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UK charities seeking opinions on their equivalency to US tax-exempt charities

By Thomas Dick
DLA Piper LLP
Jan 16, 2018

On 2 October 2017, the IRS provided guidance to US tax advisers for issuing opinions to the effect that a non-US charity is equivalent to an analogous tax-exempt US charity (Rev. Proc. 2017-53, 2017-40 IRB 263). Few non-US charities are required to obtain a determination of their status from the IRS, so most rely on a written opinion issued by a US tax adviser that they are ‘described in Internal Revenue Code (IRC) s 501(c)(3)’, or words to that effect. Revenue Procedure 2017-53 confirms that advisers can ignore certain detailed rules of US charity tax law when determining whether a non-US charity is equivalent to its US analogues.

Under this welcome guidance, those UK charities without IRS determination letters will find it easier to receive ‘equivalency opinions’ from US tax advisers, and so will access the benefits of such status more swiftly. Unfortunately, the 195 UK charities which had received determination letters that were subsequently revoked by the IRS for failure to file annual information returns cannot reinstate themselves by obtaining an opinion from a US tax adviser. These unfortunates can reinstate only by filing an application on Form 1023 with the IRS (see ‘IRS revokes US tax-exempt status of prominent UK charities’ (Thomas Dick), Tax Journal, 4 August 2017).

Principal benefits

The principal benefits to a UK charity of being considered described in s 501(c)(3) are:

  • US charitable endowments (‘private foundations’) can make grants to them without complying with complex requirements for accounting for the grantee’s expenditures
  • US citizens, including those living here, can obtain the US equivalent of gift aid by making indirect contributions via US charities (including ‘American Friends of’ organisations)
  • US citizens can reduce their exposure to US gift and estate taxation with respect to direct lifetime and testamentary gifts
  • If the UK charity has built up an endowment that is invested in US securities or property, it can obtain reduced or zero rates of US withholding tax on US source dividends and gains from selling US real property

Therefore, US tax lawyers are asked by UK charities (without IRS determination letters) to issue them equivalency opinions for the following purposes, among others:

  • Establishing their status as ‘qualifying public charities’, so as to permit US private foundations to make grants to them without exercising ‘expenditure responsibility’
  • Establishing their status as described in s 501(c)(3) so as to permit US ‘public charities’ (such as ‘American Friends of’ organisations) to make donations without requiring any accounting
  • Establishing their status as described within IRC s 501(c)(3) so as to permit US citizens to make deductible gifts for purposes of US estate and gift taxes
  • Establishing their status as ‘described in s 501(c)’ in order to qualify for reduced or zero US withholding tax on the yield from US investments

Revenue Procedure 2017-53

Revenue Procedure 2017-53 addresses the first context only, but will be re­lied on by US tax advisers in the other contexts because it addresses an issue of interpretation that is common to all. This issue is: to what extent do certain technical requirements for US charities, derived from recent US legislation rather than the common law of charities, apply when considering the equivalence of non-US charities? The answer is: depending on the technical requirement in question, not all recent US charity legislation is relevant.

Returning to the scope of Revenue Procedure 2017-53, US private foundations are charitable endowments formed by wealthy families or companies, which typically make grants to other organisations operating charitable programmes. In 1969, Congress legislated comprehensively against the tendency for private foundations to work harder to perpetuate the founder’s memory than to benefit the com­munity. Now, US private foundations suffer large excise taxes unless they give much of their income to qualifying ‘public charities’ (churches, hospitals, educational institutions, and other charities deriving broad financial support from the public or government) and not to other private foundations. Thus, the current generous grant-making by US private foundations (such as the Bill and Melinda Gates Foundation) complies with rules en­suring that a grant recipient, whether organised in the US or elsewhere, is a ‘public charity’.

Under these diligence procedures, the grantor US private foundation must make a ‘good faith determination’ that the non-US grantee is equivalent to a US public charity by relying on a current written opinion of a US tax practitioner (Treas. Reg. ss 53.4942(a)-3(a)(6); 53.4945-5(a)(5)). Revenue Procedure 2017-53 iden­tifies those elements of US charity law which the US tax practitioner is permitted to modify when applying such law to categorise a non-US grantee.

The new guidance first acknowledges that the US tax practitioner must apply the standard principles for determining an entity’s charitable status found in many common law countries. Thus, for example, the organisational document must list permissible charitable pur­poses under US law, and any remaining assets upon a charity’s dissolution must pass to another charity or the government (Rev. Proc. 2017-53, ss 5.03, 5.04).

Next, the guidance tackles how three detailed prescriptions of US tax law, relating to private schools, colleges and universities (‘schools’); hospitals; and terrorist organisations, should be applied in testing the equivalency of non-US organisations.

Private schools, colleges and universities

For many years, US private schools with a curriculum, faculty and a ‘regularly enrolled body of students’ were granted tax exemption by the IRS without further inquiry (Treas. Reg. s 1.501(c)(3)-1(d)(3)(ii) Ex. 1). After the federal government dismantled the segregation of public schools on the basis of race in the 1960s, however, private schools in certain school districts were found to be discriminating against black students and attracting large numbers of white students. The IRS took the controversial view that a private school should not be considered to qualify under IRC s 501(c)(3) if it so discriminated. After 16 years of litigation, the US Supreme Court held that it is contrary to public policy for racially discriminating private schools, including church sponsored Schools, to be tax exempt (Bob Jones Univ. v United States, 461 US 574 (1983)).

The enduring word of the IRS is a set of 1975 guidelines for tax-exempt private schools in establishing that they have adopted and operate a racially non-discriminatory policy and satisfy record keeping requirements (Rev. Proc. 75-50, 1975-2 C.B. 587). While US schools continue to follow Revenue Procedure 75-50, it is impracticable of fulfilment by many non-US private schools. In particular, mandatory record keeping of ‘the racial composition of the student body, faculty and administrative staff for each academic year’ may violate local privacy laws (Rev. Proc. 75-50, s 7.01). Also, few non-US schools publicise their written nondiscriminatory policy in ‘a newspaper of general circulation that serves all racial segments of the community’ or via ‘the broadcast media’ (Rev. Proc. 75-50, s 4.03).

Faced with this impracticability, US tax practitioners have taken the view that a non-US school’s stated adherence to local statutory anti-discrimination laws and/or a written policy on the question, together with some evidence of implementation, will suffice. The IRS has now accepted this approach, noting that some countries ‘may not have the same history of racial discrimination as the United States’ (Rev. Proc. 2017-53, s 5.11). Now, the equivalency opinion must state that the non-US school has formally adopted a written policy of non-discrimination as to applicants and students ‘on the basis of race, color, or national or ethnic origin’, and provide evidence that the school ‘actually operates in a racially non-discriminatory manner as to students’. This pragmatic approach will be welcomed by all UK universities and secondary schools seeking equivalency opinions.

Hospitals

Further, Revenue Procedure 2017-53 addresses the application to non-US hospitals of those requirements for ‘hospital organisations’ that were enacted as part of the Affordable Care Act of 2010 (ACA) under President Obama. Hospitals have always been considered capable in principle of obtaining IRC s 501(c)(3) status, but the factors identified as essential by the IRS have differed over the years. Most recently the IRS implemented a ‘community benefit standard’, but this was considered so vague as to be inadministrable (Rev. Rul. 69-545, 1969-2 C.B. 117). Accordingly, in 2010 Congress enacted specific legislation conditioning IRC s 501(c)(3) status upon a hospital:

  • Conducting and implementing a ‘community health needs assessment’
  • Establishing policies on financial assistance and emergency medical care
  • Establishing transparent charges
  • Avoiding collecting bills too aggressively (IRC s 501(r))

Recognising that the strictures of IRC s 501(r) may not travel well, the IRS has determined that US tax practitioners need not consider them when evaluating whether a non-US hospital is equivalent to a charitable US hospital, unless it operates a facility in the US (Rev. Proc. 2017-53, s 5.10). Thus, a non-US hospital operating solely abroad needs to satisfy the US charity law in place before the Affordable Care Act of 2010, namely the community benefit standard. This development may not be critical to UK hospitals operated by NHS trusts, which are likely to route any US-source grants or donations to affiliated charitable trusts which do not themselves provide healthcare (e.g. Barts and The London Charity, supporting the hospitals in the Barts Health NHS Trust). Nevertheless, it is welcome evidence of the IRS’s practical approach.

Entities supporting terrorist activity

Finally, Revenue Procedure 2017-53 addresses the applicability to non-US entities of US rules which suspend or deny tax exemption to entities supporting or engaging in terrorist activity. The president is allowed to designate US and non-US organisations which support or engage in terrorism, and these organisations’ tax exemptions, if any, are suspended during the period of such designation (IRC s 501(p)). Unsurprisingly, the IRS has decided that any non-US organisation which is designated as supporting terrorism is not eligible to obtain an equivalency opinion from a US tax practitioner (Rev. Proc. 2017-53, s 5.09). Designations are easily checked on the IRS website, which currently lists nine entities as supporting terrorism, all organised in the US.

Revenue Procedure 2017-53 also exhorts US tax practitioners to confirm that the non-US entity and its ‘controlling officers, directors, or trustees’ have not had their property blocked by the president or the US Office of Foreign Assets Control, although this is not strictly necessary for the equivalency opinion (Rev. Proc. 2017-53, s 5.09). Again, this inquiry is made by checking the relevant website.

Because US private foundations can make grants to non-US charities only if the latter avoid qualification as private foundations themselves, Revenue Procedure 2017-53 explains at length the financial tests for establishing broad sources of support over time which must be satisfied by many entities to achieve ‘public charity’ status (Rev. Proc. 2017-53, s 6). Churches, schools and hospitals, however, are relieved from these financial tests because they are per se public charities. However, US tax practitioners advising other non-US entities must familiarise themselves with the rules on demonstrating ‘public support’ in this part of the guidance.

This article has previously been published in Tax Journal and is reproduced with permission.

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