As the calendar year comes to a close, all corporate entities, profit and nonprofit, look to their books and make end of year decisions to best avoid the pitfalls of the clear and concise (NOT!) Internal Revenue Code (the “Code”).  Private foundations have a unique challenge in their efforts to avoid excise taxes which are imposed on them, as well as their managers, in accordance with Section 4944(a)(1) of the Code if it is found that such foundations made investments that jeopardize the private foundation’s exempt purposes.  Such “jeopardizing investments” generally occur when foundation managers fail to exercise ordinary business care and prudence, under the facts and circumstances prevailing at the time of making the investment, in providing for the long and short term financial needs of the private foundation.

On May 21, 2012 the Service published proposed regulations that provide nine new examples of types of private foundation investments that qualify as Program Related Investments (“PRIs”).  PRIs are not classified as investments which jeopardize the carrying out of exempt purposes of a private foundation because they possess the following characteristics:

    a. have as the primary purpose the accomplishment of one or more charitable or educational purposes defined by Section 170(c)(2)(B) of the Code;
    b. do not have as a significant purpose the production of income or the appreciation of property; and
    c. do not further one or more of the purposes described in Section 170(c)(2)(D) of the Code (relating to prohibited political activities and lobbying).

To be certain both the foundation and the recipient of the PRI are on the same page (and to also prove the foundation is exercising “expenditure responsibility” to the Internal Revenue Service), a private foundation must secure a written commitment from the recipient of the PRI which specifies the purpose of the investment and contains an agreement by the organization:

    a. to use all amounts received only for the purposes of the investment and to repay any amount not used for these purposes back to the foundation, provided that, for equity investments, the repayment is within the limitations concerning distributions to holders of equity;
    b. to submit, at least once a year, a full and complete financial report together with a statement that it has complied with the terms of the investment;
    c. to keep adequate books and records and to make them available to the private foundation; and
    d. not to use any of the funds to carry on propaganda, influence legislation, influence the outcome of any public elections, carry on voter registration drives or make grants that do not comply with the requirements regarding individual grants or expenditure responsibility. 

Examples of acceptable PRIs in the proposed new regulations are based on published guidance and on financial structures that had previously been approved in private letter rulings. The regulations do not modify the existing regulation but illustrate certain principles and current investment practices.  Where the examples in the older regulations focused on domestic situations principally involving economically disadvantaged individuals in deteriorated urban areas, the new examples include a broader range of opportunities that might be presented to a private foundation.

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 individuals in poverty, may further the accomplishment of charitable purposes and qualify as a PRI.  One example specifically 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 illustrates that a private foundation’s acquisition 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 the private foundation’s provision of credit enhancement (such as a deposit agreement or a guarantee) can qualify as a PRI. 

As a result of the new examples, the Service has made it clear that the recipients of PRIs do not need to be within a charitable class if they are the instruments for furthering a charitable purpose. 
Thus, an investment in a for-profit that develops new drugs may qualify as a PRI if the for-profit business agrees to use the investment to develop a vaccine distributed to impoverished individuals at an affordable cost. Similarly, the purchase of equity in a benefit corporation or L3C that engages in the collection of recyclable solid waste or a below market rate loan to allow a social welfare organization formed to promote the arts purchase a large exhibition space may each also qualify for a PRI from the right foundation.

The new regulations should provide private foundation boards and managers in the second half of 2012 with the additional assurance they needed to make PRIs not only to traditional non-profits but to for-profit, benefit corporations and L3Cs with an articulated social enterprise consistent with the foundation’s exempt activities. Rejecting traditional boundaries between nonprofit and for-profit sectors, the PRI regulations can help encourage the most creative business minds achieve ‘double bottom line’ (financial and social) and sometimes ‘triple bottom line’ (financial, social and environmental) results.  By expanding the base for PRIs, we move beyond traditional conception of society as divided neatly into three sectors (business, nonprofit and government) help develop a new forth sector that encompasses elements of both business and nonprofit sectors.