The IRS finalized regulations (T.D. 9762) broadening the types of investments that private foundations may make without violating the rule that private foundations not make “jeopardizing investments,” which subjects them to an excise tax under Sec. 4944(a).
Sec. 4944(c) provides that “program-related Investments” are not jeopardizing investments. Program-related investments must meet the following requirements: (1) The primary purpose of the investment is to accomplish one or more of the purposes described in Sec. 170(c)(2)(B) (religious, charitable, scientific, literary, educational purposes, amateur sports, or the prevention of cruelty to animals); and (2) no significant purpose of the investment is to produce income or result in the appreciation of property. However, under the final rules, the fact that an investment produces significant income or capital appreciation will not, absent other factors, disqualify the investment.
The final regulations add nine examples to the existing rules to update what types of investments qualify. Regulations in effect since 1972, which contained nine examples of program investments that qualify and one that did not, were primarily concerned with domestic investments in programs involving economically disadvantaged individuals and deteriorated urban areas.
The new examples demonstrate that program-related investments may accomplish a variety of exempt purposes besides aiding economically disadvantaged individuals and deteriorated urban areas, may fund activities in one or more foreign countries, and can earn a high potential rate of return. A program-related investment may take the form of an equity position when making a loan, and a private foundation’s provision of credit enhancements can qualify as a program-related investment. Loans and capital are permitted to be provided to individuals or entities that are not within a charitable class themselves if the recipients are the instruments through which the private foundation accomplishes its exempt activities.
Specifically, these regulations add a number of examples of investments in foreign countries and add examples that involve investments in research for drugs unavailable to an impoverished population, as well as investments in organizations undertaking environmental, scientific, or micro-loan programs and one involving financing the building of a child care facility.
The final rules adopt proposed regulations (REG-144267-11) issued in 2012, with a few changes in response to comments. One significant amendment in response to comments was to change Example 11, which allows investing in a subsidiary of a drug company to make drugs available to people who otherwise cannot afford the price, to provide that the drug company is permitted to charge fair market value to those who can afford it.
Another change involved omitting a reference that loans to individuals to allow them to start small businesses (micro-loans) be made in response to a natural disaster. The final rules eliminate the reference to a natural disaster, recognizing that programs involving investing in foreign countries should not require a natural disaster to make them related to an exempt purpose.
One comment that the IRS did not adopt, but said it would study further, was whether a private foundation can invest in a limited liability company, rather than just loan it money, as in Example 16. These investments raise many issues that investments in corporations do not. Accordingly, the IRS did not make changes in response to this comment but stated that it is considering addressing that issue in a separate revenue ruling.
The regulations are effective April 25, 2016.
—Sally P. Schreiber (email@example.com) is a Tax Adviser senior editor.