look very different between one country and another, and it may not be possible in a particular country to achieve the kinds of control discussed further on.
Nonmembership Nonprofit Organization
In a number of countries, a nonmembership organization is a distinct form of legal entity. For example, the foundation is a form of nonmembership nonprofit legal entity found throughout much of Europe, including most CEE countries.
In many countries, a foundation has the following features:
It is formed for public benefit (charitable) purposes. It has no members. It does not raise funds from the public, but rather receives funds from one or a small number of individuals or entities.In some countries, foundations are limited to grantmaking, and they may be required to have significant endowments. The Czech Republic and Slovenia are examples. In other countries, foundations may function either as grantmakers or as operating organizations, and the lack of members distinguishes them from associations. Bulgaria and Estonia are examples.15
Some notable exceptions to the above are Germany, China, and the United States. Germany does not require that a foundation be formed solely for public benefit purposes. China permits certain foundations to raise funds from the public and, in fact, the public foundation is the only type of Chinese entity that is permitted to do so (see Chapter 10). In addition, Chinese foundations can, and often are, formed with government funding.
In the United States, state laws, which define and govern forms of legal entities, do not define a separate type of entity known as a foundation. Rather, the term private foundation is a tax law construct that triggers certain tax consequences (see Chapters 2 and 3).
Charitable Trust
Many countries (including, for example, India) afford tax-favored status to charitable trusts, similar in form to the charitable trusts that exist in the United States. Trusts are more commonly used to hold and grant funds, or to hold other property, and are generally considered less suitable for directly conducting programs, although there are exceptions.
Unincorporated or Voluntary (Informal) Association
In many countries, as in the United States, a group of individuals may come together to pursue a charitable or other purpose without creating a legal entity that is registered or otherwise recognized under the law. Not all countries permit this kind of informal association. Equally important, if your organization is operating in a foreign country on a long-term basis, hiring employees and/or owning assets, you will most likely need to register a legal office or form a legal entity.
Again, terminology can be misleading. Before you decide what kind of legal entity to form, look behind the labels to understand the characteristics of the forms of legal entity available to you in a particular country.
Form of Legal Entity: Factors to Consider
Once you decide to form a separate legal entity in a foreign country, you may have the opportunity to choose among two or more forms of legal entity. While it is always critical to seek legal advice in a foreign country, the following factors may influence your decision and should be explored with an attorney:
Which, if any, types of legal entities afford limited liability for members and directors? What kinds of tax benefits are available for a particular type of entity and its donors? What additional conditions must be satisfied to obtain those benefits? How difficult, and how expensive, is it to establish a particular type of entity? What are the ongoing reporting requirements? Do government officials have the right to examine internal documents? If a membership structure is available, can all, or at least some, membership interests be held by a U.S. (or other foreign) organization or citizen? How many founders and/or members are required in order to form and maintain a particular type of entity? What kind of governance structure (such as a board of directors) is required or permitted? Is there a requirement of local control?5.4 Do You Want a Model of Control or Collaboration, or Both?
If your U.S. 501(c)(3) organization finds that it wants or has to form a separate legal entity in a foreign country to carry out its programs, you may want to be sure that the foreign legal entity will adhere to the U.S. organization's policies and strategies. Of course, you can always attach conditions to grants from the United States. Indeed, as seen in Chapters 2 and 3, you will need to do just that in order that U.S. donors can take income tax deductions for their contributions.
You may, however, want to take further steps to ensure that the foreign legal entity conducts itself in accordance with the policies of the U.S. organization. There are a variety of ways to do that. In deciding what is right for your organization, you should consider the following:
What forms of legal entity are available in the foreign country? How much (if any) foreign control is permitted? Do you want to adopt a model of centralized control, collaboration that involves the foreign country entity in the creation of policy, or local country autonomy?You will need to weigh the pros and cons of centralized control against those of a collaborative model or one that affords local autonomy, and then decide what works best for your organization. The following sections describe a variety of formal structures for achieving control and collaboration. You can mix and match these models as appropriate, subject to whatever legal constraints may be imposed by the foreign country or countries in which you operate.
5.5 Control
Nonprofit organizations, in the Unites States and elsewhere, typically are not permitted to have shareholders in the same way that business corporations do.16 This is because the nonprofit receives special treatment, such as tax exemption and possibly the ability to attract tax-deductible contributions, in exchange for permanently dedicating funds in furtherance of its mission. As a result, you typically cannot achieve control through stock ownership as you could with a for-profit business.
There are, however, some other ways to achieve control over the foreign operations.
Control through Membership
If you can structure the foreign nonprofit legal entity as a membership corporation, such as an association or company limited by guarantee, then you may be able to designate your U.S. 501(c)(3) organization as the sole member. Or, you may be able to designate one or more individuals, such as the board members of the U.S. organization, as sole or controlling members. You will need to understand what the foreign country allows. You will also want to understand the legal limits on member liability, particularly if members must be individuals.
The key point here is, if your U.S. organization or its board members can control the membership of the foreign organization, then it will be able to ensure that the foreign organization operates consistently with the purposes for which it was formed. The U.S. organization will do this either by acting as the governing body of the foreign entity, or by electing the foreign entity's board of directors and replacing those directors as necessary. While the board of directors of the foreign organization must act independently of the U.S. organization, the U.S. organization has the ability to replace the board, thereby ensuring that the foreign organization acts in accordance with the general policies of the U.S. organization.
Of course, there are many variations on foreign country laws. Not all countries allow foreign organizations to hold membership interests. Some country laws require more than one member, some prohibit organizations from serving as members, and some prohibit foreign individuals and/or organizations from serving as members or as sole member.
As examples, Ghana permits a U.S. nonprofit organization to act as the sole member of a company limited by guarantee, while most CEE countries require that an association have more than one member. Most of the CEE countries permit foreign individuals to join as members, although not all permit organizations to be members, and some require that the founders be citizens.17
Control through Appointment of Directors
It may not be possible for your U.S. organization to control the foreign entity through membership, either because the foreign entity cannot be structured as a membership organization or because the foreign law requires local members. In this case, your U.S. organization may be able to achieve a degree of control by providing, in the foreign entity's organizational documents, that the U.S. entity's board has the right to appoint directors to the foreign entity's board or other governing body.
Alternatively, the foreign entity's governing documents might provide that its board consists of, or includes, a specified number of board members and/or officers of the U.S. entity. The use of overlapping directors is a common way to achieve some control. At the same time, it's important to keep in mind that a director who serves on the boards of both a funding organization and the recipient of its funds has a conflict of interest, and may have to abstain from voting on funding decisions. For this reason, and in order to satisfy the IRS that the U.S. 501(c)(3) organization is not controlled by the foreign entity, at least a majority of the U.S. entity's directors should not also be directors, officers, or employees of the foreign entity.
Of course, you will have to determine whether any of these strategies is permissible under the laws of the particular foreign country.
Some countries require that all or a majority of board members be local nationals. For example, in the case of an organization formed in the Netherlands, the majority of board members must be Dutch nationals.
You may also want to have representatives of the foreign entity's board on the U.S. entity's board to facilitate communication and collaboration. Under U.S. state laws, a nonprofit corporation typically is permitted to designate board members in this way.
Boards that have members residing in multiple countries encounter logistical issues in holding meetings. Most U.S. state laws permit meetings to be held by teleconference or video, but laws have not always kept up with technology. You may be surprised to find that you can't conduct formal board business across the globe using the technology of your choice. You may also find it difficult to communicate in real time with board members in remote parts of developing countries. The key point here is, before you decide to have a board that looks like the United Nations, think about how the board is going to operate and communicate, and be sure it is realistic and feasible.
Control through Contractual Arrangements
Even without direct control of the membership or board of a foreign organization, your U.S. organization can control aspects of a foreign entity's operations through contracts. Assuming your U.S. organization is the sole, or even a significant, funder of the foreign organization's operations, you should be in a good position to maintain some control through contractual provisions. Of course, you will need to comply with applicable foreign law requirements.
Your contract might include provisions addressing any or all of the following:
Mission of the organization. Values. Code of ethics. Governance structure. Scope of operations. Compliance with 501(c)(3) requirements, including conditions related to the use of funds granted by a U.S. organization.18 Use of name and other intellectual property (discussed next). Requirements that the U.S. organization approve new programs and other major changes. Certain commitments that the U.S. organization may make, such as agreeing to provide support services to the foreign organization. Other matters of importance to your organization.Control through Licensing of Name, Logo, and Other Intellectual Property
One way to maintain some control over foreign legal entities is by licensing a name and/or logo. The U.S. organization may also have copyrighted written materials that it wants to license. These kinds of intangible assets are referred to as intellectual property, and they have value to your organization. You can license these assets subject to conditions that allow your organization to maintain a consistent image and message worldwide. For example, you may enter into a written license agreement that gives the U.S. entity the right to review and approve, or refuse to approve, any use of your trademark. That way, you can be sure that the message associated with your trademark is consistent worldwide. In fact, you need to exercise this kind of control over the use of your trademarks in order to maintain protection in the United States (see section 9.7).
Always Have Written License Agreements
The legal entities should execute a written license agreement, which should be prepared in consultation with lawyers in both countries. The agreement should set forth the conditions of use, and should also make clear that the licensed intellectual property will be used to further the U.S. organization's 501(c)(3) purposes, if that is the case.
A lawyer in the foreign country can also advise you as to how to protect your intellectual property in that country. For example, it may be necessary to register a trademark in order to be able to enforce your rights against copycats.
Should You Charge Royalties?
Assuming that your organization is licensing intellectual property to a foreign organization for use in activities that further your organization's 501(c)(3) purposes, you should not have to charge a royalty. However, if the foreign licensee is not using your intellectual property exclusively for purposes that meet section 501(c)(3) requirements, you may need to charge a royalty in order to avoid jeopardizing your organization's 501(c)(3) status.19
If your U.S.-based 501(c)(3) organization does receive royalties from licensing trademarks and other intellectual property, in most cases your organization won't be taxed on that revenue in the U.S., even if the license does not further your tax-exempt purposes. That is because royalties fall under an exception from unrelated business taxable income (see section 4.9).
Service fees do not fall under this exception, however, and therefore can be taxed as unrelated business taxable income if a service is not performed in furtherance of your tax-exempt purposes. This could be the case, for example, if your organization decides to license copyrighted materials to a business entity, and you also agree to provide printing and distribution of the materials. If you are providing a service in connection with a license, it may be a good idea to enter into a separate service agreement so that the service fee is isolated from the royalty. You should consult a lawyer to help structure this type of arrangement.
Keep in mind that some countries may impose a tax on payments of royalties to a U.S. organization. This would typically be in the form of a withholding tax, which requires the payor to withhold the amount of the tax from the royalty payment and remit it to the government. Some countries may even prohibit the payment of royalties to a foreign (such as a U.S.) organization.
A Word of Caution for Private Foundations
The discussion above assumes that your U.S. organization qualifies as a 501(c)(3) public charity (see Chapter 2). If your organization is, instead, classified as a private foundation, structuring relationships with foreign organizations can be a bit more tricky.
A private foundation is well advised to consult an attorney in order to understand whether, and how, the self-dealing rules (described in section 3.1) may restrict its ability to make grants and enter into transactions with other organizations and individuals. In addition, a U.S. private foundation that controls a foreign (or domestic) organization, must meet additional requirements if it wants to make grants to the organization it controls, and to include those grants in computing its annual minimum distribution requirement.20 See Chapter 3 for a summary of additional restrictions on cross-border grantmaking by private foundations.
5.6 Collaboration
Rather than seeking control over a foreign entity, you may want a model of collaboration in which the U.S. organization and one or more foreign entities jointly set strategy and policy. As your organization grows and evolves, you may find that it is beneficial, if not essential, to set organizational policies collaboratively with those people who are closest to the provision of services.
Nonprofit corporations formed in the United States (under the laws of a particular state or the District of Columbia) typically are permitted to have board members who are not U.S. citizens or residents. You may want to provide in your bylaws that one or more board members will be appointed by a foreign service organization, or that one or more of its board members will be members of the U.S. organization's board of directors. Be mindful, however, that your 501(c)(3) organization must be able to satisfy the IRS that it is not controlled by the foreign entity.
Alternatively, you might adopt an informal mode of collaboration, for example by designating an advisory council comprised of representatives from the foreign entity or entities, as well as from the U.S. organization. If you use this approach, be sure that each entity's board of directors, or other governing body, has and exercises the right to make final decisions regarding any recommendations by the advisory council. This is critical to maintaining the separate legal status of the entities (see section 5.12).
These forms of collaboration can be combined with any of the control models described earlier in this chapter. For example, your U.S. organization may be the sole member of a foreign membership entity, such as an association or company limited by guarantee, and have the power to control policy and strategy by appointing, and if necessary removing, the foreign entity's board. At the same time, you may recognize that the leaders of the foreign entity understand the environment in which it is operating, and for that reason you want their participation in setting policy. To achieve that balance, you might provide in the U.S. organization's bylaws that the foreign entity will designate one representative to the U.S. organization's board. If more than one foreign entity is involved, each one might designate a representative, while the U.S. entity continues to have ultimate control over the foreign entities.
As you consider structuring relationships among your U.S. and foreign entities, you should also think about whether you are concerned about public disclosure of the identities of foreign affiliates, and transactions among foreign and U.S. entities. These kinds of disclosures are required by the IRS (through Form 990, which is available to the public) when a U.S. tax-exempt organization is treated as controlling a foreign entity, whether or not tax-exempt, in certain ways. This is discussed further in section 8.10.
5.7 Two Case Studies: One Very Large and One Very Small Organization
This section presents two case studies, showing how two very different organizations chose to structure the relationships among U.S. and foreign entities, and the considerations that influenced their decisions. The first case study provides an overview of how one very large, mature, global organization is structured, and some of the major considerations that drive the legal structure. The second case study provides a glimpse into the way one very small start-up organization is structured. Each of these organizations worked to find the right balance between central control and local autonomy to best achieve its objectives, while taking into account the organization's size and complexity.
Providing microfinance services in rural African communities. Developing young leaders for the microfinance sector by providing opportunities for young people to gain hands-on volunteer experience.5.8 Headquarters Offices: Centralized versus Decentralized Services
You may be able to operate two or more legal entities more efficiently by centralizing some administrative services in one of the entities. For example, you might have a U.S. 501(c)(3) organization provide accounting, website, information technology, treasury, human resources, and/or other support services for one or more foreign entities. Or, you may decide to centralize administrative services in another country entity, perhaps somewhere in Europe.
How Much Centralization Do You Want?
If you are operating in multiple countries, you should think about the advantages and disadvantages of centralizing services, and then decide whether, and to what extent, centralization is right for your organization.
Here are some reasons to centralize services:
You may save money by avoiding redundant functions in multiple countries. You may end up with more consistency, for example, in adherence to policies. You may be better able to hire experts in a headquarters location for some functions, like treasury and information technology, whereas it may be difficult to find and hire qualified experts in the countries where you are operating.Here are some reasons to opt for decentralization:
Some functions may require an understanding of local laws and sensitivity to local culture. This may be true, for example, in human resources. You may need some local administrative staff to maintain adequate internal controls, or to oversee the management of financial resources. Decentralization may avoid some of the costs of travel for headquarters personnel.How Will the Headquarters Office Be Funded?
Once you decide to centralize some functions in a headquarters office, you need to determine how you will fund those functions. If the headquarters office is also a fundraising office, this may be as simple as retaining sufficient funds to cover expenses, before funding foreign operations. Be aware, however, that funders, particularly institutional funders (foundations, corporations, and government bodies) often prefer to fund programs, and many place strict limitations on the extent to which grant funds can be used for administrative (overhead) expenses.
Do You Want to Charge Fees?
As a practical matter, it may be quite difficult to fund headquarters costs by charging fees to the foreign entities that benefit from centralized functions. Particularly in developing countries, it can be extremely difficult to raise enough funds through any combination of contributions and grants, earned revenue, and investment income (assuming all of those are permitted) to fund the local operations while maintaining adequate cash reserves. Even when a foreign entity has its own revenue stream, such as through fees or foreign government grants, it may have trouble collecting those funds. In addition, it can be highly inefficient, if it is even possible, to transfer funds out of some developing countries, due to the costs of transferring funds and converting currencies.
Do You Have to Charge Fees?
In some circumstances, you will have to charge fees for headquarters services. If the foreign entity is engaged in any activities that do not further your U.S. organization's 501(c)(3) purposes, you need to be sure that either you are not assisting those activities, or that you are charging a fair price for the benefit you are providing. Failing to do so could jeopardize your organization's tax-exempt status, as the IRS could find that you are providing a so-called private benefit.
Will Fees Be Taxed by the United States?
Moreover, if you do charge fees for providing management and administrative services, that revenue may be treated as unrelated business taxable income (UBTI), and taxed in the United States, if there is profit after deducting allocable expenses.21 This is an evolving area of U.S. tax law. Even if your organization is providing management and administrative services to an organization that furthers your exempt purposes, it is possible the IRS may treat fees for management services as unrelated business income.22
The key point here is that, if your 501(c)(3) organization is providing management and administrative support services to foreign entities, you are entering into a highly technical and evolving area of U.S. tax law. Careful drafting of an agreement for the provision of services can help ensure that the services you are providing are treated as furthering your organization's exempt purposes, and that any fees are treated as exempt purpose revenue. You should engage a lawyer to help draft this type of agreement, and to advise you whether your organization will be subject to any U.S. or foreign taxes.
Of course, if you are using a non-U.S. entity to provide headquarters functions, you will need to determine what is required under the laws of the country in which that entity is established.
Always Have a Written Service Agreement
In Chapter 2, we explored the need to document and monitor the use of funds you provide to a foreign grantee to be sure that those funds are used exclusively for 501(c)(3) purposes. Similarly, when your U.S. organization provides services to a foreign entity, you are providing something of value, and if you don't charge a fee you need to be sure that the services are furthering your organization's own tax-exempt purposes. You should have a written agreement between the two (or more) entities that describes the services to be provided. The agreement should make clear that the support provided by your organization will be used by the foreign recipient solely to further your organization's tax-exempt purposes, if that is the case. If you are providing services for non-501(c)(3) purposes, you also need a written agreement, describing the services and fees to be paid. Particularly if you are charging fees, you are well advised to consult a lawyer in each country.
Individual philanthropy development. Creating communities of lifelong informed, and inspired philanthropists. SVPI partners are individuals who make meaningful contributions to nonprofit organizations by sharing their skills, time, and financial resources. Nonprofit capacity building. Making strategic investments that build long-term capacity for nonprofits so they can better fill their missions. SVPI grant recipients are nonprofit organizations that seek new resources and innovative approaches for addressing a variety of issues, including education, environmental protection, and youth development. Capacity building grants focus on increasing the ability of each grantee to achieve its mission, and include cash grants, skilled volunteers, professional consultants, leadership development, and management training opportunities. Engaged Venture Philanthropy. Partners invest time, expertise, and money in nonprofits. They seek collaborative relationships with nonprofits that last for at least three years. Entrepreneurial Spirit. Partners use innovative approaches to achieve leveraged results in their nonprofit partnerships and communities. They delegate decisions, resources, and authority to those closest to the work. Philanthropic Education. Partners educate themselves and become informed, effective lifetime philanthropists. Ongoing individual philanthropy is catalyzed through hands-on experience and education. Community and Collaborative Action. Partners believe in the power of collective, self-organized effort. They encourage and maintain highly participatory, partner-driven organizations that use non-hierarchical communications and operating practices. SVPs support an open exchange of knowledge and lessons learned, and avoid partisan, religious, or political activities. Mutual Respect. Partners respect the expertise of community nonprofit organizations. They form close working relationships with organizations. Accountability and Results. Partners are mutually accountable to each other, their grant recipients, and their community. They achieve and document measurable results, both in their own work and through their nonprofit partnerships. Determine its own grantmaking focus. Construct appropriate philanthropy promotion vehicles. Choose organizational governance structure. Determine appropriate levels of corporate or foundation support. Seek local sponsorship or strategic alliances. Evaluate its own organizational development needs. Choose its grantees. Determine the best ways to support grantees with capacity building support. Determine appropriate methods of providing administrative support. Hire and fire its own staff and contractors.5.9 Shared Employees
Similar to the centralized services situation, you may have employees that split their time between your U.S. 501(c)(3) organization and a foreign legal entity. If U.S.-based employees are traveling outside the United States to monitor the use of funds provided by the U.S. organization, they are working on behalf of the U.S. organization. However, if they are providing services directly for the benefit of the foreign entity, for example, by managing staff in the foreign country, then they are working for the foreign legal entity. If an employee is working for two separate legal entities, then that employee should have two separate employment contracts, and should be compensated separately by the two organizations. This is commonly referred to as a dual employment arrangement.
Each of the respective employment contracts should comply with applicable labor laws of the relevant country. The contracts should also take local tax considerations into account. For example, in some countries it is legal, and efficient from a tax perspective to provide significant fringe benefits, such as use of a car, while reducing cash compensation. In the United States, and some other countries, many forms of fringe benefits are subject to tax and require burdensome recordkeeping on the part of the employer and employee.23 You should always seek legal advice in each country when crafting employment agreements.
5.10 Will a Foreign Legal Entity Be Tax-Exempt in Its Local Country?
In section 4.8, we looked at whether, and when, a U.S. organization might be taxed by a particular foreign country when operating through a local office or branch, or even sending employees for extended periods. In contrast, once you create a separate legal entity in a foreign country, that entity falls under the taxing jurisdiction of that country. In this case, the question is not whether the activities reach a threshold that makes them taxable, but rather, whether the nature of the entity or its activities makes it eligible for exemption from tax.
Do Not Assume a Foreign Legal Entity Will Be Tax-Exempt
Do not assume that an organization will be tax-exempt in a foreign country, even if it would qualify for 501(c)(3) status in the U.S. The criteria for tax-exempt status vary widely from country to country. When exploring the question of tax-exemption, make sure you understand which taxes apply, and from which you can claim exemption. For example, VAT can be a greater burden than income tax for nonprofit organizations. See section 9.14.
In some countries, the form of legal entity you create may determine its tax status. In others, you may need to apply separately for tax-exempt status, which may be available to organizations that serve certain purposes.
In many countries, tax-exempt status is linked to the concept of public benefit, which generally requires that an organization serve a broad class of people, and that it does not merely benefit private interests. Beyond that basic requirement, there is wide variation among countries. Some counties interpret the concept of public benefit quite broadly, while in others it is narrowly defined. And, in some countries the criteria are quite specific, while in others the determination is left to the discretion of government officials.
Tax-exempt status may also be limited to certain sources of revenue. Your organization may receive funding through some combination of contributions and grants from individuals, foundations, and governmental bodies, and also from investments, and even business activities. An exemption from taxes may be available for some but not all of these types of income.
Earned Revenue
Special considerations come into play if a foreign tax-exempt entity intends to generate earned revenue, or revenue from the sale of goods, the provision of services, or even from the rental of property or licensing of trademarks and copyrights. In the United States, a 501(c)(3) organization is exempt from tax on all revenue as long as it is substantially related to the organization's exempt purposes. On the other hand, a U.S. organization that conducts business activities unrelated to its 501(c)(3) purposes may be taxed on its unrelated business taxable income (UBTI). See section 4.9.
In the foreign context, some countries prohibit a tax-exempt organization from earning the kinds of revenue that would be taxable as UBTI in the United States. Other countries permit unrelated activities, but impose a tax on business revenue.
There are countries, however, that simply do not recognize the earning of revenue as consistent with the concept of a tax-exempt organization, whether or not the revenue-generating activity is related to the exempt purpose. In India, some organizations have been surprised to learn that their tax-exempt status was revoked because they were earning some of their revenue in the form of consulting fees or proceeds from the sale of products.24
Restrictions on earned revenue can even extend to the point of prohibiting or taxing investment income, making it difficult to accumulate needed cash reserves in a country where an organization provides services. If your organization finds itself earning business income in a foreign country, you may want to explore creating a separate for-profit subsidiary. See section 5.14.
Innovative approaches to social entrepreneurship can present great challenges in developing countries. It is beyond the scope of this book to describe the ways in which cutting-edge organizations are blending charitable and business activities.25 It is simply worth noting that organizations hoping to go down that path are well advised to hire local counsel early on to determine whether there is a legal structure that fits their business model.26
5.11 Will a Foreign Legal Entity Be Taxed in the United States?
In general, income earned by a foreign legal entity through operations outside the Unites States is not subject to U.S. federal income tax, whether or not the foreign entity is tax-exempt in its home country.27
What Kinds of Activities Trigger U.S. Tax for a Foreign Legal Entity?
There are three exceptions to the rule that a foreign legal entity is not subject to U.S. federal income tax, as follows:
How Can a Foreign Legal Entity Claim Exemption from U.S. Tax?
A foreign legal entity that meets certain requirements may be able to claim a full or partial exemption from U.S. tax under one or more of the alternatives described next. In order to rely on any of these alternatives, a foreign entity will generally have to obtain a U.S. federal tax identification number, and it may be required to file annual tax returns with the IRS. See section 8.11. Many foreign organizations prefer not to get into the U.S. tax system because it is cumbersome and it can be difficult to get out of the system at a later time, even if the organization ceases to earn income from U.S. sources.
For these reasons, a foreign entity is often well advised to avoid earning revenue from U.S. sources, if at all possible. And, if there is a related U.S. entity, you should try to structure operations and investments so that the U.S. activities and investments are conducted by the United States, not the foreign, entity.
Reciprocal Tax-Exempt Status Under a Treaty
Some foreign legal entities formed under the laws of Germany, the Netherlands, Canada, or Mexico are eligible for U.S. tax-exempt status under the reciprocal provisions of a bilateral tax treaty. Each of these reciprocity provisions (described in section 4.9) contains limitations. It is important to consult a lawyer, and you may need a formal written legal opinion if you intend to rely on one of these provisions.
Claiming Tax-Exempt Status as a Foreign Tax-Exempt Organization with Limited U.S. Source Income
A foreign entity that satisfies the requirements of section 501(c)(3) may qualify for tax-exempt status without filing an application with the IRS, if the organization receives less than 15 percent of its support from U.S. sources.29 An organization that qualifies for U.S. tax-exempt status in this way may nevertheless have to file annual tax returns with the IRS.
Claiming Exemption from U.S. Withholding Tax as a Foreign Organization that Qualifies Under Section 501(c)(3)
The U.S. income tax regulations provide a procedure by which a foreign organization can claim exemption from U.S. withholding tax if it meets the requirements of section 501(c)(3). In many cases, withholding is the sole mechanism for collection of the tax, so that elimination of withholding is equivalent to an exemption from the tax. To qualify for this withholding exemption, the organization must either apply for and obtain an IRS determination of 501(c)(3) status, or obtain a formal written opinion from an attorney licensed to practice in the U.S.30
Claiming Eligibility for Zero or Reduced Withholding under a Treaty
If a tax treaty exists between the United States and the foreign legal entity's home country, it is likely that the treaty provides for a reduction of the withholding rate, or even total exemption from withholding. A foreign organization can rely on these treaty provisions regardless of whether it meets the requirements of 501(c)(3). Certain procedural requirements apply. See section 8.11.
Applying for 501(c)(3) Status
It is possible for a nonprofit organization formed in a foreign country to apply for and obtain U.S. section 501(c)(3) status, although this has limited use. A foreign organization that has obtained 501(c)(3) status can earn revenue in the United States through activities related to its exempt purposes, and it can receive investment income from U.S. sources, without being subject to U.S. tax. Note, also, that some U.S. private foundations will make grants directly to a foreign entity only if it has qualified as a section 501(c)(3) public charity.
U.S. taxpayers (individuals and corporations), however, will not be eligible for income tax deductions for contributions they make directly to a foreign organization, even if it has 501(c)(3) status.31 Moreover, the burdens of qualifying as a U.S. 501(c)(3) organization will, in many if not most cases, outweigh the benefits. It may be easier to segregate U.S. activities and investments into a U.S. entity, while avoiding U.S. activities and investments for a foreign entity.
It is important to weigh the burdens against the benefits of obtaining 501(c)(3) status. A foreign entity that obtains 501(c)(3) status must comply with all of the requirements applicable to 501(c)(3) organizations. Once a foreign organization has obtained 501(c)(3) status, it will be required to file annual reports with the IRS, subject to limited exceptions. See section 8.10.
In short, a foreign entity should not file an application for tax-exempt status under section 501(c)(3) without carefully weighing the pros and cons.32
5.12 The Importance of Keeping U.S. and Foreign Activities Separate
Once you have established two or more separate country legal entities, it is important to be meticulous about keeping track of which employees, activities, revenue, and expenses belong to each of the entities. This requires maintaining separate financial and employment records, and making sure contracts are entered into by the right entities. In general, it is advisable to keep all U.S. activities in the U.S. entity and all foreign activities in the foreign entity. This doesn't mean that staff cannot travel between countries to oversee, monitor, learn, or otherwise do their jobs. What it does mean is that you need to look at the activities that are conducted in each country, and make sure that the employees, expenses, and revenues associated with those activities are in the right legal entity.
Here's a simple example: U.S. NGO conducts fundraising from U.S. donors to support a school in Africa. U.S. NGO formed a legal entity, Africa NGO, to operate the school. Africa NGO is a separate legal entity. It has its own board of directors and employs a staff to run the school. The school president is responsible for all of the school's operations including managing staff, and he or she reports to Africa NGO's board.
Under this scenario, the school president and other staff are formally employees of Africa NGO. All of the expenses of operating the school, including salaries and benefits for the president and staff, belong in Africa NGO's financial statements. Tuition revenue, funds received from U.S. NGO, as well as revenue from any other non-U.S. sources (such as other African NGOs) also belong to Africa NGO and must be reflected on its separate financial statements.
U.S. NGO employs all of the staff responsible for fundraising in the United States, along with an executive director and some administrative staff. The expenses related to U.S. NGO's staff belong on the financial statements of the U.S. entity. Importantly, funds raised by U.S. NGO belong to it. When U.S. NGO makes a grant to Africa NGO, that is a transaction that is reflected on the financial statements of both organizations.
If the president of Africa NGO spends significant time in the United States to engage in U.S. fundraising, she may need to enter into a dual employment arrangement. This way, she is employed by and paid by U.S. NGO when she is engaged in fundraising in the U.S. If she were to engage in U.S. fundraising as an employee of Africa NGO (rather than entering into a dual employment arrangement), she might risk subjecting Africa NGO to U.S. taxation and/or cause Africa NGO to run afoul of state laws that require registration by any entity that engages in solicitation.
By contrast, if the president of Africa NGO travels to the U.S. for, say a week or two, for purposes of reporting on Africa NGO's activities to U.S. NGO's staff and board, that is an activity that belongs to Africa NGO because part of the president's job is to communicate with the U.S. funding entity. Africa NGO can send the president to the United States for a short period of time, to represent Africa NGO, without running into tax-related trouble.
5.13 Consider the Burdens of Maintaining Two or More Separate Legal Entities
Maintaining separate legal entities will almost always be more burdensome and costly than operating in foreign countries through branches. A foreign legal entity must have its own governing body that holds regular meetings, makes decisions on behalf of the entity, and keeps minutes.33 A separate legal entity will almost always require at least one paid employee. In addition, a legal entity often, although not always, is subject to more burdensome governmental reporting requirements than a branch.
Financial reporting may or may not be more burdensome when you operate in a foreign country through a separate legal entity rather than a branch. You should consult with a lawyer or accountant in the particular country to understand financial reporting requirements. You should also explore how the choice of a branch or separate entity structure affects financial disclosure requirements in each country. For example, operating through a branch may trigger a foreign country obligation to disclose the financial results of the organization's U.S. activities because the foreign branch is part of the same legal entity. This will not be the case in all countries, but you should know what the requirements are before you decide how to structure your operations.
If one entity provides any services or licenses its name or logo to the other, you will need formal written agreements. It may become necessary to implement charges between the entities, and to research and document what is a reasonable market rate. Separate legal entities must also maintain their own websites, although they may link to each other.
Of course, the requirements for maintaining a separate legal entity vary widely by country, and some countries impose greater burdens than others.
5.14 For-Profit Subsidiaries
If your organization intends to operate a significant foreign revenue-generating business that is not related to your organization's tax-exempt purposes, you might consider forming a separate foreign entity to conduct that business. Operating a taxable business through a separate legal entity avoids any risk that the business could jeopardize your organization's tax-exempt status, as might be the case if the business were operated directly by the tax-exempt entity.
If the foreign for-profit business entity issues stock, it is permissible for the U.S. 501(c)(3) organization to own 100 percent of that stock.34 Alternatively, if you have formed a tax-exempt entity in the particular foreign country, you may want that entity to own the stock of a for-profit entity you establish in the same country to help generate revenue for the foreign tax-exempt activities.
You will, of course, need to explore the foreign law implications of operating a taxable subsidiary, including whether dividends or other payments from the foreign entity to a U.S. or foreign parent will be subject to additional foreign taxes.
5.15 Soliciting Funds from U.S. Donors
When a U.S. fundraising entity and a foreign operating entity are closely related, it is tempting to treat them as a single organization for fundraising purposes. In raising funds, the U.S. organization must be careful to comply with the discretion and control requirements described in section 2.3.
You need to make sure donors know they are contributing to the U.S. organization, not directly to the foreign organization. Donors must also be advised that, while they may suggest that contributions support a specific foreign entity's project, the U.S. organization has the discretion to withhold or redirect funds if necessary to ensure compliance with section 501(c)(3) requirements.
In addition, the U.S. organization must maintain its own website, separate from the foreign entity's website. The U.S. organization's website may include a link to the website of the foreign organization, but be careful that visitors can clearly see which organization's website they are visiting.
5.16 Review and Further Considerations
Once you decide to operate a program directly in one or more foreign countries, you need to decide whether to operate through a branch or office, or alternatively, to form a separate legal entity. It's important to weigh the pros and cons of each, given your particular situation. If you decide to create one or more separate foreign legal entities, the next step is to determine what kind of relationship those entities should have, and to figure out how you can achieve that relationship under the laws of the countries involved.
Regardless of whether you operate in a foreign country through an office or a separate legal entity, you will need staff or volunteers in that country to carry out the program. A number of legal and practical considerations come into play as you make decisions about how to staff your foreign operations. For example, should you send U.S. employees or hire locally? These considerations are addressed in the following chapter.
In addition, even if you have segregated your foreign activities into one or more separate, non-U.S. legal entities, you need to know about various U.S. laws that pertain to international operations. Some of these, such as U.S. tax-withholding requirements, apply to transactions between U.S. and foreign legal entities or individuals. Others, such as anti-bribery laws, reach the activities of foreign legal entities under certain conditions. Chapter 8 provides an overview of additional U.S. laws that apply to a U.S. organization's international activities, while Chapter 9 provides an overview of legal and practical considerations commonly encountered by nonprofit organizations operating in foreign countries.
Notes
1. See “Defending Civil Society,” co-authored by International Center for Not-for-Profit Law and World Movement for Democracy Secretariat at the National Endowment for Democracy International Journal of Not-for-Profit Law, 14, no. 3 (September 2012) (“Defending Civil Society Report”), 16, available at www.icnl.org/research/journal/vol14iss3/art1.html.
2. See David Moore and Douglas Rutzen, “Legal Framework for Global Philanthropy: Barriers and Opportunities,” International Journal of Not-for-Profit Law 13, no. 1–2 (April 2011), 21, available at www.icnl.org/research/journal/vol13iss1/index.htm.
3. See David Moore and Douglas Rutzen, “NGO Laws in Sub-Saharan Africa,” Global Trends in NGO Law 3, no. 3 (June 2011), 4, available at www.icnl.org/research/trends/trends3-3.html.
4. See International Center for Not-For-Profit Law NGO Monitor, available at www.icnl.org/research/monitor/mexico.html.
5. See David Moore and Douglas Rutzen, “Legal Framework for Global Philanthropy: Barriers and Opportunities,” supra note 2, at 25; “Survey of Arab NGO Laws,” Global Trends in NGO Law 1, no. 4 (March 2010), 5, available at www.icnl.org/research/trends/trends1-4.html; David Moore and Douglas Rutzen, “NGO Laws in Sub-Saharan Africa,” supra note 3, at 6.
6. Legislation pending in Egypt in 2012 will, if enacted, impose additional restrictions on the nonprofit sector and on foreign participation in the Egyptian nonprofit sector, including providing the government with very broad discretion to reject or revoke a nonprofit's operating license, and to interfere with a nonprofit organization's activities. See Nick Gallus, “Protection of U.S. Nongovernmental Organizations in Egypt Under the U.S.-Egypt Bilateral Investment Treaty,” International Center for Not-For-Profit Law, International Journal of Not-for-Profit Law, 14, no. 3 (September 2012), 63-64, available at www.icnl.org/research/journal/vol14iss3/index.html.
7. “Survey of Arab NGO Laws,” supra note 5, at 6.
8. See “NGO Laws in Sub-Saharan Africa,” supra note 3, at 6.
9. See David Moore and Douglas Rutzen, “Legal Framework for Global Philanthropy: Barriers and Opportunities,” supra note 2, at 26.
10. Among U.K. countries, only England and Wales share a body of law and a government commission that govern so-called charities. Scotland and Northern Ireland, which belong to the United Kingdom, have their own regimes for the governance of charitable organizations.
11. For detailed information about the legal framework for NGOs in Central and Eastern European countries, see Douglas Rutzen, David Moore, and Michael Durham, “The Legal Framework for Not-for-Profit Organizations in Central and Eastern Europe,” International Journal of Not-for-Profit Law 11, no. 2 (February 2009), available at www.icnl.org/research/journal/vol11iss2/index.htm.
12. For a detailed explanation of how to form a Mexican associación civil, see “Beyond Borders: Observations for U.S. organizations considering nonprofit incorporation in Mexico,” by U.S.-Mexico Border Philanthropy Partnership (February 2010), available at www.borderpartnership.org/membership/publications.html.
13. See United States International Grantmaking Project, Country Information, South Africa (August 2011), available at www.usig.org/countryinfo/southafrica.asp.
14. See United States International Grantmaking Project, Country Information, India (March 2012), available at www.usig.org/countryinfo/india.asp.
15. See Douglas Rutzen, David Moore, and Michael Durham, “The Legal Framework for Not-For-Profit Organizations in Central and Eastern Europe,” supra note 11, at 29.
16. There are a few states that allow nonprofit corporations to issue stock. This form of nonprofit corporation is typically not used to operate a 501(c)(3) organization.
17. See Douglas Rutzen, David Moore, and Michael Durham, “The Legal Framework for Not-for-Profit Organizations in Central and Eastern Europe,” note 11, at 28–29.
18. See Chapters 2 and 3 regarding the procedures required for a U.S. 501(c)(3) organization to make grants to a foreign organization.
19. If you are making intellectual property, such as a logo or copyrighted material, available to another entity and that entity's use does not further your organization's 501(c)(3) purposes, then the IRS could conclude that you are providing a so-called private benefit to the other organization. This could jeopardize your tax-exempt status if the value is considered more than merely incidental. See 4.8 regarding the 501(c)(3) prohibition against providing more-than-incidental private benefits.
20. I.R.C. § 4942(g).
21. See, e.g., IRS Tech. Adv. Mem. 9608003 (Jun. 28, 1996); IRS Priv. Ltr. Rul. 9641011 (Oct. 19, 1995). For a more detailed explanation of this issue, see Bruce R. Hopkins The Tax Law of Unrelated Business for Nonprofit Organizations (John Wiley & Sons, 2005). In addition, if your organization charges fees to an organization over which it has voting control (for example, as the sole member of a membership entity), then you may need to comply with technical U.S. tax rules for determining the appropriate fees. The IRS allows you to charge back your costs, without a markup, for some common headquarters-type functions. This means there is no profit for your 501(c)(3) that could be subject to tax. Other kinds of services may have to be charged back with a markup over costs, thereby generating a profit.
22. In 2011, the IRS denied 501(c)(3) status to a U.S. health care organization that primarily provided management and consulting services to fee-paying foreign hospitals and governments, for the purposes of assisting with the design, development, and operation of health care facilities in certain foreign countries. See IRS Priv. Ltr. Rul. 201128012 (Apr. 19, 2011). For a discussion of this IRS ruling, see Lawrence M. Brauer and Howard A. Levenson, “Health Care Related Services to Foreign Entity Ruled to Not Qualify for Section 501(c)(3),” Taxation of Exempts (WGL) Preview, April 2012.
23. See IRS Publication 15-B, Employer's Tax Guide To Fringe Benefits (December 2011), available at www.irs.gov/app/picklist/list/publicationsNoticesPdf.html.
24. This is a recent development, occurring in 2011 and 2012. See Noshir Dadrawala, “Income of Trusts in India Comes Under Scrutiny,” January 10, 2012, available at www.icnl.org/news/2012/10-Jan.html.
25. Outside of the United States, one of the few countries that has attempted to create a legal structure to accommodate the concept of social enterprise is the UK. In the UK, a special form of entity called a Community Interest Company (CIC) is intended for businesses conducted primarily for community benefit, rather than for private advantage. Further information is available on the website of the Office of the Regulator of Community Interest Companies, at www.bis.gov.uk/cicregulator.
26. For a description of the variety of business models and legal forms found in the realm of social entrepreneurship, see Robert A. Wexler, “Effective Social Enterprise—A Menu of Legal Structures,” Exempt Org. Tax Review 63, no. 565 (June 2009).
27. In addition, while U.S. business corporations can be subject to U.S. tax on certain types of income earned by their foreign subsidiaries, a U.S. tax-exempt organization should not be taxed on income earned by a foreign subsidiary unless the U.S. organization actually receives payments that are treated as unrelated business taxable income (UBTI). Under the so-called Subpart F regime of the Internal Revenue Code (I.R.C. §§ 951–965), certain types of income, when earned by a foreign corporation, are treated as taxable income to certain U.S. residents that have voting control over the foreign corporation (a so-called foreign controlled corporation, or CFC). While not entirely free from doubt, IRS Private Letter Ruling 9024086 (March 22, 1990) (although not an official legal authority) may be interpreted to say that a U.S. tax-exempt organization will not be taxed, under the Subpart F regime, on income of a foreign entity controlled by the U.S. tax-exempt organization.
28. I.R.C. § 882.
29. I.R.C. § 4948(b). Churches and certain organizations related to churches, whether domestic or foreign, are also exempt from the need to apply for 501(c)(3) status.
30. Treas. Reg. § 1.1441-9.
31. I.R.C. § 170(c). Estate tax deductions are, however, allowed for bequests to foreign organizations, subject to certain conditions. I.R.C. § 2055.
32. For a detailed analysis of the advantages and disadvantages of a foreign entity's claiming U.S. tax-exempt status, see Paul D. Carman, “Structuring and Operating an International Exempt Organization in the United States,” Journal of Taxation of Exempt Organizations (WG&L) 15, no. 1 (July/August 2003).
33. While a U.S. organization may have the right, for example, as sole member, to appoint the board of the foreign entity, the foreign entity's board must act independently. If the U.S. organization, through its staff or board, manages the day-to-day affairs of the foreign legal entity, one consequence could be that the foreign legal entity is treated for U.S. tax purposes as a branch. That could be disastrous to the U.S. organization, for example by jeopardizing its 501(c)(3) status if the foreign entity does not in all respects comply with 501(c)(3) requirements. In addition, the U.S. organization could become subject to liabilities in the foreign country.
34. This assumes that the U.S. 501(c)(3) entity is a public charity and not a private foundation for U.S. federal income tax purposes (see Chapters 2 and 3). Private foundations are subject to certain restrictions on the ownership of for-profit businesses. I.R.C. § 4943.