UK should look to Uncle Sam for a helping hand

Canny UK universities are tapping US donor potential. Sheldon Elliot Steinbach and Celia Roady explain.

British universities are clearly in for a tough time over the next few years. Signs of tight control on spending by the Treasury following last week's funding allocations mean that UK universities must explore every possible revenue-raising option.

Already, Cambridge, Oxford and a handful of other savvy British universities receive millions of dollars in donations from alumni in the United States. These donations are underwritten partly by the US Treasury, which offers generous tax incentives for charitable contributions. The donations come to the universities indirectly, however, since the US tax incentives are not available for donations to non-US charities. Instead, they come via so-called "friends" organisations, US charities formed to raise funds for their foreign universities. Cambridge in America and Americans for Oxford are among the oldest, but new ones are formed every year. By establishing US charities, British universities can give their American alumni the benefit of incentives for charitable giving under US tax law.

Despite increasing pressures to raise funds from the private sector, only a minority of British universities have taken this route. This is likely to change as universities recognise that their US alumni represent a substantial base of potential donors ready and willing to be tapped by the various tax-advantaged strategies available under US laws.

The most popular is the right to claim a full fair-market value deduction for a contribution of appreciated property. For instance, a donor who contributes stock originally bought for $10,000 (£7,030) and now worth $50,000 can claim a $50,000 tax write-off without having to pay tax on the $40,000 of appreciation. Depending on the donor's federal and state tax bracket, this may produce a direct tax savings of up to 40 per cent of the amount of the contribution. US tax laws, even if they are less favourable than the United Kingdom's, also offer incentives for certain types of deferred gifts, where the donor contributes property and receives an income interest (for life or a term of years) back from the charity.

A friends organisation has to be structured with some care. Tax laws require a board of directors that exercises independent control and discretion over the application of donations. This prevents the organisation from acting merely as a conduit for the British university it was founded to support. In the words of US tax authorities, the tax code "would be nullified if contributions inevitably committed to go to a foreign organisation were held to be deductible solely because, in the course of transmittal to the foreign organisation, they came to rest momentarily in a qualifying domestic organisation".

Donors cannot simply earmark their contributions for a particular project or fund of the British university. The directors must have the final say. In practice, this is usually not a concern because there is a commonality of interest between the friends organisation and the British university it is formed to support.

Setting up a friends organisation is somewhat akin to creating a registered charity under UK law. The first step is to form a non-profit corporation under the laws of one of the US states and to select at least three directors, the majority of whom should be US citizens or residents without any official relationship with the British university. This is important to avert any argument that the US charity is simply a conduit. It is customary to have at least one university official on the board. Compulsory application to the US Internal Revenue Service for tax exemption can take several months. Once tax exemption is granted, the first step is usually for the university to apply to the friends organisation for grant funding for one or more projects or purposes (to support scholarships, to support a foreign exchange programme and so on). The board reviews the grant application and, if it is approved, begins the fundraising effort. Assuming the fundraising is successful, the friends organisation makes a grant to the university for the specified project, with a request for the university to report on how the funds are used. Pre-approved projects for which funding is sought allow for flexibility in accommodating the diverse interests of donors. US donors represent a significant source of potential funding for British universities. However, these donors have come to expect tax benefits from their charitable contributions, and may be unwilling to make significant donations unless they will receive a US tax deduction. A friends organisation lets British universities achieve this result and tap the deep well that universities in the US have exploited with success for many years.

Sheldon Elliot Steinbach is vice- president of the American Council for Education and Celia Roady is a tax partner with a Washington DC law firm.