Law on Associations

Determining Whether to Make an Equivalency Determination or to Exercise Expenditure Responsibility*

The International Journal
of Not-for-Profit Law

Volume 2, Issue 4, June 2000

Many US grantmakers are presently making or looking to make cross-border grants. In deciding whether and how to make grants of that type, a grantmaker should be aware of the existing restrictions in the tax laws on grants to non-US organizations that have not obtained IRC § 501(c)(3) determinations of charitable status.

While the rules may appear to be somewhat intimidating at first glance, there are a few, easy-to-follow guidelines that can assist the grantmaker in dealing with the various requirements. This paper is designed to provide a short and simple set of specifications for such grants and to provide references to more detailed materials that explain the issues more fully. This web site includes model documents for each of the two options, equivalency determination and expenditure responsibility, which should be consulted in connection with the paper.

General Rules

US grantmakers making cross-border grants may exercise one of two options. These are:

  1. Making an equivalency determination; or
  2. Exercising expenditure responsibility.

If a foundation makes an “equivalency determination,” it determines that the grantee organization is the “equivalent” of a US public charity. If a foundation “exercises expenditure responsibility,” it becomes responsible for making certain that the grant funds are used for charitable purposes. Failure to exercise one of these options will result in the grant not qualifying for the minimal annual payout requirement for foundations, and the foundation will thus be subject to a penalty tax on the amount of the grant.

A road map for determining whether a foundation should make an equivalency determination or exercise expenditure responsibility can be found in Appendix C of International Grantmaking: A Report on U.S. Foundation Trends (Foundation Center, 1997), by John A. Edie and Jane C. Nober of the Council on Foundations. Relying primarily on the book Beyond our Borders (Council on Foundations, 2nd Ed. 1999), the authors maintain that most experienced international grantmakers undertake a process that allows them to ascertain the efficacy of both methods, by proceeding through the following steps:

  1. Confirm that the grant is for a charitable purpose;
  2. Assess whether the foreign organization is the equivalent of a US public charity, i.e., whether it is organized and operated exclusively for charitable purposes. If it is, then the US grantmaker should attempt to gather sufficient documentation to support an equivalency determination.
  3. Determine whether the foreign charity is the equivalent of a US private foundation. If the foreign charity is determined to be the equivalent of a private foundation, the US grantmaker seeking to make the grant must exercise expenditure responsibility. Grantmakers making grants to foreign private foundations also need to be aware of certain other requirements for such grants, most notably the “out of corpus” requirement. For more information about these issues, consult Beyond our Borders.
  4. If the US grantmaker is unable to assess whether the foreign organization fits into one of the categories described in steps 2 or 3, but it is certain that the grant is for charitable purposes, then it must exercise expenditure responsibility.

The opinion of legal counsel should be sought when making these determinations, because the penalties for failure to comply with the law and regulations can be severe.

Equivalency Determination

Model materials to help grantmakers make equivalency determinations are found on this web site. They include a generic affidavit and model information documents for grantees. They are based primarily on Revenue Procedure 92-94, which sets out the documents and other information to be collected in order to make the determination that the grantee is the equivalent of a US § 501(c)(3) organization.  These documents include:

  1. The founding documents of the organization;
  2. A detailed description of the purposes of the organization and its past and proposed activities;
  3. Dissolution provisions, either contained in the applicable law or in the founding documents;
  4. Legal or founding document restrictions on private benefit, non-charitable activities, lobbying, and participation in political campaigns;
  5. Financial records.

Although the equivalency determination process can be quite lengthy, it has some advantages over exercising expenditure responsibility. It does not require the continuous reporting that is required for expenditure responsibility, nor is a separate account required for the grant funds. The main obstacles to equivalency determination are the gathering of all required documents, making them available in English translation, and the detailed financial reporting from previous years (which are required to show that the foreign organization is not the equivalent of a US private foundation).

Expenditure Responsibility

Because equivalency determination can be so difficult and requires collecting a substantial amount of information, grantmakers often end up exercising expenditure responsibility. The reasons for this vary: sometimes it is difficult to translate all the documents into English, as required by the regulations, or the grantee organization is not considered to be exclusively “charitable,” as defined in US law.

Internal Revenue Code §4945(h) allows foundations make grants to organizations that do not qualify as charitable and avoid penalties if they take the following steps to make certain the grant funds are used for charitable purposes (these steps will also permit them to count the grants as qualifying distributions in meeting the minimum payout requirement):

  1. Conduct a pre-grant inquiry that makes a reasonable determination that the intended grantee is capable of fulfilling the charitable purposes of the grant;
  2. Execute a grant agreement that includes spending and reporting responsibilities, and commits the grantee to spend the money only for the specified charitable purposes of the grant;
  3. Require one or more reports from the grantee detailing how the funds have been spent;
  4.  Report and summarize the status of the grant on the foundation’s form 990-PF; and
  5. In the case of grantees that are not the equivalent of US private foundations, require the grantee to maintain the grant funds in a separate account dedicated to one or more charitable purposes.

Exercising expenditure responsibility can be very useful for foundations, especially when obtaining all of the required supporting documentation in English seems impossible. On the other hand, expenditure responsibility requires much more follow-up than equivalency determination, and that can be especially burdensome for large-scale grants or grants of tangible property.

For More Information, See:

  • Beyond our Borders: A Guide to Making Grants Outside the United States (Second Edition) by John A. Edie and Jane C. Nober of the Council on Foundations
  • International Grantmaking: A Report on U.S. Foundation Trends (Appendix C by John A. Edie and Jane C. Nober), published by the Foundation Center in cooperation with the Council on Foundations.

* This article first appeared on the United States International Grantmakers (USIG) website. USIG is a project of the Council on Foundations and ICNL, in conjunction with several large foundations. The purpose of the USIG website is to facilitate international grantmaking by providing grantmakers and grantseekers with information and other resources.