[Federal Register Volume 77, Number 76 (Thursday, April 19, 2012)]
[Proposed Rules]
[Pages 23429-23432]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-9468]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 53
[REG-144267-11]
RIN 1545-BK76
Examples of Program-Related Investments
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This document contains proposed regulations that provide
guidance to private foundations on program-related investments. These
proposed regulations provide a series of new examples illustrating
investments that qualify as program-related investments. In addition to
private foundations, these proposed regulations affect foundation
managers who participate in the making of program-related investments.
DATES: Comments and requests for a public hearing must be received by
July 18, 2012.
ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-144267-11), room
5205, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand-delivered Monday through
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
144267-11), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue NW., Washington, DC, or sent electronically via the Federal
eRulemaking Portal at http://www.regulations.gov/ (IRS REG-144267-11).
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Courtney D. Jones at (202) 622-6070; concerning submissions of comments
and requests for a public hearing, Oluwafunmilayo Taylor, (202) 622-
7180 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
Section 4944(a) of the Internal Revenue Code (Code) imposes an
excise tax on a private foundation that makes an investment that
jeopardizes the carrying out of any of the private foundation's exempt
purposes (a ``jeopardizing investment''). Section 4944(a) also imposes
an excise tax on foundation managers who knowingly participate in the
making of a jeopardizing investment. Section 4944(b) imposes additional
excise taxes on private foundations and foundation managers when
investments are not timely removed from jeopardy.
Generally, under Sec. 53.4944-1(a)(2), a jeopardizing investment
occurs when, based on the facts and circumstances at the time the
investment is made, foundation managers fail to exercise ordinary
business care and prudence in providing for the long- and short-term
financial needs of the foundation. The determination of whether an
investment is a jeopardizing investment is made on an investment-by-
investment basis, taking into account the private foundation's entire
portfolio. In exercising the requisite standard of care and prudence,
foundation managers may take into account the expected investment
return, price volatility, and the need for portfolio diversification.
Section 4944(c) excepts program-related investments (``PRIs'') from
treatment as jeopardizing investments. The regulations under section
4944(c) define a PRI as an investment: (1) The primary purpose of which
is to accomplish one or more of the purposes described in section
170(c)(2)(B); (2) no significant purpose of which is the production of
income or the appreciation of property; and (3) no purpose of which is
to accomplish one or more of the purposes described in section
170(c)(2)(D) (attempting to influence legislation or participating in
or intervening in any political campaign).
An investment is made primarily to accomplish one or more of the
purposes described in section 170(c)(2)(B) (referred to as ``charitable
purposes'') if it significantly furthers the accomplishment of the
private foundation's exempt activities and would not have been made but
for the relationship between the investment and the accomplishment of
those exempt activities. In determining whether a significant purpose
of an investment is the production of income or the appreciation of
property, Sec. 53.4944-3(a)(2)(iii) provides that it shall be relevant
whether investors who are engaged in the investment solely for the
production of income would be likely to make the investment on the same
terms as the private foundation.
The regulations under other Code sections in Chapter 42 accord
special tax treatment to PRIs. For example, Sec. 53.4942(a)-
2(c)(3)(ii)(d) excludes PRIs from the assets a private foundation takes
into account when determining how much it must distribute under section
4942 as a ``distributable amount'' for the taxable year. In addition,
Sec. 53.4942(a)-3(a)(2)(i) generally includes distributions that
qualify as PRIs as ``qualifying distributions'' for purposes of meeting
the distribution requirements under section 4942. Section 53.4943-10(b)
excludes PRIs from being treated as business holdings for the purpose
of calculating excess business holdings subject to excise tax under
section 4943. Sections 53.4945-5(b)(4) and 53.4945-6(c)(1)(i) also make
clear that PRIs will not constitute taxable expenditures under section
4945, provided the private foundation exercises ``expenditure
responsibility'' in circumstances in which it is required to do so.
Among other expenditure responsibility requirements, a private
foundation must require a written commitment from the recipient of the
PRI that the funds received will be used only for the purposes of the
program-related investment. As noted, the primary purpose of a program-
related investment must be the accomplishment of a charitable purpose.
Section 53.4944-3(b) contains nine examples illustrating
investments that qualify as PRIs and one example of an investment that
does not qualify as a PRI. The existing examples focus on domestic
situations principally involving economically disadvantaged individuals
and deteriorated urban areas.
The Treasury Department and the IRS are aware that the private
foundation community would find it helpful if the regulations could
include additional PRI examples that reflect current investment
practices and illustrate certain principles, including that: (1) An
activity conducted in a foreign country furthers a charitable purpose
if the same activity would further a charitable purpose if conducted in
the United States; (2) the charitable purposes served by a PRI are not
limited to situations involving economically disadvantaged individuals
and deteriorated urban areas; (3) the recipients of PRIs need not be
within a charitable class if they are the instruments for furthering a
charitable purpose; (4) a potentially high rate of return does not
automatically prevent an investment from qualifying as program-related;
(5) PRIs can be achieved through a variety of
[[Page 23430]]
investments, including loans to individuals, tax-exempt organizations
and for-profit organizations, and equity investments in for-profit
organizations; (6) a credit enhancement arrangement may qualify as a
PRI; and (7) a private foundation's acceptance of an equity position in
conjunction with making a loan does not necessarily prevent the
investment from qualifying as a PRI.
Explanation of Provisions
The proposed regulations add nine new examples that illustrate that
a wider range of investments qualify as PRIs than the range currently
presented in Sec. 53.4944-3(b). The proposed regulations do not modify
the existing regulations; rather, they provide additional examples that
illustrate the application of the existing regulations. Generally, the
charitable activities illustrated in the new examples are based on
published guidance and on financial structures described in private
letter rulings.
The new examples demonstrate that a PRI may accomplish a variety of
charitable purposes, such as advancing science, combating environmental
deterioration, and promoting the arts. Several examples also
demonstrate that an investment that funds activities in one or more
foreign countries, including investments that alleviate the impact of a
natural disaster or that fund educational programs for poor
individuals, may further the accomplishment of charitable purposes and
qualify as a PRI. One example illustrates that the existence of a high
potential rate of return on an investment does not, by itself, prevent
the investment from qualifying as a PRI. Another example illustrates
that a private foundation's acceptance of an equity position in
conjunction with making a loan does not necessarily prevent the
investment from qualifying as a PRI, and two examples illustrate that a
private foundation's provision of credit enhancement can qualify as a
PRI.
The last example demonstrates that a guarantee arrangement may
qualify as a PRI. The proposed regulations address solely the impact of
section 4944 on the facts described and do not address whether there is
a qualifying distribution under section 4942. However, the Treasury
Department and the IRS conclude that, based on the facts described in
the last example, there would be no qualifying distribution under
section 4942 at the time the foundation enters into the guarantee
arrangement. Under certain circumstances, a private foundation may
treat payments made under a guarantee arrangement as qualifying
distributions.
Finally, the proposed regulations include examples illustrating
that loans and capital may 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.
Proposed Effective/Applicability Date
Paragraph (b), Examples 11 through 19 of this section will be
effective on the date of publication of the Treasury decision adopting
these examples as final regulations in the Federal Register. Taxpayers
may rely on paragraph (b), Examples 11 through 19 of this section
before these proposed regulations are finalized.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
12866, as supplemented by Executive Order 13563. Therefore, a
regulatory assessment is not required. It has also been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
does not apply to this regulation, and because the regulation does not
impose a collection of information on small entities, the Regulatory
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to
section 7805(f) of the Code, this regulation has been submitted to the
Chief Counsel for Advocacy of the Small Business Administration for
comment on its impact on business.
Comments and Requests for Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any comments that are submitted timely
to the IRS as prescribed in this preamble under the ADDRESSES heading.
The IRS and the Treasury Department request comments on all aspects of
the proposed rules. All comments will be available at
www.regulations.gov or upon request. A public hearing will be scheduled
if requested in writing by any person that timely submits written
comments. If a public hearing is scheduled, notice of the date, time,
and place for the public hearing will be published in the Federal
Register.
Drafting Information
The principal author of these proposed regulations is Courtney D.
Jones, Office of the Chief Counsel (Tax Exempt and Government
Entities). However, other personnel from the Treasury Department and
the IRS participated in their development.
List of Subjects in 26 CFR Part 53
Excise taxes, Foundations, Investments, Lobbying, Reporting and
recordkeeping requirements, Trusts and trustees.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 53 is proposed to be amended as follows:
PART 53--FOUNDATION AND SIMILAR EXCISE TAXES
Paragraph. 1. The authority citation for part 53 continues to read
in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 53.4944-3 is amended by adding Examples 11, 12, 13,
14, 15, 16, 17, 18, and 19 to paragraph (b) and adding paragraph (c) to
read as follows:
Sec. 53.4944-3 Exception for program-related investments.
* * * * *
(b) * * *
Example 11. X is a business enterprise that researches and
develops new drugs. X's research demonstrates that a vaccine can be
developed within ten years to prevent a disease that predominantly
affects poor individuals in developing countries. However, neither X
nor other commercial enterprises like X will devote their resources
to develop the vaccine because the potential return on investment is
significantly less than required by X or other commercial
enterprises to undertake a project to develop new drugs. Y, a
private foundation, enters into an investment agreement with X in
order to induce X to develop the vaccine. Pursuant to the investment
agreement, Y purchases shares of the common stock of S, a subsidiary
corporation that X establishes to research and develop the vaccine.
The agreement requires S to distribute the vaccine to poor
individuals in developing countries at a price that is affordable to
the affected population. The agreement also requires S to publish
the research results, disclosing substantially all information about
the results that would be useful to the interested public. S agrees
that the publication of its research results will be made as
promptly after the completion of the research as is reasonably
possible without jeopardizing S's right to secure patents necessary
to protect its ownership or control of the results of the research.
The expected rate of return on Y's investment in S is less than the
expected market rate of return for an investment of similar risk.
Y's primary purpose in making the investment is to advance science.
No significant purpose of the investment involves the production of
income or the appreciation of property. The investment significantly
furthers the accomplishment of Y's exempt activities and would not
have been made but for such relationship between the investment and
Y's
[[Page 23431]]
exempt activities. Accordingly, the purchase of the common stock of
S is a program-related investment.
Example 12. Q, a developing country, produces a substantial
amount of recyclable solid waste materials that are currently
disposed of in landfills and by incineration, contributing
significantly to environmental deterioration in Q. X is a new
business enterprise located in Q. X's only activity will be
collecting recyclable solid waste materials in Q and delivering
those materials to recycling centers that are inaccessible to a
majority of the population. If successful, the recycling collection
business would prevent pollution in Q caused by the usual
disposition of solid waste materials. X has obtained funding from
only a few commercial investors who are concerned about the
environmental impact of solid waste disposal. Although X made
substantial efforts to procure additional funding, X has not been
able to obtain sufficient funding because the expected rate of
return is significantly less than the acceptable rate of return on
an investment of this type. Because X has been unable to attract
additional investors on the same terms as the initial investors, Y,
a private foundation, enters into an investment agreement with X to
purchase shares of X's common stock on the same terms as X's initial
investors. Although there is a high risk associated with the
investment in X, there is also the potential for a high rate of
return if X is successful in the recycling business in Q. Y's
primary purpose in making the investment is to combat environmental
deterioration. No significant purpose of the investment involves the
production of income or the appreciation of property. The investment
significantly furthers the accomplishment of Y's exempt activities
and would not have been made but for such relationship between the
investment and Y's exempt activities. Accordingly, the purchase of
the common stock is a program-related investment.
Example 13. Assume the facts as stated in Example 12, except
that X offers Y shares of X's common stock in order to induce Y to
make a below-market rate loan to X. X previously made the same offer
to a number of commercial investors. These investors were unwilling
to provide loans to X on such terms because the expected return on
the combined package of stock and debt was below the expected market
return for such an investment based on the level of risk involved,
and they were also unwilling to provide loans on other terms X
considers economically feasible. Y accepts the stock and makes the
loan on the same terms that X offered to the commercial investors. Y
plans to liquidate its stock in X as soon as the recycling
collection business in Q is profitable or it is established that the
business will never become profitable. Y's primary purpose in making
the investment is to combat environmental deterioration. No
significant purpose of the investment involves the production of
income or the appreciation of property. The investment significantly
furthers the accomplishment of Y's exempt activities and would not
have been made but for such relationship between the investment and
Y's exempt activities. Accordingly, the loan accompanied by the
acceptance of common stock is a program-related investment.
Example 14. X is a business enterprise located in V, a rural
area in State Z. X employs a large number of poor individuals in V.
A natural disaster occurs in V, causing significant damage to the
area. The business operations of X are harmed because of damage to
X's equipment and buildings. X has insufficient funds to continue
its business operations and conventional sources of funds are
unwilling or unable to provide loans to X on terms it considers
economically feasible. In order to enable X to continue its business
operations, Y, a private foundation, makes a loan to X bearing
interest below the market rate for commercial loans of comparable
risk. Y's primary purpose in making the loan is to provide relief to
the poor and distressed. No significant purpose of the loan involves
the production of income or the appreciation of property. The loan
significantly furthers the accomplishment of Y's exempt activities
and would not have been made but for such relationship between the
loan and Y's exempt activities. Accordingly, the loan is a program-
related investment.
Example 15. A natural disaster occurs in W, a developing
country, causing significant damage to W's infrastructure. Y, a
private foundation, makes loans bearing interest below the market
rate for commercial loans of comparable risk to H and K, poor
individuals who live in W, to enable each of them to start a small
business. H will open a roadside fruit stand. K will start a weaving
business. Conventional sources of funds were unwilling or unable to
provide loans to H or K on terms they consider economically
feasible. Y's primary purpose in making the loans is to provide
relief to the poor and distressed. No significant purpose of the
loans involves the production of income or the appreciation of
property. The loans significantly further the accomplishment of Y's
exempt activities and would not have been made but for such
relationship between the loans and Y's exempt activities.
Accordingly, the loans to H and K are program-related investments.
Example 16. X is a limited liability company treated as a
partnership for federal income tax purposes. X purchases coffee from
poor farmers residing in a developing country, either directly or
through farmer-owned cooperatives. To fund the provision of
efficient water management, crop cultivation, pest management, and
farm management training to the poor farmers by X, Y, a private
foundation, makes a loan to X bearing interest below the market rate
for commercial loans of comparable risk. The loan agreement requires
X to use the proceeds from the loan to provide the training to the
poor farmers. X would not provide such training to the poor farmers
absent the loan. Y's primary purpose in making the loan is to
educate poor farmers about advanced agricultural methods. No
significant purpose of the loan involves the production of income or
the appreciation of property. The loan significantly furthers the
accomplishment of Y's exempt activities and would not have been made
but for such relationship between the loan and Y's exempt
activities. Accordingly, the loan is a program-related investment.
Example 17. X is a social welfare organization that is
recognized as an organization described in section 501(c)(4). X was
formed to develop and encourage interest in painting, sculpture and
other art forms by, among other things, conducting weekly community
art exhibits. X needs to purchase a large exhibition space to
accommodate the demand for exhibition space within the community.
Conventional sources of funds are unwilling or unable to provide
funds to X on terms it considers economically feasible. Y, a private
foundation, makes a loan to X at an interest rate below the market
rate for commercial loans of comparable risk to fund the purchase of
the new space. Y's primary purpose in making the loan is to promote
the arts. No significant purpose of the loan involves the production
of income or the appreciation of property. The loan significantly
furthers the accomplishment of Y's exempt activities and would not
have been made but for such relationship between the loan and Y's
exempt activities. Accordingly, the loan is a program-related
investment.
Example 18. X is a non-profit corporation that provides child
care services in a low-income neighborhood, enabling many residents
of the neighborhood to be gainfully employed. X meets the
requirements of section 501(k) and is recognized as an organization
described in section 501(c)(3). X's current child care facility has
reached capacity and has a long waiting list. X has determined that
the demand for its services warrants the construction of a new child
care facility in the same neighborhood. X is unable to obtain a loan
from conventional sources of funds including B, a commercial bank,
because X lacks sufficient credit to support the financing of a new
facility. Pursuant to a deposit agreement, Y, a private foundation,
deposits $h in B, and B lends an identical amount to X to construct
the new child care facility. The deposit agreement requires Y to
keep $h on deposit with B during the term of X's loan and provides
that if X defaults on the loan, B may deduct the amount of the
default from the deposit. To facilitate B's access to the funds in
the event of default, the agreement requires that the funds be
invested in instruments that allow B to access them readily. The
deposit agreement also provides that Y will earn interest at a rate
of t% on the deposit. The t% rate is substantially less than Y could
otherwise earn on this sum of money, if Y invested it elsewhere. The
loan agreement between B and X requires X to use the proceeds from
the loan to construct the new child care facility. Y's primary
purpose in making the deposit is to further its educational purposes
by enabling X to provide child care services within the meaning of
section 501(k). No significant purpose of the deposit involves the
production of income or the appreciation of property. The deposit
significantly furthers the accomplishment of Y's exempt activities
and would not have been made but for such relationship between the
deposit and Y's exempt activities. Accordingly, the deposit is a
program-related investment.
[[Page 23432]]
Example 19. Assume the same facts as stated in Example 18,
except that instead of making a deposit of $h into B, Y enters into
a guarantee agreement with B. The guarantee agreement provides that
if X defaults on the loan, Y will repay the balance due on the loan
to B. B was unwilling to make the loan to X in the absence of Y's
guarantee. X must use the proceeds from the loan to construct the
new child care facility. At the same time, X and Y enter into a
reimbursement agreement whereby X agrees to reimburse Y for any and
all amounts paid to B under the guarantee agreement. The signed
guarantee and reimbursement agreements together constitute a
``guarantee and reimbursement arrangement.'' Y's primary purpose in
entering into the guarantee and reimbursement arrangement is to
further Y's educational purposes. No significant purpose of the
guarantee and reimbursement arrangement involves the production of
income or the appreciation of property. The guarantee and
reimbursement arrangement significantly furthers the accomplishment
of Y's exempt activities and would not have been made but for such
relationship between the guarantee and reimbursement arrangement and
Y's exempt activities. Accordingly, the guarantee and reimbursement
arrangement is a program-related investment.
(c) Effective/applicability date. Paragraph (b), Examples 11
through 19 of this section will be effective on the date of publication
of the Treasury decision adopting these examples as final regulations
in the Federal Register. Taxpayers may rely on paragraph (b), Examples
11 through 19 of this section before these proposed regulations are
finalized.
Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2012-9468 Filed 4-18-12; 8:45 am]
BILLING CODE 4830-01-P