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Beware U.S. tax rules on grants to foreign organizations.

Countries are recognizing a need for public assistance with their social welfare and educational systems, as well as for relief from disasters, natural or otherwise. Many nations have enacted laws to allow for the creation of nongovernmental not-for-profit organizations (NGOs). Many NGOs receive assistance from U.S. nonprofit organizations in the form of grants. Making grants to foreign organizations in the post-September 11 era has become more challenging and can result in adverse tax consequences for unwary U.S. grantor organizations. The IRS and Treasury have provided some guidance, but there are few rules on which U.S. exempt organizations can rely when making cross-border grants.

A U.S. tax-exempt grantor organization making grants is under increased scrutiny to document its relationships to foreign grantees, and can be penalized if it does not. These organizations should examine four factors for cross-border grants and determine whether the:

1. Organization receiving the grant has an IRS-issued U.S. determination letter;

2. Foreign recipient organization uses the grant for activities consistent with the grantor's exempt purpose;

3. Grantor organization is a public charity or private foundation; and

4. Grant is made in consideration of the Treasury's updated anti-terrorist financing guidelines.

Foreign Organization with U.S. Determination Letter

If the foreign recipient organization has a determination letter from the Service, a grant will be treated as if made to a U.S. organization with a determination letter. A U.S. public charity is limited to making grants for activities consistent with its exempt purposes; the requirement is presumed to have been met if the grant is made to another Sec. 501(c)(3) organization. The presumption that a grant was a qualifying payment to a public charity can, however, be rebutted by the IRS if evidence exists that the grant was not used for allowed exempt purposes (e.g., a grant used for excessive legislative lobbying in a foreign country).

If the grantor organization is a private foundation, Sec. 4945(h), dealing with expenditure responsibility, will apply. The foundation's determination of whether a grant is a qualifying distribution for Sec. 4942 purposes will be simplified if the foreign recipient has an IRS determination letter; it may rely on the Service's determination that the foreign organization is exempt under Sec. 501(c)(3).

Grant by U.S. Public Charity to Foreign Organization without Determination Letter

A U.S. public charity may make a grant to any individual or organization that will use it for activities consistent with the grantor's exempt purpose; see Rev. Rul. 68-489. If the recipient is a foreign or domestic organization that does not have an IRS determination letter, no basis exists for a presumption of exempt purpose. The U.S. grantor will have the burden of establishing that the grant was made for an exempt activity and that the grant was actually used for the purpose for which it was made; see Rev. Ruls. 56-304 (grants to individuals) and 68-489 (grants to nonexempt organizations).

Grant by U.S. Private Foundation to Foreign Organization without Determination Letter

Private foundations are subject to statutory requirements that do not apply to public charities. In general, private foundations that make grants to (foreign or domestic) individuals or to organizations other than public charities or exempt operating foundations are required to exercise "expenditure responsibility "under Sec. 4945(h) as to the grant. The grant must meet the requirements of a "qualifying distribution" under Sec. 4942(g) as an amount (including certain administrative expenses) paid to accomplish one or more of the purposes described in Sec. 170(c)(1) or (2)(B). The grant cannot be a contribution to (1) an organization controlled by the private foundation or a disqualified person(s) or (2) a nonoperating private foundation.

These rifles require a U.S. organization to document that the grantee foreign charity is equivalent to a U.S. public charity, and require a U.S. grantor private foundation to obtain a significant amount of information from the potential grantee. The information required to be obtained is comparable to that required by an organization that files an application for exempt status under Sec. 501(c)(3); see Regs. Sec. 53.4945-5. Failure to obtain documentation and make the necessary determination and a qualifying distribution, could result in the grant being termed a "taxable expenditure," subject to Sec. 4942's 15% excise tax. Also, the Sec. 1443 withholding tax provisions may apply; under this provision, a U.S. grantor is required to obtain documentation to determine whether the grant to the foreign grantee will be used for activities outside the U.S., or be subject to 30% withholding (or the applicable rate established by a tax treaty with the U.S.).


To relieve U.S. exempt organizations of some of the burden, the IRS and Treasury set out exceptions to the cumbersome documentation requirements, in Regs. Sec. 53.4945-5(a)(4) and (5) and Rev. Proc. 92-94.

Regs. Sec. 53.4945-5(a)(4) and (5) provide that an exception to expenditure responsibility exists when the:

1. Foreign grantee demonstrates that it satisfies the one-third public support test of Regs. Sec: 1.509(a)-2(a) and uses the grant exclusively for charitable purposes;

2. Grantee is a college or university that is an agency or instrumentality of a foreign government or of any political subdivision thereof and uses the grant exclusively for charitable purposes; or

3. Grantee is a foreign government or any agency or instrumentality thereof or is an international organization designated as such by executive order under 22 USC Section 288 (even if not described in Sec. 501(c)(3)), and uses the grant exclusively for charitable purposes.

Rev. Proc. 92-94 relieves some of a U.S. grantor's burden to collect the required data from foreign grantees, especially from smaller grantees or those in less-developed countries. This procedure allows the U.S. grantor to rely on information provided by the foreign grantee. The procedure is not available if the grant is a "transfer of assets pursuant to any liquidation, merger, redemption, recapitalization, or other adjustment, organization, or reorganization described in section 507 (b)(2)" of the Code.

Rev. Proc. 92-94 provides that a "currently qualified affidavit" from the grantee may be relied on in making the equivalency determination for both the Sec. 4945 expenditure-responsibility requirement and the Sec. 4942 qualifying-distribution requirement. A currently qualified affidavit is defined as an affidavit prepared by the grantee that certifies "the facts it contains are up to date." An affidavit's facts will be treated as up to date if: (1) the facts reflect the foreign grantee's "latest complete accounting year" in the case of an organization that depends on financial data to establish its public charity or private operating foundation status; or (2) "the affidavit is updated to reflect the grantee organization's current data," in cases in which the organization's status does not depend on financial data. If the facts have not changed, "an attested statement by the grantee to that effect is enough to update an affidavit."

If the organization's status depends on financial data on public support, "the affidavit must be updated by asking the grantee to provide an attested statement containing enough financial data to establish that it continues to meet the requirements of the applicable Code section." The U.S. grantor organization may rely on a qualified affidavit that the foreign grantee has prepared for one or more other grantors, which means that it may prepare one affidavit on which all its U.S. private foundation grantors may rely. However, a U.S. private foundation grantor that "possesses information that suggests the affidavit may not be reliable" may not simply rely on the affidavit, but "must consider that information in determining whether the affidavit is currently qualified."

These two exceptions provide U.S. grantors some much-needed relief from the documentation requirements. However, under the anti-terrorist financing guidelines, U.S. grantor organizations face a potential quandary as to "best practices" and the amount of information they may be required to maintain.

Anti-Terrorist Financing Guidelines

On Dec. 8, 2005, Treasury issued its updated "Anti-Terrorist Financing Guidelines: Voluntary Best Practices for U.S.-Based Charities," available at key-issues/protecting/docs/guide lines_charities.pdf. These "best practices" are an updated version to the original guidelines issued by Treasury in November 2002. They were drafted to create awareness of basic documentation principles for U.S. charitable organizations and to reduce the risk that grants made to grantee organizations would not reach their intended charitable organization and would finance terrorism around the world.

The revised guidelines provide an outline of (1) the fundamental principles of good charitable practices; (2) governance; (3) disclosure and transparency in governance and finance; (4) financial practices and accountability; and (5) anti-terrorist financing procedures.

These revised guidelines also provide more detailed and specific direction to charities as to their obligations to check lists of organizations and individuals maintained by Treasury and the U.S. State Department, to identify organizations and individuals that may have connections with terrorists or their organizations. Particularly useful in the footnotes to the revised guidelines are the websites provided to facilitate such searches.


With the upsurge in cross-border grantmaking, a U.S. exempt grantor organization is under increased scrutiny to document its relationships to foreign grantees. Tax advisers should encourage clients to follow the four-factor approach discussed above before issuing foreign grants.

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Author:Cocco, James W.
Publication:The Tax Adviser
Date:Nov 1, 2006
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