Charitable loan program qualifies for two private-foundation exceptions

Plain-English summary

A private operating foundation proposed loans to nonprofit and for-profit service providers helping underserved children and families, as well as intermediaries experienced in charitable lending. The loans could carry below-market or no interest, require only partial repayment, or be forgiven, and income production was not a significant purpose. The foundation would use specialized staff and consultants to provide technical assistance, set lending standards, oversee major decisions, and require financial and activity reports. The IRS ruled that the loans were program-related investments and therefore were not jeopardizing investments under Section 4944. It also ruled that the foundation's significant involvement made the loans qualifying distributions directly for the active conduct of its charitable and educational activities under Section 4942(j)(3)(A).

Ruling snapshot

• Question: Would the charitable loan program qualify both as program-related investments and as direct qualifying distributions of a private operating foundation?
• Outcome: Approved on both issues.
• Key authorities: IRC §§ 4942 and 4944(c); Treas. Reg. §§ 53.4942(b)-1 and 53.4944-3

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201821005 Third Party Communication: None
Release Date: 5/25/2018 Date of Communication: Not Applicable
Index Number: 4942.03-05, 4944.03-00
Person To Contact:
------------------------------------- -----------------, ID No. ------------------
-------------------------------------- Telephone Number:
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---------------------------------- Refer Reply To:
CC:TEGE:EOEG:EO2
PLR-125533-17
Date:
February 14, 2018

Legend

Foundation = -------------------------------------

Dear -------------------------------------:

This letter responds to a letter from your authorized representative dated August 16,
2017, and subsequent correspondence, requesting rulings under Internal Revenue
Code (“IRC”) §§ 4942 and 4944.

Facts

Foundation is recognized by the Internal Revenue Service as an organization described
in IRC § 501(c)(3) and a private operating foundation under IRC § 509(a). Foundation’s
mission is to operate and support educational programs and projects assisting
underserved and impoverished children and families.

Foundation represents that it accomplishes its mission by operating a program that
achieves lasting positive outcomes for the children and families it serves. Foundation
states it builds the capacity of providers and community based organizations to enhance
their financial sustainability, operational effectiveness, management knowledge and
ability, physical and organizational infrastructure, and policy environment. In addition,
Foundation represents it provides technical assistance to policy makers to enhance the
regulation and support of early learning providers, offers technical assistance and
financing to service providers to enhance the adoption and use of best practices in
childhood development, and conducts research and evaluation to identify lessons
learned from these efforts.

Foundation proposes to operate a Loan Program. The primary purpose of the Loan
Program is to further Foundation’s educational and charitable purposes by making loans
to service providers that provide educational programs and other support to
impoverished children and families. The Loan Program includes making direct loans to

service providers who lack the stable revenue needed to qualify for commercial loans,
and to more financially-secure organizations to fund charitable and educational projects
that are financially risky and may not have been undertaken without the financial
support offered by Foundation. Additionally, Foundation will make loans to
intermediaries that have unique expertise in lending money to and assisting educational
and community-based organizations, of which intermediaries will identify qualified
service providers and make loans of the Foundation’s funds to these service providers.
Utilizing intermediaries in this way helps Foundation effectively use its loans to further
its charitable and educational purposes.

The borrowers under the Loan Program include providers of education, health, housing
or other social services serving Foundation’s exempt activities. In addition to lending
money to non-profit organizations, Foundation may also loan money to for-profit
organizations.

Foundation represents all loans must be used to advance the charitable and
educational purposes of the Foundation. Foundation represents that production of
income or appreciation of property is not a significant purpose of the Loan Program.
Foundation states that the Loan Program typically involves high-risk loans and
repayment terms are designed to be favorable to the service provider.

Foundation states that specific repayment terms are determined by the nature of the
individual loan and the financial status of the borrower. Foundation represents these
loans may have a longer repayment period, below market rate interest rates, charge no
interest, require only a portion of the loan to be repaid, or provide that the loan may be
forgiven altogether. Foundation states a large portion of its work focuses on capacity
building of higher-risk service providers and therefore expects that a sizable portion of
the loans will consist of forgivable loans.

In addition, Foundation represents that all loans made under the Loan Program prohibit
the recipients from using the loan to fund prohibited activities such as influencing
legislation, participating in a political campaign, and undertaking any activity for any
purpose other than one specified in IRC §170(c)(2)(B). Foundation states none of the
loans will be made to disqualified persons as defined in IRC § 4946.

Foundation represents it conducts the Loan Program through a staff of full-time, salaried
experts in education and related areas, as well as expert consultants that specialize in
key areas to supplement the work of its staff. Foundation represents it will provide
technical assistance and oversight to enhance the quality of the services that all
providers and community based organizations provide to Foundation’s target
population.

Foundation represents it will establish guidelines for the operation of loans provided
through an intermediary, advise on how loans to service providers are to be structured,

and provide qualifications required for service providers seeking a loan. Foundation
states that this includes, but is not limited to, standards for curriculum, staff, facilities,
and criteria governing how borrowers should use their loans.

In addition, Foundation represents it requires and monitors regular reports from
intermediaries. Foundation represents it will oversee the operations of partners by
providing a primary program and financial contact from Foundation’s staff. Foundation
states it will require service providers and intermediaries to work closely with
Foundation regarding major decisions, such as planning substantive elements and
providing financial and activity reports to Foundation. Foundation provides technical
assistance including training, knowledge sharing, data collection assistance and
educational materials.

Rulings Requested, Law and Analysis

Requested Ruling 1: Loans made by Foundation pursuant to the Loan Program
constitute program-related investments under IRC § 4944(c) and are not investments
that jeopardize the carrying out of an exempt purpose.

Section § 170(c)(2)(B) refers to organizations organized and operated exclusively for,
among other things, charitable and educational purposes.

Section 4944(a) imposes an excise tax on the making of an investment by a private
foundation in such a manner as to jeopardize the carrying out of any of its exempt
purposes.

Section 4944(c) provides that program-related investments shall not be considered as
jeopardizing the carrying out of exempt purposes if the primary purpose of the
investment is to accomplish one or more of the purposes described in
IRC § 170(c)(2)(B), and no significant purpose is the production of income or the
appreciation of property.

Treas. Reg. § 53.4944-3(a)(1) provides that a program-related investment is an
investment which possesses the following characteristics:

   (i) The primary purpose of the investment is to accomplish one or more of the
   purposes described in IRC § 170(c)(2)(B);

   (ii) No significant purpose of the investment is the production of income or the
   appreciation of property; and

   (iii) No purpose of the investment is attempting to influence legislation or
   participating or intervene in (including the publishing or distributing of

  statements), any political campaign on behalf of (or in opposition to) any
  candidate for public office.

Treas. Reg. § 53.4944-3(a)(2)(i) provides that an investment shall be considered as
made primarily to accomplish one or more purposes described in IRC § 170(c)(2)(B) if it
significantly furthers the accomplishment of the private foundation’s exempt activities
and if the investment would not have been made but for such relationship between the
investment and the accomplishment of the foundation’s exempt activities.

Treas. Reg. § 53.4944-3(a)(2)(iii) provides that in determining whether a significant
purpose of an investment is the production of income or the appreciation of property, it
shall be relevant whether investors solely engaged in the investment for profit would be
likely to make the investment on the same terms as the private foundation. However,
the fact that an investment produces significant income or capital appreciation shall not,
in the absence of other factors, be conclusive evidence of a significant purpose
involving the production of income or the appreciation of property.

Treas. Reg. § 53.4944-3(b) example 1 involves a business enterprise located in a
deteriorated urban area and owned by economically disadvantaged minority group.
Conventional sources of funds are unwilling or unable to provide funds to the business
enterprise. A private foundation makes a loan to the business enterprise bearing
interest below the market rate for commercial loans of comparable risk. Private
foundation’s primary purpose for making the loan is to encourage the economic
development of such minority groups. The loan has no significant purpose involving the
production of income or the appreciation of property. The loan significantly furthers the
accomplishment of private foundation’s exempt activities and would not have been
made but for such relationship between the loan and private foundation’s exempt
activities. Therefore, the loan is a program-related investment even though private
foundation may earn income from the investment in an amount comparable to or higher
than earnings from conventional portfolio investments.

Treas. Reg. § 53.4944-3(b) example 4 involves a business enterprise which is not
owned by low-income person or minority group members. The continued operation of
the business enterprise is important to the economic well-being of a deteriorated urban
area because the business enterprise employs a substantial number of low-income
persons from the area. Conventional sources of funds are unwilling or unable to provide
funds to the business enterprise at reasonable interest rates. A private foundation
makes a loan to business enterprise at an interest rate below the market rate for
commercial loans of comparable risk. The loan is made pursuant to a program run by
the private foundation to assist low-income persons by providing increased economic
opportunities and to prevent community deterioration. No significant purpose of the loan
involves the production of income or the appreciation of property. The investment
significantly furthers the accomplishment of private foundation’s exempt activities and

would not have been made but for such relationship between the loan and private
foundation’s exempt activities. Therefore, the loan is a program-related investment.

Treas. Reg. § 53.4944-3(b) example 5 involves a business enterprise which is
financially secure and the stock of which is listed and traded on a national stock
exchange. Private foundation makes a loan to business enterprise at an interest rate
below the market rate in order to induce business enterprise to establish a new plant in
a deteriorated urban area which because of the risks involved, business enterprise
would be unwilling to establish absent such inducement. The loan is made pursuant to a
program run by private foundation to enhance the economic development of the area by
providing employment opportunities for low-income persons at the new plant and no
significant purpose involves the production of income or the appreciation of property.
The loan significantly furthers the accomplishment of private foundation’s exempt
activities and would not have been made but for such relationship between the loan and
private foundation’s exempt activities. Accordingly, even though business enterprise is
large and established, the investment is program-related.

Treas. Reg. § 53.4944-3(b) example 18 involves a non-profit corporation that provides
child cares services in a low-income neighborhood enabling many residents of the
neighborhood to be gainfully employed. Non-profit corporation has determined that the
demand for its services warrants the construction of a new child care facility in the same
neighborhood. Non-profit corporation is unable to obtain a loan from conventional
sources of funds including from a commercial bank because of non-profit corporation’s
credit record. Private foundation has agreed to deposit funds into Bank and Bank lends
an identical amount to non-profit corporation to construct the new child care facility. The
deposit agreement provides that private foundation will earn an interest rate on the
deposit which is substantially less than what private foundation could otherwise earn on
this sum of money if private foundation invested it elsewhere. The loan agreement
between Bank and non-profit corporation requires non-profit corporation to use the
proceeds from the loan to construct the new child care facility. Private foundation’s
primary purpose in making the deposit is to further its educational purposes by enabling
non-profit corporation 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 private
foundation’s exempt activities and would not have been made but for such relationship
between the deposit and private foundation’s exempt activities. Accordingly, the deposit
is a program-related investment.

Generally, IRC § 4944(a) imposes a tax on jeopardizing investments. However,
IRC § 4944(c) provides an exception for program-related investments. The primary
purpose of the Loan Program is to further Foundation’s educational and charitable
purpose as described in IRC § 170(c)(2)(B). Furthermore, the loans would not have
been made but for such relationship between the loan and the accomplishment of

Foundation’s exempt activities. Treas. Reg. §§ 53.4944-3(a)(2)(i) and 53.4944-3(b),
Examples 4 and 5.

Foundation will make loans to service providers that lack stable revenue needed to
qualify for commercial loans paying market-rate interest. Under the Foundation’s Loan
Program, Foundation will make loans bearing interest rates below market interest rates
or interest free. The loans made under the Foundation’s Loan Program have no
significant purpose of income production or the appreciation of property.
Treas. Reg. §§ 53.4944-3(a)(1)(ii), 53.4944-3(b), Example 1.

Foundation may also make loans to more financially secure for-profit organizations
solely for supporting the educational and charitable activities of the Foundation. The
loans made to more financially secure entities will be made at a below market rate
interest in order to induce these entities to engage in education and charitable work that
they may not otherwise engage in. Loans made to these organizations have no
significant purpose that involves the production of income or the appreciation of
property and would not have been made but for such relationship between these
entities, the Loan Program, and Foundation’s exempt activities. Treas. Reg. § 53.4944-
3(b), Example 5.

In addition, Foundation will make loans to intermediaries that have unique expertise in
lending money to and assisting educational and community-based organizations. The
intermediaries will identify qualified service providers and make loans of the
Foundation’s funds to these service providers. Intermediaries and service providers can
only use the loan amount to advance Foundation’s charitable and educational purposes.
Utilizing intermediaries in this way helps Foundation effectively use its loans to further
its charitable and educational purposes. Treas. Reg. § 53.4944-3(b), Example 18.

Finally, all loans made under the Foundation’s Loan Program prohibit the recipients
from using the loan for any purpose other than one specified in IRC §170(c)(2)(B) and
to fund prohibited activities which include influencing legislation, participating in a
political campaign, and undertaking any activity. Treas. Reg. § 53.4944-3(a)(1)(i)
and (iii).

Therefore, the loans made under the Foundation’s Loan Program are program-related
investments as described in IRC § 4944(c) and Treas. Reg. § 53.4944-3.

Requested Ruling 2: Loans made by Foundation pursuant to the Loan Program
constitute qualifying distributions made directly for the active conduct of activities
constituting Foundation’s charitable and education purposes, within the meaning of
IRC § 4942(j)(3)(A).

Section 4942(g)(1) defines “qualifying distribution,” in relevant part, as any amount paid
to accomplish one or more purposes described in IRC § 170(c)(2)(B).

Section 4942(j)(3)(A), in relevant part, provides an organization which is an operating
foundation must make qualifying distributions, within the meaning of IRC § 4942(g)(1),
directly for the active conduct of the activities constituting the purpose or function for
which it is organized and operated.

Treas. Reg. § 53.4942(a)-3(a)(2)(i), in relevant part, defines the term “qualifying
distribution” to mean any amount (including program related investments, as defined in
IRC § 4944(c), and reasonable and necessary administrative expenses) paid to
accomplish one or more purposes described in IRC § 170(c)(2)(B), other than any
contribution to a private foundation which is not an operating foundation or to an
organization controlled (directly or indirectly) by the contributing private foundation or
one or more disqualified persons with respect to such foundation.

Treas. Reg. § 53.4942(b)-1(b)(1), in relevant part, provides except as provided in
subparagraphs (2) or (3) qualifying distributions are not made by a foundation “directly
for the active conduct of activities constituting its charitable, educational, or other similar
exempt purpose” unless such qualifying distributions are used by the foundation itself,
rather than by or through one or more grantee organizations which receive such
qualifying distributions directly or indirectly from such foundation. Thus, grants made to
other organizations to assist them in conducting activities which help to accomplish their
exempt purpose are considered an indirect, rather than direct, means of carrying out
exempt purpose of the grantor foundation, regardless of the fact that the exempt
activities of the grantee organization may assist the grantor foundation in carrying out its
own exempt activities.

Treas. Reg. § 53.4942(b)-1(b)(2)(i) provides that if a foundation makes or awards
grants, scholarships, or other payments to individual beneficiaries (including program
related investments within the meaning of IRC § 4944(c) made to individuals or
corporate enterprises) to support active programs conducted to carry out the
foundation’s exempt purpose, such payments will be treated as qualifying distributions
made directly for the active conduct of exempt activities only if the foundation, apart
from the making or awarding of the grants, scholarships, or other payments, otherwise
maintains some “significant involvement” – as defined in in Treas. Reg. § 53.4942(b)-
1(b)(2)(ii) – in the active programs in support of which such payments were made or
awarded. Whether the making or awarding payments constitutes qualifying distributions
made directly for the active conduct of the foundation’s exempt activities is to be
determined on the basis of the facts and circumstances of each particular case. The test
applied is a qualitative, rather than a strictly quantitative, one. Therefore, if the
foundation maintains a significant involvement it will not fail to meet the general rule of
Treas. Reg. § 53.4942(b)-1(b)(1) solely because more of its funds are devoted to the
making or awarding of payments than to the active programs which such payments
support. However, if a foundation does no more than select, screen, and investigate
applicants for grants or scholarships, pursuant to which the recipients perform their work

or studies alone or exclusively under the direction of some other organization, such
grants or scholarships will not be treated as qualifying distributions made directly for the
active conduct of the foundation’s exempt activities.

Treas. Reg. § 53.4942(b)-1(b)(2)(ii)(B) provides that a foundation will be considered as
maintaining a “significant involvement” in an exempt activity in connection with which
payments are made or awarded if the foundation has developed some specialized skills,
expertise, or involvement in a particular discipline or substantive area, such as social
work or education, it maintains a salaried staff of administrators, researchers, or other
personnel who supervise or conduct programs or activities which support and advance
the foundation’s work in its particular area of interest, and, as a part of such programs or
activities, the foundation makes or awards payments to individuals to encourage and
further their involvement in the foundation’s particular area of interest and in some
segment of the programs or activities carried on by the foundation such as grants to
engage in social work projects which are under the general direction and supervision of
the foundation.

Foundation’s mission is to operate and support educational programs and projects
serving underserved and impoverished children and families by direct involvement in
the improvement and expansion of education opportunities. Foundation will make loans
under the Loan Program to service providers that provide educational and other support
to underserved and impoverished children and families. As such, loans under the Loan
Program are considered an indirect, rather than direct, means of carrying out the
exempt purpose of the foundation and would not be qualifying distributions.
Treas. Reg. § 53.4942(b)-1(b)(1).

As discussed above, loans made under the Foundation’s Loan Program were
determined to qualify as a program-related investment. In general, if a foundation
makes other payments, including program-related investments to corporate enterprises,
to support active programs conducted to carry out a foundation’s charitable, educational
or other exempt purpose such other payments will be treated as qualifying distributions
made directly for the active conduct of exempt activities only if the foundation maintains
some significant involvement in the active programs in support of which other payments
were made. Treas. Reg. § 53.4942(b)-1(b)(2)(i).

As discussed in Treas. Reg. § 53.4942(b)-1(b)(2)(i), Foundation does more than select,
screen, and investigate recipients of loans under the Loan Program. Foundation will
provide technical assistance to all service providers receiving loans. Furthermore, as
discussed in Treas. Reg. § 53.4942(b)-1(b)(2)(ii)(B), Foundation engages a staff of full-
time, salaried experts in education and related areas, as well as expert consultants that
specialize in key areas to assist intermediaries and service providers who will receive
training, knowledge sharing, data collection, assistance, and educational materials to
facilitate capacity building.

In addition, Foundation will have stringent guidelines and rules for loans to be made
under the Loan Program to intermediaries and service providers. This includes advising
on how loans to service providers are to be structured and setting forth qualifications
required for service providers seeking a loan from an intermediary. Foundation will have
sole and absolute discretion to forgive of any portion of a loan. Foundation will require
regular reports during the year from intermediaries.

Foundation will oversee operations of partners funded with loans from the Loan
Program by providing a primary program and financial contact from Foundation’s
salaried staff. Foundation will require service providers and intermediaries to work
closely with Foundation regarding major decisions such as planning substantive
elements and providing financial and activity reports to Foundation.

Accordingly, as Foundation has specialized skills, expertise, and involvement in
education; it maintains a salaried staff of administrators, researchers, or other personnel
who supervise activities which support and advance Foundation’s mission; and the
Loan Program encourages others to further their involvement in Foundation’s area of
interest under the Foundation’s general direction and supervision, Foundation will be
considered as maintaining significant involvement in a charitable or educational exempt
activity in connection with the loan payments made under the Loan Program as
described in Treas. Reg. § 53.4942(b)-1(b)(2)(i) and (ii)(B).

Rulings

Based solely on the facts and representations submitted by Foundation, we rule as
follows:

1. Loans made by Foundation pursuant to the Loan Program constitute program-
   related investments under IRC § 4944(c) and are not investments that jeopardize
   the carrying out of exempt purposes.

2. Loans made by Foundation pursuant to the Loan Program constitute qualifying
   distributions made directly for the active conduct of activities constituting
   Foundation’s charitable and education purposes, within the meaning of
   IRC § 4942(j)(3)(A).

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter.

Except as expressly provided herein, no opinion is expressed or implied as to the
federal tax consequences of the facts described above under any other provision of the
IRC.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of the
letter ruling.

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for rulings, it is subject to verification on examination.

                                   Sincerely,



                                   James Zelasko
                                   Branch Chief
                                   Exempt Organizations Branch 2
                                   (Tax Exempt and Government Entities)

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