Domestic Charity Funding of International Operations
The question is whether there are any restrictions on the ability of a U.S. organization to fund international activities.
Fact Assumptions
Suppose that donors of the domestic charity are solicited for donations to be used overseas. Donors are also asked to fund its work in specific nations. Sometimes they are asked to support overseas employees, not all of whom are on the payroll of the domestic charity. Nearly all donations to the domestic charity are made with a designation as to intended use in one form or another. In the event a donor makes a designation which cannot be reasonably accommodated, the donation will either be returned and the donor asked to make a new designation, or the donor will be told his donation will be used elsewhere unless he asks for his money back. Nearly all donations, regardless of how they are designated, will in some part used to compensate international personnel.
Funds are transferred from the central office to the accounts of the various regional offices. Some of the regional directors are on the payroll of the domestic charity. Each time funds are accepted by the regional offices, someone must sign a statement agreeing to honor all fund designations made by U.S. donors. Some of the regional offices have one or more U.S. bank accounts to facilitate funds handling. The regional offices disburse funds to each national charity office which are under them. All national leaders are citizens of the nations in which they work ("nationals"), and are not on the domestic charity payroll. Funds are disbursed by each national charity office for employee support, etc.
Tax Requirements
The law primarily applicable to the use of funds by U.S. organizations overseas is the availability of a charitable deduction for donors of a domestic charity. IRC Sec. 170(c)(2) defines a charitable contribution as a gift to or for the use of a corporation: 1) created or organized in the U.S.; 2) organized and operated exclusively for exempt purposes; 3) in which there is no private inurement; and 4) which does not fail to qualify for Sec. 501(c)(3) status by reason of lobbying or political campaigning. If these criteria are not met, a gift to a charity will not be deductible to the donor. See IRC Sec. 170(a)(1).
However, the IRS has taken the position that a U.S. charity cannot be used as a mere conduit for diverting funds to foreign charities. [For purposes of this discussion, what would be considered a foreign charity in the U.S. will be referred to as a "national charity," viewing it from the perspective of the nation in which it exists.] In other words, "to or for the use of" a U.S. charity is interpreted to mean "to and under the control of" a U.S. charity. Where control is lacking, a contribution is not "for the use of" the charity, and a deduction will be denied.
The main concept promoted by the IRS in applicable rulings is that funds contributed to a U.S. charity cannot be earmarked for payment, or subject to an obligation to be paid, to a (foreign) national charity. The circumstances under which deductibility is preserved are discussed below.
CAVEAT: The following discussion applies only to designated funds, that is, donations the donor specifically requests be applied to some international operations, or which the domestic charity is otherwise under an obligation to pass along to another organization. It does not apply to undesignated funds, that is, general donations, employee contributions, administrative charges and other revenues which the domestic charity may choose to apply to international operations. Donations which are not "earmarked" pose no deductibility issue.
Analysis
Under the fact assumptions above, U.S. money leaves the control of the domestic charity at the point where it is used to compensate the services of persons who are not on the payroll of the domestic charity. By definition, these people are not its employees and are not under its legal control. Typically, persons not on the domestic charity payroll are "nationals," although this is not necessarily always the case. Most frequently, once funds leave the control of the regional director's office, they leave control of the domestic charity. The key to this analysis is to realize that when money is used to pay someone not on the domestic payroll, it has been transferred from one organization to another organization. It pays to be very conscious of separate entities. Just because two charities work closely together, even if one was started by the other, it does not mean that they are the same organization. Legal distinctions are real and make a difference!
Donors to the domestic charity will be assured of a charitable contribution deduction for funds which are transferred to an incorporated or otherwise formally organized national charity office separate from the domestic charity only when the following situations exist:
The organized national charity office is controlled by the domestic charity. Tax regulations require the national charity office to be a "mere administrative arm" of the domestic charity. The most clear-cut form of control exists when the national charity is legally a corporate subsidiary of the domestic charity. Tax rulings do not acknowledge that a bare legal affiliate may be considered as a "mere administrative arm" of a domestic charity.
In some countries, a corporate subsidiary relationship may not be possible. Some countries may be hostile toward U.S. control of a national charity, or may oppose the incorporation of charities, etc. In this event, its funding of a national charity must meet the requirements of A.2. or A.3. below.
If the formally organized national charity office is not controlled by the domestic charity, its funding may continue if the following conditions exist:
The national charity is not the exclusive means of charity conducted by the domestic charity in that nation. In other words, the domestic charity must have an independent presence in that nation, apart from the national charity. The primary example given by the IRS when deductibility is preserved is where "a domestic organization conducts a variety of charitable activities in a foreign country." Clearly, this expressly contemplates that the U.S. charity has an independent presence in that nation.
The domestic charity has no obligation to fund the national charity, either by charter, contract, or otherwise. That is, the domestic charity must "maintain at all times full control of the donated funds and discretion as to their use." This does not prohibit the domestic charity donors from designating a national preference, however. So long as the domestic charity has an independent presence in that country, the domestic charity has control over whether to use the funds designated for that nation itself, or pay them over to the national charity.
The domestic charity makes donations to the national charity only out of general or unrestricted funds. In other words, contributions to the domestic charity cannot be earmarked, preferred or designated to be used for the national charity. The domestic charity donors cannot be told their funds will be paid to the national charity, either.
Donations to the national charity serve a charitable purpose of the domestic charity. This means that the domestic charity must regularly review and approve all donations to the national charity. Preferably, this would occur on a project basis. Budgetary review and approval is relevant here.
If the formally organized national charity office is not controlled by the domestic charity, but the domestic charity has no independent presence in that nation, its funding may continue only if the conditions which are described in the
accompanying memo, entitled "Relationship of a Domestic Charity Organization to Certain Charitable Foreign Activities" and the attached "Guidelines for Funding Foreign Charities" are satisfied.
In the event a national charity office is not separately organized, it may be a division of a charity formed in another country. If it is a division of the domestic charity, then no problem exists. If it is a division of a charity formed in a different country, then the charity of which it is a part must be treated according to the guidelines in A. above.
In the event the national charity office is not part of a formally organized charity at all, the IRS could either regard the national charity office as an association which can be treated as an organization subject to the guidelines in A. above, or treat payments to nationals as a private inurement, which would seriously jeopardize the exempt status of the domestic charity. For this reason, payments to any national charity office which is not part of a formally organized national charity should be entirely avoided.
Recommendations
The legal structure of the various national charities funded by the domestic charity should be carefully examined. Hopefully, the results of this examination will determine the degree of affiliation between the domestic charity and the various national charity office organizations.
There are a variety of response options:
Assume legal control of each national charity office organization.
Modify overseas employee assignments to include the independent presence of U.S. employees in each nation who would work with (but who would not control) the local national charity offices.
Limit or remove the obligation of regional directors to honor country designations to allow them some true discretion and control over the use of funds.
Tell U.S. donors that contributions for activities in certain countries are not tax deductible.
Follow the Guidelines for Funding Foreign Charities, which sets up an accountability mechanism for funding such projects.
Stop the funding of activities in certain nations.
One or more of the above responses in combination.
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