April 27, 2016

IRS Issues Final Regulations for New Examples of Private Foundation Program-Related Investments

Arnold & Porter Advisory

Effective April 25, 2016, the Internal Revenue Service has published final regulations that adopt, with some changes, the proposed regulations released in 2012 that provide guidance and examples to private foundations engaging in program-related investments (PRI).1 PRIs are investments, as opposed to grants, that are made primarily to accomplish a charitable purpose.

The purpose of this regulatory project was to update the long-standing examples of investments that qualify as program-related investments, most of which focused on supporting domestic community redevelopment projects through below-market loans. The new examples reflect the diverse ways that foundations currently employ program-related investments to further their charitable missions. The final regulations also complement the increasing focus of the foundation community (and other institutional investors) on how to use their entire investment portfolios to further their mission.2

The proposed (and now final) regulations add nine new examples to the existing nine examples illustrating investments that qualify as program-related investment. The final regulations made changes to three of the proposed examples, as described below.

  • Example 11 describes an investment in a subsidiary of a drug company to develop a vaccine for the treatment of a disease that predominantly affects the poor in developing countries. The foundation’s investment required the company to distribute the vaccine at a price that is affordable to the target population. The final regulations revised the example to make clear that the drug company can also sell the vaccine to those who can afford it at fair market prices. In its explanations of the changes adopted, the IRS notes that this revision is appropriate given that the example already specifies that the foundation’s primary purpose in making the investment is to fund scientific research in the public interest and no significant purpose of the investment is the production of income or appreciation of property. 
  • Example 13 involves one of the difficult legal and practical aspects of PRIs, namely, devising an exit strategy. Example 13 describes a situation in which a business enterprise offers a private foundation common stock as an inducement for the foundation to make a below-market rate loan. The final regulations revised the example to remove the sentence that stated that the foundation plans to liquidate its stock in the business as soon as the business is profitable or it is established that the business will never become profitable. While the IRS removed this sentence, the commentary to the final regulations indicate that the IRS believes that establishing an exit strategy at the outset of an investment is an important indication that a foundation’s primary purpose in making a PRI, and hence qualifying an investment as a PRI, is the furtherance of its charitable purposes. 
  • Example 15 involves a loan by a private foundation to two poor individuals living in a developing country who desire to start a small business when a natural disaster strikes. The IRS revised the example to remove the reference to a natural disaster to clarify that an investment to enable poor persons to become economically self-sufficient by starting a small business may qualify as a PRI without the necessity of an intervening natural disaster.
The preamble to the final regulations includes an explanation of additional changes that commentators requested to the proposed examples and why the IRS rejected those requests. For example, the IRS rejected a request to include examples involving investments in low-profit limited liability companies (L3C) or benefit corporations. Based on the IRS’s explanation, it is clear that the IRS views, for purposes of PRIs, L3Cs and benefit corporations (and presumably other similar types of new legal entities) as no different than regular for-profit business enterprises.

The IRS also received numerous requests to modify existing administrative procedures to allow foundations to obtain rulings on PRIs faster and at less cost than the existing private letter ruling process. One of the recommendations was to allow other private foundations, other than the requesting foundation, to rely on private letter rulings regarding PRIs. The IRS noted that all of these proposed changes are outside the scope of these final regulations and would require changes to administrative regulations to implement. In the meantime, there are numerous ways that private foundations can make PRIs without significant costs and administrative burdens. For example, there are charitable organizations that have established “PRI funds” that allow private foundations to make investments while relying on these intermediary charitable organizations to oversee the use of the investments by grantees.
  1. T.D. 9762 (81 Fed. Reg. 24014), available here; Our prior advisory on the proposed regulations, and an overview of PRIs, is available here.

  2. See IRS Notice 2015-62 (September 15, 2015) (guidance to clarify that private foundations are permitted to make certain “mission-related” investments (MRIs) in companies that further a foundation’s charitable purposes, even when those investments do not qualify as program-related investments); U.S. Department of Labor, Interpretive Bulletin 2015-01 (October 22, 2015) (guidance regarding how ERISA fiduciaries may take into account environmental, social and governance factors into investment considerations).

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