By Thomas St.G. Bissell
The Treasury issued proposed regulations in September that would expand the range of persons who may certify the "public" status of foreign charities, to include certified public accountants (CPAs) and IRS enrolled agents.1 Where a private foundation makes a grant for charitable purposes to any foreign "organization," under §4945 it must exercise oversight over the use of the funds by the foreign grantee, unless it receives documentation showing that the organization is a "public charity" (and not itself a private foundation or a non-charitable entity) for U.S. tax purposes.2 The current §4945 regulations provide that in lieu of an "affidavit" of public charity status from the foreign grantee, an "opinion of [U.S.] counsel" to this effect is also acceptable. Thus, the new proposed regulations would permit a CPA certified within the United States, or an enrolled agent, to provide a written opinion to this effect as well.
In 1969, Congress created the "private foundation" (PF) concept as part of its overhaul of the federal tax rules affecting charitable organizations, and it enacted numerous rules (including special penalty taxes) to ensure that PFs conduct their activities in accordance with strict guidelines. As part of these rules, §4945 provides that if a PF makes a grant to any "organization" that is not a so-called "public charity" with broad public funding, the PF must exercise ongoing oversight (called "expenditure responsibility") over the grantee's use of the funds (including grant-specific reports to the IRS), or else pay an excise tax equal to 20% of the amount of the grant.3 Although a domestic organization receiving funds from a PF would almost always know whether it was a public charity or not and could notify the PF of its status, a foreign organization would often not know. It is possible for a foreign charity to apply to the IRS for recognition as an exempt organization under §501(c)(3) in order to obtain certainty on this question, but in general the Code does not require this, and in practice most foreign charities have declined to apply for recognition.4 The §4945 regulations specifically recognize this situation, and provide that if a foreign entity has not been formally recognized by the IRS as an exempt organization under §501(c)(3), it may nevertheless be treated as a public charity for §4945 purposes if either it furnishes to the PF an "affidavit" certifying its public charity status for U.S. tax purposes or the PF obtains an "opinion of counsel" (admitted to practice within the United States) of either the grantor or the grantee to the effect that the grantee is a public charity for U.S. tax purposes.5 In Rev. Proc. 92-94,6 the IRS provided details on what documents and information must be provided if the PF receives an affidavit from the foreign grantee (rather than an opinion of counsel), and it also ruled that the PF could rely on an affidavit that the grantee had previously prepared for other PFs if the affidavit was "currently qualified."
The certification of public charity status of a foreign organization is colloquially referred to as an "equivalency determination." Because a grant by a PF to a foreign organization must usually be classified also as a "qualifying distribution" under §4942 in order to avoid a separate penalty tax on a PF that does not disburse a required portion of its assets for charitable purposes, the same "equivalency determination" usually needs to be done for §4942 purposes. The IRS applies the same rules that are in the §4945 regulations for §4942 purposes. Accordingly, the new proposed regulations under §4945 would also expand the range of persons who may issue an opinion for §4942 purposes to include CPAs and enrolled agents. (The proposed regulations under both sections would change the term "opinion" to "written advice.")
In the absence of IRS statistics, it is not clear how often PFs that make grants to foreign organizations receive an "equivalency determination" in lieu of exercising "expenditure responsibility," and when they do receive an equivalency determination, to what extent they receive an "opinion of counsel" rather than an "affidavit" from the foreign grantee itself. The Preamble to the proposed regulations states that expanding the class of practitioners that may give written advice on public charity status "will decrease the cost of seeking professional advice …, [thus] enabling foundations to engage in international philanthropy in a more cost-effective manner." However, the Preamble also states that the Treasury is still not prepared to allow non-U.S. practitioners (whether attorneys or accountants) to give written advice on equivalency determinations to PFs. It also states that the Treasury is considering changing the rules to eliminate the foreign grantee affidavit procedure completely, because that "may be a less reliable basis for making a good faith determination than advice from a qualified [U.S.] tax practitioner." It also states further that the Treasury may change the rules in the future so as to provide a strict time limit (such as 12 months) on the period during which a PF may rely on written advice of a U.S. tax practitioner.
The Preamble does not mention a recommendation that was made to the IRS in 2009 by a blue-ribbon advisory panel urging that the IRS consider establishing an "Equivalency Determination Information Repository" consisting of existing affidavits and of opinions of counsel with respect to specific foreign organizations, so as to save many PFs the time and expense of seeking out such documents (or of obtaining new documentation on their own).7 Because the purpose of the new §§4942/4945 proposed regulations is to make it easier for PFs to make grants to foreign entities, and because the IRS is not proposing to change the rule of Rev. Proc. 92-94 that permits one PF to rely in many cases on documentation that was received by a different PF, it would seem that establishing such a repository would also make it easier for PFs to make foreign grants while not at the same time jeopardizing the enforcement of the §§4942/4945 rules by the IRS. Thus, it is hoped that, as the IRS proceeds to finalize the new proposed regulations, it will consider adopting this proposal as well.
It is noteworthy that, although the IRS in the new proposed regulations is expanding the range of U.S. professionals who may give written advice on equivalency determinations, it has not proposed to broaden the similar rules under §§1441/1442 that apply to foreign charities that realize U.S.-source fixed or determinable annual or periodical income (FDAP). A foreign entity that qualifies as an exempt organization under §501(c)(3) is exempt from 30% withholding under §§1441/1442 on its U.S.-source FDAP, provided that it gives a properly completed Form W-8EXP to the U.S. withholding agent. Regs. §1.1441-9(b)(2) provides that if the foreign entity has not been issued a determination letter from the IRS stating that it is tax-exempt, it may nevertheless claim exemption if it attaches an "opinion … from U.S. counsel" to its Form W-8EXP. This is apparently the only way that the foreign entity may claim the withholding exemption - thus, the foreign entity may not provide a "self-certifying" affidavit to the U.S. withholding agent, in contrast with the rule in the §4945 regulations that permits a foreign grantee to provide an affidavit to the domestic PF without the involvement of counsel for either party. However, if the foreign entity that signs the Form W-8EXP wishes to claim that it is a public charity and not a foreign PF, it must also attach to its form an affidavit of public charity status in the form prescribed by Rev. Proc. 92-94 (discussed above).8
The fact that the new proposed regulations under §§4942/4945 do not also apply for §§1441/1442 purposes is probably due to the fact that a different group within the IRS is responsible for the withholding tax regulations. Nevertheless, it is hoped that before the new §§4942/4945 regulations become final, the exempt organizations group that promulgated them will coordinate with the withholding tax group in an effort to expand the new approach to cover the exempt organization certification under §§1441/1442 as well.
It should be noted, nevertheless, that in practice the exempt organization certification procedure in Regs. §1.1441-9 may not be utilized extensively by foreign charities that make portfolio investments in the U.S. securities markets. Capital gains from non-FIRPTA securities are usually exempt from U.S. tax whether or not the foreign entity is tax-exempt under §501(c)(3), as is "portfolio interest" on most publicly traded debt obligations. Although dividends paid by U.S. companies are subject to 30% withholding tax under §§1441/1442, if the foreign charity is resident in a tax treaty country, this rate is usually reduced to 15%, and the benefit of avoiding the 15% withholding tax on U.S.-source dividends may often be outweighed by the cost of complying with the Form W-8EXP requirements.
This commentary also will appear in the January 2013 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see Bissell, 6810 T.M., U.S. International Tax Aspects of Charitable Giving and Charitable Operations, Sanders, Roady and Berry, 474 T.M., Private Foundations - Taxable Expenditures (Section 4945), and Tello, 915 T.M., Payments Directed Outside the United States - Withholding and Reporting Provisions Under Chapters 3 and 4, and in Tax Practice Series, see ¶6910, Taxes on Taxable Expenditures, and ¶7170, U.S. International Withholding and Reporting Requirements.
1 See REG-134974-12, 77 Fed. Reg. 58796 (9/24/12).
3 For details on the expenditure responsibility rules of the Code, see Sanders, Roady and Berry, 474 T.M., Private Foundations - Taxable Expenditures (Sec. 4945).
4 One reason may be out of concern that if the foreign charity receives an exemption letter from the IRS, it could be required in many cases to file annual tax returns with the IRS thereafter on Form 990, or face severe penalties for non-filing.
5 Regs. §53.4945-5(a)(4).
6 1992-2 C.B. 507.
7 See Report in 2009 of the Advisory Committee on Tax Exempt and Government Entities (ACT), http://www.irs.gov/pub/irs-tege/tege_act_rpt8.pdf, at 11-13.
8 The advantage of claiming public charity status and not foreign PF status for §§1441/1442 purposes is that a foreign public charity would avoid the 4% excise tax on U.S.-source FDAP that may be imposed on a foreign PF under §4948. This 4% tax is withheld at source by the U.S. withholding agent in lieu of the 30% tax under §§1441/1442.