Pathways for Socially Conscious Investing by Private Foundations – New IRS Guidance for Program-Related Investments Now FinalPDF
Program-Related Investments allow private foundations to make investments that generate both charitable impact and some financial return. On April 25, 2016, the IRS finalized long-awaited guidance that includes additional examples of permissible PRIs. These examples broaden the range of investment opportunities available to private foundations by illustrating how PRIs can further tax-exempt purposes and potentially turn a profit.
PRIs provide private foundation managers and board members with comfort that socially conscious investments will not be considered jeopardizing investment subject to excise taxes under Section 4944(a) of the Internal Revenue Code.
PRIs are investments which are made to accomplish a charitable purpose, and they must meet the following requirements:
- The primary purpose of the investment must be to accomplish one of the foundation’s exempt charitable purposes, and
- The production of financial gain must not be a significant purpose of the investment. However, an investment that produces significant financial gain can still qualify as a PRI absent other evidence indicating financial gain was a significant purpose underlying the investment.
Typical examples of PRIs include low-interest or interest free loans to students, small businesses, and other businesses in low-income areas, as well as high-risk investment in low-income housing projects and other nonprofit organizations.
Because PRIs primarily serve a charitable purpose, they also count toward the annual mandatory minimum distribution requirement imposed on foundations under IRC Section 4942. So, PRIs may serve to further a foundation’s charitable goals while both generating a profit and contributing to its annual distribution requirement.
New Examples of Permissible PRIs
The new regulation clarifies and expands what types of investments qualify as PRIs. The examples included in the regulation will be valuable for foundations because they will allow foundations to rely on those examples, thereby relieving financial burdens and time delays associated with obtaining individual private letter rulings.
The new examples demonstrate that PRIs are not limited to investments involving low-income individuals or areas in the United States. Instead, PRIs may also include funding for activities in foreign countries or provide less traditional means of support for communities. Some of the noteworthy examples of qualifying PRIs are as follows:
- Example 11 provides that a transaction in which a private foundation enters into an investment agreement with a business that develops new drugs. The business’s research indicates that it could develop a vaccine within ten years to prevent a disease that primarily affects low-income individuals in developing countries, but the business is unwilling to develop the vaccine because the return on the investment would likely be too low. The business and the foundation enter into an agreement in which the foundation invests in a subsidiary of the business that is intended to research, develop, and distribute the vaccine to individuals in developing countries at an affordable price. The example was modified from its original version in order to clarify that the subsidiary could also sell the vaccine are fair market value to those who can afford it. The IRS explains that such clarification is appropriate because the primary purpose of the investment is to fund scientific research in the public interest, not to generate a profit.
- In Example 13, a foundation accepts common stock as part of a loan to a business that collects recyclable solid waste materials in a developing country and delivers them to recycling centers. The final version removed a portion of the example which provided that the foundation planned to liquidate the stock once the business became profitable or once it had been established that the business would never be profitable. This sentence was removed to clarify that a foundation does not necessarily have to sell its stock in a business once the business becomes profitable in order for the investment to be a PRI. However, the IRS notes that the inclusion of an exit condition that is tied to a foundation’s charitable exempt purpose can help show that the foundation’s primary purpose in undertaking the investment was to promote charitable activity.
- Example 15 describes a foundation that provides loans to poor individuals in developing countries in order to help them start small business. The example originally specified that the foundation provided loans in a developing country where a natural disaster had occurred. The IRS removed the reference to any natural disaster in order to clarify that a natural disaster would not be necessary in order for the loans to qualify as PRIs.
- For all of the examples, the IRS emphasizes again that no significant purpose of the investments may involve financial gain and the investments must significantly further the accomplishment of the foundations' exempt charitable activities.
On the same day the final regulations were adopted, the IRS added seven guiding principles to its website in order to help foundations determine whether an investment will qualify as a PRI. These principles directly track some of the new examples, but also suggest when an investment that does not fall squarely within one of the examples that would qualify as a PRI. These guiding principles are as follows:
- An activity conducted in a foreign country furthers an exempt purpose if the same activity would further an exempt purpose if conducted in the United States,
- The exempt purposes served by a PRI are not limited to situations involving economically disadvantaged individuals and deteriorated urban areas,
- The recipients of PRIs need not be within a charitable class if they are the instruments for furthering an exempt purpose,
- A potentially high rate of return does not automatically prevent an investment from qualifying as program-related,
- PRIs can be achieved through a variety of investments, including loans to individuals, tax-exempt organizations and for-profit organizations, and equity investments in for-profit organizations,
- A credit enhancement arrangement may qualify as a PRI, and
- A private foundation’s acceptance of an equity position in conjunction with making a loan does not necessarily prevent the investment from qualifying as a PRI.
The full text of the final regulations may be found on the Federal Register.
This article was prepared with the assistance of Megan Clemency, a rising 3L at the University of South Carolina School of Law.