The IRS recently issued proposed regulations that provide new examples that illustrate what types of investments qualify as "program-related investments" (PRIs). These new examples are based on published guidance and on financial structures that had previously been approved in private letter rulings.
Program Related Investments—In General
Excise taxes are imposed on private foundations, as well as their managers, for making investments that jeopardize the carrying out of the private foundation’s exempt purposes. Generally, such "jeopardizing investments" occur when foundation managers fail to exercise ordinary business care and prudence in providing for the long- and short-term financial needs of the private foundation.
PRIs are exempt from being treated as jeopardizing investments. In general, PRIs are defined as investments that (1) have the primary purpose to accomplish one or more "charitable" purposes, (2) do not have the significant purpose of producing income or appreciating property, and (3) do not support legislation or political campaigns.
Using PRIs can be a great way for a private foundation to stimulate and advance charitable objectives. High-profile private foundations using PRIs include the Bill and Melinda Gates Foundation.
The Proposed Regulations
The proposed regulations do not modify the existing regulations—instead, they provide new examples of investments that qualify as PRIs by illustrating certain principles and current investment practices. While the examples in the existing regulations focus on domestic situations principally involving economically disadvantaged individuals in deteriorated urban areas, the new examples illustrate a broader range of situations more likely to be encountered in practice:
- PRIs can be achieved through a variety of investments, such as loans to individuals, tax-exempt organizations, and for-profit organizations, as well as equity investments in for-profit organizations.
- A private foundation’s acceptance of an equity position in conjunction with making a loan does not necessarily prevent such investment from qualifying as a PRI.
- A credit enhancement arrangement (such as a deposit agreement or a guarantee agreement) may qualify as a PRI.
- A potentially high rate of return does not automatically prevent an investment from qualifying as a PRI.
- The charitable purposes that a PRI may serve are broad, and include advancing science, combating environmental deterioration, and promoting the arts.
- Activities conducted in foreign countries are considered to further a charitable purpose so long as the same activities would further a charitable purpose in the U.S.
- The recipients of PRIs do not need to be within a charitable class if they are the instruments for furthering a charitable purpose. For example, an investment in a for-profit that develops new drugs may qualify as a PRI if the for-profit business agrees to use the investment to develop a vaccine that will be distributed to poor individuals at an affordable cost.
Private foundations are permitted to rely on the new examples, even though the proposed regulations will not be effective until the Treasury publishes them as final regulations.
Benefits of Program Related Investments
PRIs receive special tax treatment, such as:
- PRIs are excluded from the assets that a private foundation takes into account when determining its "distributable amount" for the taxable year.
- PRIs are excluded from being treated as "business holdings" subject to excise tax.
- PRIs are generally treated as "qualifying distributions" for purposes of private foundation distribution requirements.
- PRIs do not constitute "taxable expenditures" provided that "expenditure responsibility" is exercised by the private foundation when required.
The new examples will be helpful to private foundations in determining if their investments may qualify as a PRI and receive such beneficial tax treatment.
This update has been prepared by Sheppard, Mullin, Richter & Hampton LLP for informational purposes only and does not constitute advertising, a solicitation, or legal advice, is not promised or guaranteed to be correct or complete and may or may not reflect the most current legal developments. Sheppard, Mullin, Richter & Hampton LLP expressly disclaims all liability in respect to actions taken or not taken based on the contents of this update.