It is not often that you can find inspiration within the Treasury regulations. But if you are a family foundation looking for innovative ways of pursuing your charitable mission, you will come away from reading the nineteen examples in the regulations finalized by the Treasury Department last year with a new enthusiasm for program-related investments, known simply as PRIs. The stories these examples tell of the myriad ways PRIs can achieve positive impact will be compelling to many foundations, especially those that have been reluctant to incorporate PRIs into their grantmaking and investment strategies.
The hesitancy of foundations to use PRIs can be partly attributed to lack of guidance. Although PRIs have been utilized in certain circles of the charitable foundation world since the 1960s, until recently, the IRS and Treasury had only offered ten examples in the regulations – mostly involving economically disadvantaged individuals and/or deteriorated urban areas – to guide everyone on investments that could qualify as PRIs. In response to calls from the community, a Notice of Proposed Rulemaking (NPRM) was published in April 2012 proposing that nine new examples be added to the regulations to shed new light on the scope of qualifying PRIs. After a comment period and a few tweaks (highlighted below), the regulations with the nine new examples were finalized on April 25, 2016.
The new examples cover everything from ‘valley of death’ funding for vaccine development, to micro-loans to help poor entrepreneurs in a developing country, to guarantee agreements for a provider of child care services. Overall, as noted in the NPRM, the new examples are meant to reflect current investment practice and illustrate these principles:
- An activity conducted in a foreign country furthers an exempt purpose if the same activity would further an exempt purpose if conducted in the United States,
- The exempt purposes served by a PRI may include any of the purposes described in section 170(c)(2)(B) and are not limited to situations involving economically disadvantaged individuals and deteriorated urban areas,
- The recipients of PRIs need not be within a charitable class if they are the instruments for furthering an exempt purpose,
- A potentially high rate of return does not automatically prevent an investment from qualifying as program-related,
- PRIs can be achieved through a variety of investments, including loans to individuals, tax-exempt organizations and for-profit organizations, and equity investments in for-profit organizations,
- A credit enhancement arrangement may qualify as a PRI, and
- 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.
Just as these principles are instructive, so is the Summary of Comments and Explanation of Revisions that accompanied the publication of the final regulations in the Federal Register. The highlights of the summary and explanation are:
- After public comment, a few examples within the proposed regulations were amended before the regulations were finalized, including:
- A foundation invested in a drug company’s subsidiary to develop a vaccine to prevent a disease typically affecting poor individuals in developing countries. The subsidiary was obligated to distribute the vaccine to such poor individuals at a relatively affordable price. The IRS clarified that the vaccine could also be sold to those who can afford it at its fair market value price.
- A foundation accepted stock in a business as part of a loan to that business. In the proposed regulations’ version, the investment agreement included language that the foundation planned to liquidate the stock as soon as the business became profitable or it was established that this would never be the case. The IRS removed this language in response to comment, because it was not required for this investment to qualify as a PRI. Yet the IRS did note that establishing an exit condition at the outset “can be an important indication that a foundation’s primary purpose in undertaking the investment is in fact accomplishment of the exempt purpose.”
- Treasury and the IRS noted that they are considering whether to address PRIs in the form of investments in partnership interests through the issuance of a revenue ruling.
Looking toward the future, these final regulations should be a powerful incentive to those family foundations that had questioned the extent to which the IRS would endorse PRIs. The foundations standing on the sidelines now have more “official” inspiration than ever to explore the opportunities that PRIs offer, both to further their charitable missions and expand their investment portfolios.
Julia Satti Cosentino is a partner in the Nutter's Private Client Department and co-chair of the Nonprofit and Social Impact practice group. She is experienced in complex estate and tax planning, probate and trust administration ...
Erin Whitney is an associate in the Tax Department. Businesses, nonprofit organizations, and individuals rely on Erin to advise them on a variety of domestic and international tax matters. She counsels nonprofit entities on issues ...
- Editor in Chief, Co-Chair, Nonprofit and Social Impact practice group
- Chair, Tax Department and Co-Chair, Nonprofit and Social Impact practice group