U.S. charitable organizations

With expanded exposure to international issues and needs, U.S. charitable organizations continue to look for ways to expand their reach and increase their impact beyond U.S. borders. Whether considering international activities for the first time, or looking to expand activities in multiple foreign jurisdictions, U.S. charitable organizations should consider opportunities to do good in light of significant challenges that can be present when working outside the U.S. 

Conducting international activities

Generally, U.S. charitable organizations (including public charities and private foundations) have been granted tax-exempt or charitable status by the Internal Revenue Service (IRS) as organizations described in Internal Revenue Code (IRC) Section 501(c)(3). To receive this designation, charitable organizations must be organized and operated for exclusively religious, charitable, scientific, testing for public safety, literary, or educational purposes, or foster national or international amateur sports competition, or for the prevention of cruelty to children or animals. If a U.S. charitable organization chooses to operate internationally, its international activities and operations must be permittable under its organizational documents and must serve its charitable purpose(s).

An organization’s charitable purposes are stated in its organizational documents, including its articles of incorporation, by-laws, or trust agreement, and on its Form 1023, “Application for

Recognition of Exemption under IRC Section 501(c)(3) of the IRC,” which the IRS relied on when it granted tax-exempt status to the organization. Some organizational documents may apply activity or geographical limitations that could limit or prohibit international activities and operations. It is common, for example, for older private foundations that were created as a trust to have geographical or state level limitations. 

International activities and operations must serve the charitable organization’s charitable purposes. The term “charitable” is used in its generally accepted legal sense and includes:

• Relief of the poor and distressed or of the underprivileged
• Advancement of religion
• Advancement of education or science
• Erection or maintenance of public buildings, monuments, or works
• Lessening the burdens of government
• Promotion of social welfare, or to lessen neighborhood tensions, eliminate prejudice or discrimination, defend human and civil rights secured by law, or combat community deterioration and juvenile delinquency

Types of international activities

Once a U.S. charitable organization has confirmed that its anticipated activities are permittable under its organizational documents and the anticipated activities further its charitable purposes, the organization can engage in international activities in several ways: 

1. Funding international activities conducted by other U.S. organizations. Usually, the least complex way for U.S. organizations to fund international charitable activities is to provide general or program support for the international activities or programs of other U.S. charitable organizations. When providing support for international activities, charitable organizations should note that if funding is earmarked for specific purposes or to an ultimate beneficiary, the IRS might require the donor organization to look-through the U.S. charitable organization to the ultimate grant recipient. 
   
   
2. Direct conduct of international activities. U.S. charitable organizations may operate some or all programs physically in a foreign country. Direct international activities can include:
   
   • Working through independent contractors and agents
   • Sending U.S. personnel to international locations
   • Opening a branch office in an international location
   • Establishing an entity under local law in an international location
   • A combination of these, which might also be combined with grantmaking efforts
   
   Before beginning a direct international activity, it is prudent to consult tax and legal advisers as direct international activities could create foreign country risks and obligations, in addition to U.S. risks and obligations. 


3. Direct international grantmaking. Many U.S. charitable organizations provide direct financial support to the charitable efforts of foreign entities, most of which have not been recognized by the IRS as charitable organizations. When granting to foreign entities, there are special rules that apply to U.S. charitable organizations – public charities are required to maintain “control and discretion” over the use of funds for IRC Section 501(c)(3) purposes, and private foundations are required to exercise expenditure responsibility or determine that the recipient is the “equivalent” of a U.S. public charity. Direct international grantmaking might create other U.S. risks and obligations, as well as certain foreign risks and obligations that should be considered prior to granting funds. While it might appear straightforward, the IRS might more closely scrutinize direct international grantmaking than engaging in direct international activities.

Special rules for international grantmaking

The IRS provides guidance on international grantmaking situations for both public charities and private foundations that:

• Permits charitable funding to organizations located outside the U.S., including noncharitable entities
• Places the burden on the U.S. charitable organization to ensure all grant funds are spent solely for charitable purposes
• Uses a process that follows the principles of good grantmaking

Public charities have fewer specific requirements, compared to private foundations, when making charitable grants to foreign organizations. Public charities must exercise “control and discretion” over the use of funds for charitable purposes (Revenue Ruling 68-489, 1968-2, C.B. 210) and must maintain records establishing that the funds were used for IRC Section 501(c)(3) purposes. Limited other interpretations of this guidance exist, but the IRS has indicated that a public charity’s adherence to the expenditure responsibility rules (Treasury Regulation Section 53.4945-5(b)) were “consistent” with the exercise of “control and discretion” (PLR 200234071).

Private foundations making grants to non-exempt and foreign organizations are required to follow the rules under IRC Section 4945, for instance, a private foundation will incur an excise tax and require correction of grants made if it makes certain payments including:

• Grants to individuals for travel, study, or other similar purposes, unless the grants are nondiscriminatory, objective, and made using grant procedures preapproved by the IRS
• Grants to organizations that are not federally recognized public charities, unless the private foundation exercises expenditure responsibility or, in the case of a foreign grantee, determines that the foreign organization is the equivalent of a U.S. public charity
• Grants for any amounts expended for noncharitable purposes

Private foundations required to exercise expenditure responsibility (Treasury Regulation Section 53.4945-5(b)) for nonexempt and foreign grantees first must conduct a pre-grant inquiry. Once it is determined that the grant will move forward, the private foundation must obtain a signed, written grant agreement signed by both the private foundation and an authorized officer of the grantee and that must include the following terms defined in Treasury Regulation Section 53.4945-5(b)(3):

• The grantee must not use any grant funds for: (i) lobbying or political campaign activities; (ii) grants to individuals for travel, study, or other similar purposes; (iii) subgrants to organizations that are not public charities unless expenditure responsibility is exercised; and (iv) undertaking any activity without a charitable purpose described in IRC Section 170(c)(2)(B).
• The grantee must repay any funds not used for the charitable purposes of the grant.
• The grantee must maintain records of receipts and expenditures, making its books and records available to the grantor at reasonable times.

As part of the expenditure responsibility process, the private foundation must obtain annual grantee reports on the use of grant funds, grant progress, and compliance with the grant agreement. If the private foundation becomes aware of the diversion of any funds from the charitable purpose of the grant, steps must be taken to recover any diverted funds. 

Finally, the private foundation must provide certain grant information for these grants to the IRS on its Form 990-PF, “Return of Private Foundation or Section 4947(a)(1) Nonexempt Charitable Trust Treated as a Private Foundation,” for each year until all grant funds are reported expended and used for charitable purposes. Failure to comply with any of these requirements (Revenue Ruling 77-213, 1977-1, C.B. 357) could result in a taxable expenditure with imposition of the IRC Section 4945 excise tax on the private foundation and on the foundation’s managers who knowingly approved of the transaction, as well as the requirement to correct the taxable expenditure.

Equivalency determinations

Private foundations conducting direct international grantmaking might be able to determine that certain foreign grantees are the equivalent of a U.S. public charity. This option is available only for grantees that are foreign organizations. An equivalency determination is a process by which a U.S. grantmaker evaluates and makes a good-faith determination that a potential foreign grantee would be the equivalent of a U.S. public charity. Charitable organizations no longer may rely on an affidavit from the foreign grantee that it would qualify as the equivalent of a U.S. public charity.

In preparing an equivalency determination, the private foundation must collect information, in English, about the grantee’s organizational status, operations, and finances, including language that indicates the potential foreign grantee is organized and operated exclusively for charitable purposes and that upon dissolution all assets will be contributed to another charitable entity. There also must be documentation to show how the foreign entity would qualify as a U.S. public charity. For instance, if the foreign entity is inherently a public charity, such as a hospital, school, church, or if the entity meets a public support test calculation demonstrating that it receives substantial contributions from a variety of public sources. It should also be noted that final regulations issued in 2015 (U.S. Treasury Regulations Section 53.4942(a)-3(a)(6) and Section 53.4945-5(a)(5) (TD 9740; 80 FR 57709; 2015-42 IRB 573) and Revenue Procedure 2017-53 state that the equivalency determination may be relied upon if provided by a qualified tax practitioner, defined as a U.S. attorney, certified public accountant (CPA), or enrolled agent. 

Equivalency determinations might be attractive as they can be used for more than one grant and grantor, and they might be particularly helpful for private foundations funding capital assets or endowments when lengthy IRS reporting would be required under the expenditure responsibility rules. An equivalency determination is valid for up to two years after the advice is provided. Although in some cases, the equivalency process might be more challenging than exercising expenditure responsibility due to organizational document requirements and required translations of all documents to English.  

Charitable organizations making grants to non-exempt and foreign grantees should be mindful of these additional requirements and other applicable laws, and they should be aware of challenges and risks to operating internationally.

Challenges and risks to operating internationally

For U.S. charitable organizations, many challenges and risks need to be considered when operating in outside the United States:

• Differences in local business practices
• Political risks and corruption
• Actual versus perceived beneficiary or stakeholder needs
• Differences in charitable laws and practices
• Suspicions of foreign interference
• Government restrictions on philanthropy

Even the most seasoned charitable organizations conducting international activities encounter operating risks such as slow-moving judicial systems, banking and monetary issues (including moving funds between countries), access to and repatriation of funds, day-to-day logistical challenges, intellectual property protection, considerations for expatriate staff (including travel, safety, double taxation, health and employee benefits), and cultural norms versus U.S. expectations.

Importantly, U.S. charitable organizations should understand and respect local cultural norms, context, and expectations. Charitable activities and grant programs might fail to reach their potential if a charitable organization cannot adjust and realign its beliefs in line with those in the local environment, including understanding the actual needs based upon local input. 

Additionally, many foreign jurisdictions are concerned that nongovernmental organizations (NGOs) will attempt to inappropriately influence domestic policies, and some aggressively regulate NGOs and local recipients when enforcing compliance with local laws. However, requirements for implementing applicable foreign laws are not always clear and failing to comply (as determined by the local regulatory body, not always transparently) might lead to reputational and other legal risks. 

Reputational risks may threaten a U.S. charitable organization, either directly or indirectly. These risks might come from the U.S. charitable organization itself, such as from management, employees, contractors, vendors; from program implementers and other external stakeholders; or even from unrelated third parties. 

U.S. tax and nontax considerations for organizations with an international presence 

U.S. tax compliance issues might apply to charitable organizations with international activities, ranging from reporting of foreign bank accounts and operations in or related to boycotting countries, controlled foreign corporation reporting, foreign transaction reporting, and foreign branch reporting. Public charities should also consider reporting implications for federal Form 990, “Return of Organization Exempt from Income Tax,” such as disclosing foreign activities and foreign entities on Form 990, Schedules F and R. 

Charitable organizations working outside the U.S. should determine if their activities create a permanent establishment (PE), which relates to creating a taxable presence in a foreign jurisdiction – generally a fixed place of business through which activities are carried out. This determination might be dependent on income tax treaty positions and local law determinations and typically will look to people (including agents) and property (including computers) located in the foreign jurisdiction. Creation of a PE might create other foreign jurisdiction reporting and compliance issues, such as in-country registrations and other taxes (income, payroll, property, sales, and value-added taxes, among others).

When both U.S. and international related entities exist, charitable organizations should consider potential transfer pricing issues and shared-resource models or global employment organizations to gain efficiencies with global payroll and reporting issues. And importantly, care should be given to planned entry and exit strategies, which might be particularly difficult from a sustainable charitable program perspective and due to government-legislated obligations to employees. 

Other significant nontax considerations for U.S. charitable organizations with international activities or operations include: 

1. U.S. Department of the Treasury, Office of Foreign Asset Control (OFAC). OFAC administers and enforces economic and trade sanctions based on U.S. foreign policy and national security goals. OFAC imposes country-specific sanctions that can be overly broad in scope, however, some general or specific licenses might be available, often for humanitarian assistance. OFAC also works with charitable organizations working internationally by providing resources, such as Voluntary Best Practices for U.S. Based Charities (Anti-Terrorist Vetting).


2. U.S. Department of Justice, Foreign Agents Registration Act (FARA). FARA requires certain agents of foreign principals engaged in political or certain other activities to make periodic public disclosure of their relationship with the foreign principal, as well as their activities, receipts, and disbursements in support of those activities. It is important to note that assisting certain foreign entities in soliciting charitable funds in the U.S. might trigger registration requirements and both civil and criminal penalties might apply for noncompliance. As a result, careful attention should be paid when directly engaged with foreign governments to ensure compliance with FARA.

Before engaging in international activities and operations, U.S. charitable organizations should understand the country context and specific country laws in the jurisdictions where it intends to engage. Charitable organizations with international operations and activities should consider accounting, tax, and legal counsel with appropriate country-specific experience, specifically as it pertains to compliance, privacy and data restriction rules, and other relevant country laws, to help mitigate potential financial, operational, programmatic, and reputations risks.

This article originally appeared in the June 2023 TaxStringer and is reprinted with permission from the New York State Society of Certified Public Accountants.