On March 13, 2015, the Internal Revenue Service (“IRS”) released LTR 201511033 (“the Letter”), which
is a final adverse determination by the IRS revoking the tax-exempt status of an “American Friends of”
organization, because it did not exercise full control and discretion over how funds donated to it were used
by its related foreign organization. In the Letter, the IRS described why it concluded that the actions of
the “American Friends of” organization in question (identifying details such as the name of the
organization have been redacted from the Letter) resulted in the organization being a mere conduit for the
foreign organization in question.
In the United States, organizations referred to as “American Friends of” organizations are used to raise
tax-deductible funds to support the tax-exempt purposes of foreign organizations, which must correspond
to the purposes described in section 170 and subsection 501(c)(3) of the Internal Revenue Code (the
“Code”), which set out the requirements for tax-exempt status as well as the tax deductions for charitable
gifts. Specifically, “American Friends of” organizations must comply with the requirements in IRS Revenue Ruling 63-252, which contains five examples of tax-deductibility involving foreign organizations and concludes that if “contributions [are] subject to control by the domestic organization” or “the foreign organization is merely an administrative arm of the domestic organization,” the contributions are tax deductible. This ruling therefore underscores the importance of an “American Friends of” organization retaining control and discretion over all payments, disbursements, and grants made by it.
In the Letter, the IRS highlighted a number of ways in which the organization in question failed to
demonstrate sufficient control and discretion. These include making payments to personnel, including the director, of the foreign organization without being able to provide sufficient documentation regarding the
identity of the recipients or the exempt purpose of the payment. Additionally, the IRS maintained that the
“American Friends of” organization could not provide records to show that:
- the making of grants was within the exclusive power of the board of directors;
- the board of directors reviewed all requests for funds;
- the board of directors required that the grantees could provide periodic accounting; and
- the board of directors could, at its discretion, refuse to make grants.
Due to these findings, the IRS determined that the organization no longer qualified for tax-exempt status
under the Code.
Although the legislative schemes regarding charitable contributions to foreign organizations are different
in Canada and the United States, this Letter illustrates interesting parallels between the “control and
discretion” analysis in the United States and the “direction and control” analysis in Canada. It is also
noteworthy that some lawyers in the United States, including Victoria B. Bjorklund and Morey O. Ward,
in their recent continuing legal education presentation at Georgetown Law, have called for the IRS to use
this Letter as an opportunity to create an updated precedential guidance on this important topic. Additionally, among other recommended best practices, they also suggested that “American Friends of” organizations should review, in advance, all requests for funds, analyze such requests and approve only those which are satisfactory and reflective of their own purposes, as opposed to providing blanket support of a general nature to a foreign organization. When combined with the fact that, in Canada, the Federal Court of Appeal recently heard the appeal in Public Television Association of Québec v Minister of National Revenue (see the separate article above on this case in this Charity Law Update), which considers Canadian law on this topic, it is clear that the question of contributions to foreign organizations is becoming a topic of greater importance for charities on both sides of the border.