More Clarity for Program-Related Investments

The IRS issued proposed regulations on April 19 that add nine new examples of private foundation investments that qualify as program-related investments (“PRIs”) under section 4944 of the Internal Revenue Code. The new examples provide an important update to the current regulations, and reflect a variety of arrangements (equity investment, below-market loan, deposit and loan guarantee) and charitable endeavors (advancing science, combating environmental deterioration, promoting the arts and poverty relief). They also illustrate certain principals that will be of interest to private foundations, including:

• Foreign activities are charitable if they would be considered to further a charitable purpose if conducted in the United States;
• PRIs are not limited to situations involving economically disadvantaged individuals and deteriorated urban areas;
• PRI recipients need not be within a charitable class if they are the instruments for furthering a charitable purpose;
• A potentially high rate of return does not automatically prevent PRI status for investments; and
• PRIs can be made to a variety of recipients, including individuals, exempt organizations (501c)3) as well as others) and for-profit businesses (including LLCs).

The examples are summarized below:

Example 11: Purchase of common stock in a business enterprise in order to induce the enterprise to produce a vaccine, which must be distributed to poor individuals in developing countries at an affordable price.

Example 12: Purchase of common stock in a business enterprise that collects recyclable waste in developing country (which would otherwise be burned and contribute to pollution and environmental degradation). Business enterprise was able to get a few investors who were concerned about environment, but was unable to get more due to expected low return. Private foundation purchases shares on the same terms as initial investors, and the example indicates there is a potential for a high rate of return if the business is successful.

Example 13: Same facts as in Example 12, except that the foundation accepts shares of common stock offered as an inducement to make a below market rate loan to the business. The private foundation plans to liquidate stock as soon as business is profitable or it is established it will never become profitable.

Example 14: Making a below market rate loan to a business that employs low-income individuals in a particular region, after a natural disaster causes extensive damage to the business’ equipment and buildings. The loan is intended to help the business rebuild and continue to employ these individuals.

Example 15: Making a below market rate loan to two low-income individuals in a developing country, to allow them to start small businesses.

Example 16: Making a below market rate loan to an LLC that purchases coffee from low-income farmers in a developing country. The loan is to fund the provision of efficient water management, crop cultivation, pest management and farm management training to the low-income farmers by the LLC, which would not otherwise provide this training.

Example 17: Making a below market rate loan to a 501(c)(4)  organization that works to promote the arts, to aid the organization in purchasing an exhibition space within the community.

Example 18: Making a deposit in a commercial bank in order to induce the bank to lend to a 501(c)(3) child care organization that wants to expand due to demand. The deposit needs to remain at the bank throughout the loan term, and can be accessed by the bank if the child care organization defaults. The private foundation will earn modest return on the deposit.

Example 19: Same facts as in Example 18, except the private foundation enters into a guarantee arrangement with the bank rather than making a deposit, and will pay the balance due if the child care organization defaults on the loan. The private foundation and the child care organization also enter into an agreement where the child care organization will reimburse the foundation for any amounts paid to the bank under the guarantee agreement.

As background, in order to qualify as a program-related investment, an investment must (1) have as a primary purpose the accomplishment of one or more charitable purposes related to the exempt organization’s exempt purposes; (2) not have financial gain as a significant purpose; and (3) not be intended for lobbying or political campaign purposes.

The regulations are not final and are subject to change, but may be relied on until final regulations are published. Comments on the proposed regulations can be submitted until July 18, 2012.