[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]


=======================================================================
-----------------------------------------------------------------------

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.

-----------------------------------------------------------------------

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