U.S. Charities and International Philanthropy: What You Need to Know
June 22, 2009
According to the Council on Foundations, international giving by U.S. charities reached a record in 2007 – an estimated $5.4 billion. Moreover, the Foundation Center has determined that international giving from the United States has increased significantly in recent years and at a rate faster than overall giving. For example, the Bill and Melinda Gates Foundation raised its annual international giving from $525.8 million to $2 billion between 2002 and 2006.
Despite the current economic crisis, U.S. charities with international activities and reliance on charitable giving remain strong. However, U.S. charities have been under close scrutiny by the U.S. government and its agencies in recent years, especially after the 9/11 attacks. Charities are considered to be the second most significant source of funds to terrorist activities according to the U.S. government. U.S. charities are not immune from prosecution and should be aware of some basic requirements and risks involved when they engage in international grantmaking.
What Options Are Available to U.S. Charities for International Grantmaking?
- Grant to another 501(c)(3) with an established international program
The simplest option is to make a grant directly to another U.S. 501(c)(3) charitable organization to support an already established international program. This avoids many complications, due diligence requirements and expenses as discussed below.
- Grant to another 501(c)(3) “friends of” organization
Another easy option is to make a grant to a U.S.-based 501(c)(3) “friends of” organization that has been set up to raise funds for a specific charitable program or activity outside of the U.S., often a university, museum or hospital. The term “friends of” derives from the fact that the names of so many organizations that support foreign charities begin with these two words (e.g., the American Friends of the London Business School, Friends of Foundation de France and Friends of China Heritage Fund).
The “friends of” organization is almost always a U.S. nonprofit corporation established for the primary purpose of raising funds in the U.S. for foreign charities. It can be classified as a public charity or as a private foundation. If a U.S. “friends of” organization is listed in the Internal Revenue Code (IRS) Section 170(c), Publication 78, a grant to the organization will generally be considered as made for charitable purposes. Note that a so-called “friends of” organization may not function solely as a conduit to pass funds along to a specific foreign organization. Its board of directors must have discretion over the use of its funds, including the power to use the funds for a purpose other than making a grant to the named foreign organization.
Still another relatively straightforward option is to establish a donor-advised fund with a U.S.-based 501(c)(3) public charity that can, for a fee, provide a range of legal and monitoring services to donors wishing to support organizations located outside the U.S. A relatively new but growing option for making international grants is to set up a donor-advised fund with a willing U.S. community foundation, some of which are linking local ethnic communities they serve with their countries of origin
However, before taking this step, it is best to discuss the donor’s objectives with the charity that sponsors the donor-advised funds to confirm it is willing to make international grants. Also, “due diligence” should be used to ensure that the charity is financially sound, since assets in a donor-advised fund are considered property of the sponsoring charity and subject to its creditors.
Prior to the Pension Protection Act of 2006 (PPA), a sponsoring organization approving grants from donor-advised funds to foreign charities had to comply with the basic requirements that applied to all public charities making international grants. For international grants, the PPA now requires donor-advised funds to comply with certain rules imposed on private foundations as detailed below.
- Direct cross-borders grants
Making cross-border grants directly to organizations located in other countries is an option that requires some additional steps due to special IRS rules for private foundations. Many private foundations choose this option because it enables them to have a one-to-one relationship with their overseas grantee partners. International grantmaking requirements for public charities are significantly less onerous than those for private foundations and are limited to a fiduciary duty to see that the grant funds are used exclusively for charitable purposes. Private foundations, however, must follow one of the two options provided in section 4945(h) of the U.S. tax code:
- Make reasonable efforts to ensure that a grant to a foreign charity is spent for its intended purposes, obtain reporting from the grantee that shows how the funds were expended and provide reporting about the grant to the IRS. This process is called “expenditure responsibility.”
- As an alternative, a private foundation can make a good faith determination that the foreign organization is the equivalent of a U.S. public charity. This process is known as “equivalency determination.”
Different factors and circumstances will determine which option is most appropriate and efficient. As a general rule, expenditure responsibility provides more flexibility and is a widely-used due diligence option for international grantmaking. The disadvantage of the equivalency determination is that the process of showing that the foreign grantee is the “equivalent” of a U.S. public charity can be administratively burdensome and costly, and in some cases not possible for lack of the required documentation. For example, the foreign grantee’s governing documents may generally define its purposes as charitable, but may lack specific provisions required by U.S. law (e.g., the requirement as to how the organization’s assets must be distributed in the event of its dissolution).
What Existing Anti-Terrorist Rules and Guidelines Are Applicable to U.S. Charities?
- Executive Order 13224, the USA PATRIOT Act and the OFAC Sanctions
Executive Order 13224 prohibits transactions by U.S. persons with individuals and organizations listed on any terrorism watch lists issued by the U.S. government. Executive Order 13224 also allows the U.S. government to freeze all assets controlled by or in possession of such individuals or organizations and those who support them.
In addition to Executive Order 13224, the USA PATRIOT Act expanded the scope of criminal prohibitions on providing support to terrorist organizations, especially by imposing fines and imprisonment for organizations knowingly or intentionally providing material support to terrorist organizations. U.S. charitable organizations should be aware that, in addition to a criminal cause of action, the USA PATRIOT Act also provides for a civil cause of action against organizations which provide material support to terrorists.
The USA PATRIOT Improvement and Reauthorization Act of 2005 makes permanent certain provisions of the original USA PATRIOT Act, enhances criminal penalties and expands the reach of asset seizures, even prior to trial. A violation of a presidential order is now subject to a monetary penalty up to $50,000 and imprisonment up to 20 years.
The United States Department of the Treasury’s Office of Foreign Assets Control (OFAC) has also focused considerably on charities. OFAC’s sanctions can be divided into country-based programs, which restrict a broad range of activities in or with specific countries (e.g., Cuba, North Korea, Sudan, Burma, Iran and Syria) and list-based programs, which forbid transactions with specific named entities and individuals.
The Specially Designated Nationals and Blocked Persons (SDN) list was created to list organizations and individuals restricted from doing business with the United States government and its agencies, U.S. companies or U.S. individuals and is available on the OFAC website. The SDN list is a critical reference point for charities in their dealings with grantees, and should also be used by their attorneys, accountants and auditors. The SDN list, as last updated on March 4, 2009, consists of 417 pages and provides an extensive list of organizations.
- The Anti-Terrorist Financing Guidelines
To assist nonprofits making foreign grants to better comply with the Executive Order 13224 and the USA PATRIOT Act, the U.S. Department of Treasury issued in November 2002 the Anti-Terrorist Financing Guidelines: Voluntary Best Practices for U.S.-Based Charities (“Guidelines”). The Guidelines are voluntary – non-adherence to the Guidelines does not constitute a violation of existing U.S. law – they are designed to assist charities that attempt in good faith to protect themselves from terrorist abuse.
Criticized as being unworkable by charities, the Guidelines were revised in 2005 and 2006. Furthermore, representatives of nearly 30 organizations gathered to develop what are now known as the Principles of International Charity: a framework of guidance and recommended practices for U.S. charities with international activities.
In addition to the federal anti-terrorist rules, the IRS rules generally prohibit the use of charitable assets for non-charitable purposes, including for terrorist activities. A violation of the IRS rules may result in revocation of the tax-exempt status of the U.S. charities. Furthermore, since 2003, the U.S. Tax Code provides for the suspension (automatic and retroactive) of tax-exempt status for an organization having terrorist activities, i.e., for an organization designated as a terrorist organization under the USA PATRIOT Act or on any relevant U.S. government terrorist list.
U.S. Withholding Tax Considerations of International Grantmaking
A 30 percent U.S. tax withholding is generally required if the foreign grantee will conduct activities in the United States. Therefore, U.S. charities making grants to foreign individuals or organizations who perform all or part of their grant-funded activities in the U.S. have to withhold U.S. tax from these payments. However, no U.S. tax withholding is due if any of the following is met: (i) the activities that are conducted as a result of the grant will be performed outside of the U.S; (ii) the recipient qualifies for an exemption under a U.S. tax treaty; (iii) the recipient can establish that it could qualify as a U.S. tax-exempt organization; or (iv) the international organization is designated by executive order.
The U.S. charity is responsible for paying the tax to the IRS (Form 1042 and 1042-S). A copy of the forms must be provided to the foreign recipient, otherwise significant liabilities are incurred. A U.S. charity risks penalties if it does not provide the required forms or fails to withhold the tax required. A new Schedule F has been added to IRS Form 990 and requires substantial disclosure (e.g., Schedule F, Part I, General Information on Activities Outside the United States, must be completed by organizations that have had aggregate revenues or expenses of more than $10,000 from grantmaking, fundraising, business and program service activities outside the United States).
Conclusion
U.S. charities should not be discouraged about international grantmaking – legitimate humanitarian activity is almost always authorized. However, U.S. charities should carefully evaluate their policies and procedures to ensure they comply with IRS and federal counter-terrorism regulations. Grantmakers are looking for safe-harbors and clear guidelines as to what they should do to protect themselves. To date, no branches of the U.S. government or its agencies have provided them with any clear guidance.
Some fundamentals should be followed such as conducting a risk assessment, considering partnering with another organization with experience in the field, checking available lists (such as the SDN list but also lists maintained by other U.S. agencies, the European Union, the United Nations and other countries). Once the risks have been identified, U.S. charities should manage such risks (e.g., by including indemnification provisions in the charity’s organizational and governing documents and by obtaining D&O insurance), and consider using existing compliance software and training staff to use this software. Such compliance software programs allow the U.S. charities staff to check the federal and international published antiterrorist lists against the organization names and contacts from the U.S. charities database.
Finally, considering the many regulations currently under review by the new Obama Administration and subject to change, U.S. charities should consult with legal counsel to stay abreast of new regulations and effectively manage all other aspects of international grantmaking.
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