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Final regs allow wider range of foundation program-related investments

T.D. 9762, 04/21/2016; Reg. § 53.4944-3

IRS has issued final regs that provide guidance to private foundations on program-related investments (PRIs) — i.e., certain types of investments made by private foundations for charitable purposes that are excepted from treatment as “jeopardizing investments” subject to excise tax under Code Sec. 4944. The final regs, which largely adopt nine examples illustrating types of qualifying PRIs that were set out in 2012 proposed reliance regs, affect both private foundations and the foundation managers who participate in making these investments.

Background. Code Sec. 4944(a)(1) imposes an excise tax on a private foundation that makes investments in a manner that jeopardizes the carrying out of any of its charitable purposes, and Code Sec. 4944(a)(2) imposes an excise tax on the participation of any foundation manager who knowingly participated in making such a “jeopardizing investment.”

Under Code Sec. 4944(c), PRIs are excepted from treatment as jeopardizing investments. A PRI is an investment of which the primary purpose is to accomplish one or more of the purposes described in Code Sec. 170(c)(2)(B) (“exempt purposes”), and no significant purpose of which is the production of income or the appreciation of property.

The regs under Code Sec. 4944(c) provide that an investment is made primarily to accomplish one or more exempt purposes if it significantly furthers the accomplishment of the private foundation’s exempt activities and would not have been made but for the relationship between the investment and the accomplishment of those exempt activities. (Reg. § 53.4944-3(a)(2)(i)) In determining whether a significant purpose of an investment is the production of income or the appreciation of property, one must consider whether investors solely engaged in investment for profit would be likely to make the investment on the same terms as the private foundation. However, the fact that the investment produces significant income or capital appreciation does not by itself establish that the investment was made with a significant purpose of producing income or the appreciation of property. (Reg. § 53.4944-3(a)(2)(iii))

Since ’72, Reg. § 53.4944-3(b) has contained nine examples illustrating investments that qualify as PRIs and one example of an investment that does not qualify as a PRI. These long-standing examples focus on domestic situations principally involving economically disadvantaged individuals and deteriorated urban areas.

2012 proposed reliance regs. In 2012, IRS issued proposed reliance regs (Prop Reg § 53.4944-3; see Weekly Alert ¶ 7 4/26/2012) that added nine new examples to Reg. § 53.4944-3(b) to demonstrate that:

  • PRIs may accomplish a variety of exempt purposes (e.g., advancing science (Example 11), combating environmental deterioration (Examples 12 and 13), and promoting the arts (Example 17));
  • PRIs may fund activities in one or more foreign countries (Examples 15 and 16, involving, respectively, investments that alleviate the impact of a natural disaster and that fund educational programs for poor individuals);
  • PRIs may earn a high potential rate of return (Example 12);
  • PRIs may take the form of an equity position in conjunction with making a loan (Example 13);
  • A private foundation’s provision of credit enhancements can qualify as a PRI (Examples 18 and 19); and
  • PRI recipients can be individuals or entities that are not within a charitable class themselves, provided that the recipients are the instruments through which the private foundation accomplishes its exempt activities (Examples 11, 12, 13, 14, and 16).

Proposed regs adopted, as amended. After consideration of public comments, IRS adopted the proposed regs, with amendments described below:

  • Example 11 involved a private foundation’s investment in a subsidiary of a drug company for the development of a vaccine to prevent a disease that predominantly affects poor individuals in developing countries. Under the investment agreement described in the Example, the subsidiary is required to distribute the vaccine to the poor individuals in developing countries at a price that is affordable to the affected population and to promptly publish its research results. In response to a comment, IRS modified this example to make it clear that the subsidiary can also sell the vaccine to those who can afford it at fair market value prices. (Reg. § 53.4944-3(b), Example 11)
  • Example 13 described a private foundation that accepts common stock in a business enterprise as part of a loan to the business and that plans to liquidate the stock as soon as the business becomes profitable or it is established that the business will never become profitable. IRS removed the language about liquidating the stock upon the business becoming profitable in response to a query as to whether such is required in order for the investment to be a PRI. (Reg. § 53.4944-3(b), Example 13) However, IRS nonetheless noted in T.D. 9762 that establishing an “exit condition” at the outset of an investment that is tied to the foundation’s exempt purpose can be an “important indication that a foundation’s primary purpose in undertaking the investment is in fact accomplishment of the exempt purpose.”
  • Example 15 involved loans by a private foundation to two poor individuals living in a developing country where a natural disaster has occurred. The final regs eliminate the reference to a natural disaster in response to a comment that that reference isn’t necessary for the described loans to qualify as PRIs. The final regs also modify the example to reference loans to a group of individuals, rather than two specific individuals with identified business endeavors. (Reg. § 53.4944-3(b), Example 15)

Effective date. Examples 11 through 19 of Reg. § 53.4944-3(b) apply on or after Apr. 25, 2016 (i.e., their publication date).

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Meet Paul Raymond

Meet Paul Raymond

Mr. Raymond is a sought after speaker in tax controversy law by many attorney, accountant, and business groups and at the request of the Internal Revenue Service, has presented programs at the IRS Nationwide Tax Forum, attended by tax professionals throughout the United States.

Additionally, he continues to be an active member in the Section of Taxation, American Bar Association, where he was the Past Chair of the Employment Taxes Committee.

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