In an announcement released by the IRS, mission-related investments (MRIs) – investments made from a foundation’s endowment with the intention of generating social impact in addition to financial returns – made by foundations will be seen as “non-jeopardizing”, and thereby will not be subject to an investment gains tax.
PRIs and MRIs: A Tax Perspective
MRIs differ from Program-Related investments (PRIs) based on the investment intent and how the investment is viewed from a tax perspective. PRIs are considered investments out of a foundation’s grant-making budget that can be made in below-market guarantees, loans, and equity investments, for which the primary objective is to achieve a charitable purpose. Additionally, PRIs account for approximately 5% of a foundation’s annual payout requirement – the minimum amount that a private foundation must spend annually for charitable purposes, in order to avoid paying excise taxes. MRIs are market-rate investments in which the foundation intends to generate both social and financial returns; however, endowment officers must follow prudent investor standards similar to conventional investments. In addition to achieving social outcomes, MRIs are primarily seen as finance engines that allow the foundation to continue its charitable operations. (http://www.ussif.org/files/publications/unleashing_potential.pdf)
Foundations are taxed for gains made on investments, if, the IRS states, foundation investment officers do not exercise “ordinary business care and prudence.” That is, foundations are subject to taxation on investments that are seen as risky or compromising to a foundation’s financial security and its charitable, tax-exempt operations.
However, according to the IRS ruling, endowment officers are “not required to select only investments that offer the highest rate of return, the lowest risks, or the greatest liquidity so long as the foundation managers exercise the requisite business care and prudence... in making investment decisions that support, and do not jeopardize, the furtherance of the private foundation’s charitable purposes.” In other words, incorporating social impact metrics to achieve impact returns, in line with the foundation’s mission, as well as financial returns when making an investment decision is not deemed as a lack of “business care and prudence”, and is not taxable as a risky investment. (http://impactalpha.com/irs-gives-green-light-to-foundation-investment-for-impact/)
Until the IRS ruling, it was unclear whether private foundations could select an investment for which the primary purpose was to achieve a social outcome alongside financial return without facing investment gains taxes. However, the IRS ruling definitively clarifies that it is permissible for endowment managers to incorporate impact metrics as legitimate factors when making investment decisions, and allows for foundations to potentially devote more of their annual endowment payout toward impact-focused investments in line with their charitable purpose, while also achieving a financial return.