How can U.S. foundations make a tax-advantaged gift to a foreign NGO that is not designated as exempt under Section 501(c)(3) of the Internal Revenue Code? And, how can donors be assured that their donation is used appropriately?
The IRS provides U.S. grantmakers with two different tools for ensuring grants to non-501(c)(3)s are exempt transactions:
1. Conducting an equivalency determination (ED)
2. Exercising expenditure responsibility (ER)
While both options provide grantmakers with the ability to fund non-exempt entities, there are situations where one may be more useful than the other.
Equivalency Determination
Equivalency determination (ED) is the process by which a U.S. grantmaker makes a good faith determination that a foreign grantee is considered the equivalent of a U.S. public charity under IRS Sections 501(c)(3) and 509(a) of the tax code.
A good faith determination about the foreign grantee’s equivalency must be based on a written statement (affidavit) from the potential grantee. This statement is then reviewed and the ED is formally issued by an attorney or qualified tax practitioner. IRS Revenue Procedure 92-94 lists the documents and information that must be included in an affidavit from the board of the foreign charitable organization:
1. Charter of the organization
2. Detailed description of the purposes of the organization and its past and proposed activities
3. Dissolution provisions (either as a part of applicable law, or in the charter)
4. Legal or charter-based restrictions on private benefit, non-charitable activities, lobbying, and participation in political campaigns
5. Detailed, audited financial records for the past five years
Advantages of Equivalency Determination
An equivalency determination can be an effective method for making grants to a foreign non-exempt grantee. With an ED, foreign recipients are not required to submit annual reports on the expenditure of grant funding, and grantmakers don’t need to provide any further information on their IRS Form 990-PF. Much of the financial burden and time commitment on the charity occurs prior to the grant being made, allowing for minimal maintenance of the giving relationship and ease of future gifts.
CAF America strongly recommends the use of EDs when funding large, complex projects, when making truly unrestricted grants, or the acquisition of capital assets and/or their transfer from grantor to grantee. The most important benefit of using an ED is that there is no legal requirement for reporting on grants made using it. While this can be a benefit for grantors wishing to give a gift with a long-term impact without requiring unlimited reporting, all donors should keep in mind the benefit of some reporting requirements, proportional to the levels of trust they have in the grantee.
While ED is a powerful tool to fund foreign charitable organizations, grantmakers should consider many other factors prior to giving, including compliance with local regulations in the recipient organization’s country and accounting for ongoing risk management. Learn more about the complexities of ED funding here.
Not All Charities Meet ED Requirements
Equivalency determination offers grantmakers the opportunity to build impactful relationships with foreign NGOs that are able to meet the high standards required by the ED affidavit.
Challenges with Required Documents
Many organizations have difficulty providing the necessary documentation for ED, and the administrative process can be prohibitive when working with grantees incorporated in countries without a well-defined charity sector.
In the U.S., we are used to an easily-accessible framework for an “approved” charity thanks to the IRS’s Publication 78 list of charities and the common understanding of IRC Section 501(c)(3). But outside our borders things are not so simple. Many countries simply do not provide an option for organizations to register as a “non-profit” as we define it.
Many organizations with legitimate charitable purposes also incorporate as “social enterprises” or other types of businesses in countries where it is difficult or impossible to incorporate as a non-profit entity. Organizations like this can have structures that resemble a U.S. for-profit corporation, and as a result—despite having a legitimate charitable purpose—they may be unable to pass ED reviews. Additionally, smaller organizations with less administrative capacity may not have access to the detailed financial reporting required to pass an ED.
Finally, all documents should be provided in English, and if the source documents are not in English it is best practice for them to be translated using a certified translator that meets the requirements of Section 7.01(2)(c) of Rev. Proc. 2017-1, 2017-1 I.R.B. 1, 24, or the corresponding provision of the most recent annual update of that procedure.
While this translation standard is not a requirement, it is defined as ‘acceptable’ for accepting foreign document translations in ED regulations. Remember, an ED is a ‘good faith determination,’ and if your team is reviewing non-English documents without credible language skills to support a good-faith determination the ED may not stand up under audit. For example, if the ED issuer is reviewing documents written in Arabic and they do not have Arabic language skills or access to credible translations, it is difficult to argue that the certificate would have been issued in good faith.
Passing the “Public Support Test”
Equivalency determination requires that qualifying organizations are equivalent to U.S. public charities as classified under IRC Section 509(a), which specifically requires that the entity is “supported by the general public.” In real terms, the IRS uses what is called the “public support test” to evaluate the level of funding coming from multiple donors.
Foreign grantees must be able to demonstrate that 33% of their contributions over the past five years came from public sources. Many otherwise eligible charities cannot reach this milestone–or do not have five years of audited financial statements–which makes this test a difficult one to pass. You can read more about the ins and outs of the public support test here.
For many charities, an Equivalency Determination is a powerful tool to access funding from U.S. foundations. But it is a time-intensive and context-specific process that may not work for all grantees. Many times, the flexibility of expenditure responsibility provides grantmakers with a viable alternative.
Learn more about equivalency determination’s counterpart, expenditure responsibility, here. Contact info@cafamerica.org today to learn how we can facilitate giving via ED for your foundation.