The issue of a nonprofit operating in a foreign country is rather complex. It can involve multiple government agencies and be fraught with pitfalls that can only be avoided if you understand the rules. If you are like many of our clients who operate abroad, understanding the rules is critically important.
Foundation Group has worked with thousands of 501(c)(3) clients with charitable activities in foreign countries and continue to work with them every day… and each situation is different. First, it’s important to understand what type of activity is being conducted, the government agencies involved, and the necessary procedures required to stay compliant. For example, will your nonprofit be conducting direct activities, charitable giving, or both? Regardless, you will be working not only to satisfy the IRS like every other tax-exempt organization, but you will also be accountable to more specific U.S. Treasury requirements. Examples include the need to stay aware of the restricted countries as identified by the U.S. Department of State, and understand the acceptable financial transactions outlined for charitable work by a U.S. organization abroad.
Operating in a foreign country is not easy and takes way more than just making sure your passport is current. It comes with its own set of requirements and complexities. That doesn’t make it impossible, though. Let’s start with the ‘what’.
Direct activities are defined as domestic (U.S.) tax-exempt organizations operating some or all of their programs physically in a foreign country. There are many examples of this: schools, clinics, economic development programs, orphanages, etc. This can involve U.S. citizens living in and operating the program in the foreign country, a program fully staffed by foreign nationals, or a combination of the two. The biggest challenge in maintaining an IRS-compliant foreign country program is the same as for any 501(c)(3) organization, that is, the program must satisfy a charitable purpose. What is different is the ever-changing landscape of international relations and its effects on maintaining compliant oversight. More on that below.
This activity usually involves a U.S. charity financially supporting the efforts of a foreign charitable organization. This topic may seem straight-forward on the surface, but it is actually treated with greater scrutiny by the IRS than direct activities. An example of this might be a U.S. charity gives money to a poverty relief program based in Ecuador. In principle, this is OK, so long as the foreign country or agency doesn’t have any defined restrictions. The problem is the lack of direct fiduciary responsibility for the expenditure of funds by the U.S. organization. In our example, the U.S. charity must ensure that the program being supported qualifies as one that would be recognized as a 501(c)(3) if it were in the U.S. In addition, the U.S. charity must require a detailed accounting of the expenditure of funds in order to monitor compliance with 501(c)(3) related expenditures. Should the domestic organization find out that money is not being spent in a way that could be acceptable by the IRS, the donations to that foreign organization should cease immediately.
Also, the IRS will not allow a domestic charity to be simply a “money conduit” to a foreign organization. U.S. law does not allows such direct-affiliate organizations. In other words, a charity cannot exist for the sole purpose of financially supporting a specific foreign charity. A U.S. charity must be able to prove that it is sovereign from the foreign entity it’s giving to and that it is organized for specific charitable purposes that it alone is responsible for, one of which may be the support of charitable work. It is best when that support is not tied to any specific foreign charity on an exclusive basis. For a new organization it is OK to name the foreign charities to be supported initially, but it is often a mistake to make the support of those named charities the sole purpose.
As previously stated, the IRS isn’t the only area of the U.S. Department of Treasury that will be involved if your nonprofit decides to operate overseas. What we’re referring to is the Office of Foreign Asset Control. As explained at U.S. Department of Treasury’s Website,
The Office of Foreign Assets Control (“OFAC”) of the U.S. Department of Treasury administers and enforces economic and trade sanctions based on U.S. foreign policy and national security goals against targeted foreign countries and regimes, terrorists, international narcotics traffickers, those engaged in activities related to the proliferation of weapons of mass destruction, and other threats to the national security, foreign policy or economy of the United States.”
In a nutshell, OFAC determines where you can and cannot go and who you can and cannot work with. While technically it is a Treasury Department program, Homeland Security is directly involved. It is imperative that any U.S. charity that intends to put programs in place in a foreign country know what OFAC is saying about sanctions and these Specifically Designated Nationals (SDN).
The Treasury Department and Homeland Security aren’t the only departments outlining restrictions. As of the publication of this article, the U.S. Department of State has identified the following countries as State Sponsors of Terrorism: Cuba, North Korea, Iran, and Syria. This designation requires specific licenses from OFAC that must be approved prior to any activity being conducted.
As discuss time and time again, the fiduciary responsibility always comes back to the organization and its board members. With this next level of complexity by operating abroad, one more government agency comes into play – the U.S. Department of Justice and the U.S. Attorney General. The DOJ not only required the IRS to expand on the questions asked during the 501(c)(3) application process for more accountability, the DOJ also works with OFAC to enforce the sanctions in place.
We say all of this not to scare you out of conducting charitable activities in a foreign country, but to reinforce just how heavily scrutinized the activity is to keep everyone safe in the name of national security. It is difficult enough to learn how to acclimate to a unique culture. You certainly do not need the headache of running afoul with any of these additional agencies.
Now that you know what type of activity is being conducted and who is involved, you need to know how to proceed to compliantly operate abroad. If you plan to conduct activity in a foreign country within the first three years of existence, you are required to answer the below questions on your Form 1023 application. And, yes, the IRS is particular about the answers.
- Do you or will you make grants, loans, or other distributions to organizations that are not recognized by the IRS as tax-exempt under section 501(c)(3) such as NGOs and other programs? If “Yes,” name and/or describe the non-section 501(c)(3) organizations to whom you do or will make distributions and explain how these distributions further your exempt purposes.
- Do you or will you make grants, loans, or other distributions to foreign organizations? If “Yes,” name each foreign organization, the country and region in which each foreign organization operates, any relationship you have with each foreign organization, and whether the foreign organization accepts contributions earmarked for a specific country or organization (if so, specify which countries or organizations).
- Do you or will you make pre-grant inquires about the recipient organization? If “Yes,” describe these inquiries, including whether you inquire about the recipient’s financial status, its tax-exempt status under the Internal Revenue Code, its ability to accomplish the purpose for which the resources are provided, and other relevant information.
- Do you or will you use any additional procedures to ensure that your distributions to foreign organizations are used in furtherance of your exempt purposes? If “Yes,” describe these procedures, including periodic reporting requirements, auditing guarantees, site visits by your employees or compliance checks by impartial experts, etc., to verify that grant funds are being used appropriately.
- Do you share board members or other key personnel with the recipient organization(s)? If “Yes,” identify the relationships.
- When you make grants, loans, or other distributions to foreign organizations, will you check the OFAC List of Specially Designated Nationals and Blocked Persons for names of individuals and entities with whom you are dealing to determine if they are included on the list? Describe any other practices you will engage in to ensure that foreign expenditures or grants are not diverted to support terrorism or other non-charitable activities.
- Will you comply with all United States statutes, executive orders, and regulations that restrict or prohibit U.S. persons from engaging in transactions and dealings with designated countries, entities, or individuals, or otherwise engaging in activities in violation of economic sanctions administered by OFAC?
- Will you acquire from OFAC the appropriate license and registration where necessary?
- Do you or will operate in a foreign country or countries? If “Yes,” name each foreign country and region within each country in which you do or will operate and describe your operations in each one.
- When you conduct activities in foreign countries, will you check the OFAC List of Specially Designated Nationals and Blocked Persons for names of individuals and entities with whom you are dealing to determine if they are included on the list? Describe any other practices you will engage in to ensure that foreign expenditures or grants are not diverted to support terrorism or other non-charitable activities.
Even if your programs change later in the nonprofit’s journey, you’re still accountable for OFAC compliance. You are not required to go back and re-file anything, but if your organization is ever audited, the burden of proof of compliance lies squarely on your shoulders – and these agencies do not take “I didn’t know” as an answer.
It goes without saying that conducting charitable activities in a foreign country comes with a lot of moving parts and a lot of accountability and scrutiny. It’s not a decision to be taken lightly. And that doesn’t even take into account any currency conversions from donations or program revenue that may have occurred during any direct activities. But that hasn’t stopped us from assisting thousands of nonprofits compliantly operate abroad… even with the what, who, and how complexities.
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