Part 7. Rulings and Agreements

Chapter 27. Exempt Organizations Tax Manual

Section 27. Application of Taxes and Denial of Exemption to Certain Foreign Organizations

7.27.27  Application of Taxes and Denial of Exemption to Certain Foreign Organizations

7.27.27.1  (02-22-1999)
Introduction

  1. Some of the private foundations rules set out in IRC 507 and 508 and Chapter 42 of the Internal Revenue Code of 1954, could not easily be applied in practice to foreign organizations. To take account of this fact IRC 4948 provides a series of modifications of the private foundation rules for application to foreign organizations.

  2. For purposes of IRC 4948 a "foreign organization" is any organization not created or organized in the United States or any possession thereof, or under the laws of the United States, any State, the District of Columbia, or any possession of the United States.

7.27.27.2  (02-22-1999)
Tax on Investment Income of Private Foundations Under IRC 4948(a)

  1. In lieu of the tax imposed under IRC 4940, there is imposed on foreign private foundations exempt under IRC 501(a) a tax equal to 4 percent of their gross investment income derived from sources within the United States. Gross investment income and United States source income are respectively defined in IRC 4940(c)(2) and IRC 861 and the regulations thereunder.

  2. The tax on gross investment income applies for each taxable year beginning after December 31, 1969, during which the organization is exempt from taxation under IRC 501(a).

7.27.27.2.1  (02-22-1999)
Withholding and Reporting IRC 4948(a) Tax

  1. IRC 1443(b) and the regulations thereunder describe requirements for withholding of tax on gross investment income of foreign private foundations subject to the IRC 4948(a) tax.

  2. The tax (if any) is to be reported on the form required to be filed by the foundation under IRC 6033 for the taxable year, at the time prescribed for filing such annual return without regard to any extension of time for filing.

7.27.27.2.2  (02-22-1999)
Effect of Tax Treaty

  1. Whenever there exists a tax treaty between the United States and a foreign country, and a foreign private foundation subject to IRC 4948(a) is a resident of such country or is otherwise entitled to the benefits of such treaty, if the treaty provides that any item or items of gross investment income shall be exempt from income tax, such item or items are not to be taken into account by the foreign private foundation in computing the tax to be imposed under IRC 4948(a) for any taxable year for which the treaty is effective.

7.27.27.3  (02-22-1999)
Foreign Private Foundations Which Receive Substantially All Support From Sources Outside the United States

  1. A foreign private foundation which has received "substantially all" of it support (other than investment income) from sources outside the United States is excepted from the requirements regarding change of status (IRC 507), governing instruments and other special rules (IRC 508), and Chapter 42 of the Code (other than IRC 4948).

  2. IRC 4948 and the regulations thereunder do not provide any exceptions concerning the application of the private foundation rules to private foreign foundations which have not received "substantially all" of their support from source outside the United States.

7.27.27.3.1  (02-22-1999)
Meaning of "Substantially All"

  1. "Substantially all" for purposes of the exception in IRC 4948(b) means that the organization, from the date of its creation, has received at least 85 percent of its support as defined in IRC 509(d), other than gross investment income, from sources outside the Unites States.

  2. In computing support for purposes of this test, gifts, grants, contributions or membership fees received directly or indirectly from a Unites States person (as defined in IRC 7701(a)(30)) are from sources within the United States.

7.27.27.4  (02-22-1999)
Denial of Exemption for Prohibited Transactions

  1. A foreign private foundation which receives substantially all of its support from sources outside the Unites States is generally excepted from the private foundation rules.

  2. However, tax exemption under IRC 501(a) is to be denied such as organization, pursuant to IRC 4948(c)(2), if it engages in a "prohibited transaction" after December 31, 1969.

7.27.27.4.1  (02-22-1999)
Meaning of Prohibited Transaction

  1. "Prohibited transaction" for purposes of denial of exemption under IRC 4948(c)(2) means any act or failure to act (other than with respect to IRC 4942(e) relating to minimum investment return) which would subject a foreign private foundation or a person with respect thereto to liability for a penalty under IRC 6684 or a termination tax under IRC 507 if the foreign private foundation were a domestic private foundation.

  2. Thus, foreign private foundations described in IRC 4948(b) and their disqualified persons are held to the same requirements as other private foundations except for the minimum investment return requirements and certain special variances concerning grants. See (3) and (4) below.

    1. However, for such foundations the sanction for failure to observe requirements is a potential denial of exemption under IRC 501(a) as opposed to a tax on nonconforming activity.

    2. Also, the applicable sanction, denial of exemption, is operative only where the failure to observe requirements would result in a penalty tax under IRC 6684 or a termination tax under IRC 507 if the organization were a private foundation other than one described in IRC 4948(b).

  3. In applying the "prohibited transaction" rule described in (1) above:

    1. Approval by an appropriate foreign government of grants by a foreign private foundation to individuals is sufficient to satisfy the requirements of IRC 4945(g);

    2. In the case of a grant to an organization by a foreign private foundation, the grantor’s determination as to the status of the grantee for purposes of IRC 4942(g)(1)(A)(ii) (relating to qualifying distributions to a private foundation which is not an operating foundation) or for purposes of IRC 4945(d)(4) and (h) (relating to grants for which expenditure control is required of the grantor) will be accepted if such determination is made in good faith after a reasonable effort to identify the status of its grantee.

  4. In order for an act or failure to act (without regard to IRC 4942(e)) to be treated as a "prohibited transaction" under IRC 4948(c)(2) by reason of the application of IRC 6684(1) (prior liability for tax under Chapter 42 of the Code) there must have been a prior act or failure to act which:

    1. Would have resulted in liability for tax under Chapter 42 of the Code if the foreign private foundation had been a domestic private foundation; and

    2. Had been the subject of a warning that a second act or failure to act (without regard to IRC 4942(e)) would result in a prohibited transaction.

    Note:

    The act, or failure to act, mentioned in this paragraph (4) need not be related to the act (or failure to act) giving rise to the IRC 6684 penalty.

7.27.27.5  (02-22-1999)
Taxable Years Affected With Respect to Denial of Exemption

  1. If a foreign private foundation subject to the provisions of IRC 4948(c)(2) engages in a prohibited transaction, it will be denied exemption for all taxable years (except as provided in IRM 7.27.27.6 below) beginning with the taxable year during which it is notified that it has engaged in a prohibited transaction.

  2. A notice of such denial is to be published in the Federal Register on the day on which the foreign private foundation is so notified. The Washington POD will coordinate issuance and publication of the notice of denial of exemption.

    1. However, in the case of an act or failure to act which would result in a penalty under IRC 6684(1) if the foreign private foundation were a domestic private foundation, before giving notice the private foundation will be warned that the act or failure to act may be treated as a prohibited transaction.

    2. If the act or failure to act is corrected within 90 days from the date of warning, it will not be treated as a prohibited transaction.

7.27.27.6  (02-22-1999)
Reestablishment of Exempt Status

  1. A foreign private foundation whose exempt status is denied because it engaged in a prohibited transaction may reapply for exemption by filing an application on Form 1023, Application for Recognition of Exemption, with respect to the second or any subsequent taxable year following the taxable year in which the notice of denial was issued. In addition to the information generally required in connection with the filing of an application for exemption under IRC 501(a), there is also required a written declaration made under the penalties of perjury by a principal officer of such foundation that it will not knowingly again engage in a prohibited transaction.

  2. If the foreign private foundation satisfactorily establishes that it will not knowingly again engage in a prohibited transaction and that it otherwise satisfies the requirements for recognition of exemption, it will be notified in writing.

    1. In such a case the foundation will not be denied exemption by reason of any prohibited transaction engaged in before notice of denial was issued.

    2. However, in no case may an organization denied exemption under IRC 4948(c), be again exempt under IRC 501(a) sooner than the conclusion of one full taxable year following the year in which notice of loss of exemption is given.

7.27.27.7  (02-22-1999)
Disallowance of Charitable Deductions

  1. No deduction is allowed under IRC 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2) or 2522, if made:

    1. To a foreign private foundation after the date on which notice has been published in the Federal Register that the organization has been notified that it has engaged in a prohibited transaction; or

    2. In a taxable year of such organization for which it is not exempt by reason of the issuance of a notice of denial of exemption for engaging in a prohibited transaction.


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