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Distinguishing between “grants” and “contracts for services”

Mott has concluded that contracts for services or products generally do not present the same risk of diversion of funds to support terrorism as do outright grants. Therefore, the key is to distinguish between a “grant” and a true “contract for products or services.”

It is not always possible to distinguish between a grant and a contract for products or services. In those uncertain areas, prudent judgment is necessary. If there is doubt as to whether a particular payment is, or is not, subject to the list-checking requirement, the prudent approach would be to perform the list-check.

Grants primarily benefit a particular grantee by furthering the grantee’s own exempt purposes and programs. A grantor’s involvement with a grant generally is limited to grant administration and monitoring.

In contrast, a contract for services primarily benefits the payor’s own program directly, although the recipient of the contract payments may receive incidental benefits in addition to compensation for services (that is, use of the report or study for its own purposes). Usually there will be some direct tangible benefit, such as a report or study that is given to the payor. Common examples of contracts for services involve hiring consultants or other resource persons to prepare a report for the payor. The payor also may maintain some significant, direct involvement in the activities funded by a contract for services — for example, the right to review the work done, make suggestions, and the like.

Examples of grants

A. To organizations

  1. A payment to a Code section 501(c)(3) organization (or its foreign equivalent) to enable that organization to fulfill its own charitable purposes.
  2. A program-related investment (for example, a below-market rate loan) to a for-profit business to induce the business to locate in an impoverished area and employ minority, unemployed, and/or underemployed individuals.
  3. A payment to a municipality or other governmental unit to enable it to fulfill some public purpose.

B. To individuals (see your Mott grant agreement for possible restrictions on grants to individuals):

  1. A payment to an individual for travel, study, or similar purposes.
  2. A payment to an individual in the form of a prize or award recognizing a past accomplishment.
  3. A payment to an impoverished individual for food, clothing, housing, or transportation (for example, to enable the individual to get to and from work).

Examples of payments that are not grants

On the other hand, if a payment is made to an organization or individual to perform a service or to deliver some product to the Foundation or to the payor organization, the payment is not a grant. Some examples of payments that are not grants include:

A. A payment to an individual or organization to prepare a research report for the payor, which the payor will own and use in its own activities.

B. A payment to an individual to teach a class at a seminar or conference the payor is presenting.

C. Payments for legal or accounting services performed for the payor.

The expenditure responsibility rules (that is, the U.S. federally mandated procedures that a private foundation must follow for any grant made to an organization that is not an IRS-recognized public charity) apply to grants, and provide an instructive definition. Not every payment made to individuals and other organizations is a grant. Treasury regulation section 53.4945-4(a)(2) defines grants as follows: 

“Grants” defined. For purposes of section 4945 of the Internal Revenue Code of 1986, as amended (the “Code”), the term “grants” shall include, but is not limited to, such expenditures as scholarships, fellowships, internships, prizes, and awards. Grants shall also include loans for purposes described in Code section 170(c)(2)(B) and “program related investments” (such as investments in small businesses in central cities or in businesses which assist in neighborhood renovations). Similarly, “grants” include such expenditures as payments to exempt organizations to be used in furtherance of such recipient organizations’ exempt purposes whether or not such payments are solicited by such recipient organizations. Conversely, “grants” do not ordinarily include salaries or other compensation to employees. For example, “grants” do not ordinarily include educational payments to employees which are includible in the employees’ incomes pursuant to Code section 61. In addition, “grants” do not ordinarily include payments (including salaries, consultants’ fees and reimbursement for travel expense such as transportation, board, and lodging) to persons (regardless of whether such persons are individuals) for personal services in assisting a foundation in planning, evaluating, or developing projects or areas of program activity by consulting, advising, or participating in conferences organized by the foundation.”

Mott decided to distinguish between grants and contracts for products
and services for several reasons:

1. Many contracts involve the routine purchases of products [such as office supplies and equipment] and services [such as accounting, travel, or financial services] that involve little, if any, risk of diversion of funds to terrorist organizations or for terrorist purposes. In Mott's view, the burden of list-checking all such contracts far outweighs whatever limited benefit list-checking might provide.

2. As noted above, contracts, as opposed to grants, generally require the contractor to produce some specific work product or service for the payor, often at a contract price that is negotiated or which is set by the market for such products or services. Mott therefore concluded that this limitation on how the contractor spends the payor's funds greatly reduces the opportunity for the contractor to divert funds to improper purposes.

3. Finally, unlike the case with grants, most contracts involve some supervision or control by the payor over the expenditure of funds by the contractor [and on the ultimate product or service]. This again reduces the opportunity for an improper diversion of funds.

Still, as noted earlier, the line between a grant and a contract can sometimes be blurry and some contracts may represent some or all of the same risks presented by grants. Consider, for example, a contract with a public charity for the conduct of long-term project evaluation or study, where the organization often engages in project evaluations [for others] within its field of interest, sometimes using grant funds and sometimes on a contract basis. Therefore, Mott reserves the right in a particular case to require a Mott grantee to list-check a contractor [or to take other appropriate steps to assure funds paid to the contractor are not diverted].

Under applicable IRS rules and regulations, payments by a foundation to third parties for travel, lodging, and tuition (and reimbursements for these purposes) are typically considered grants. When a Mott grantee makes such payments to or on behalf of third party individuals or organizations using Mott funds, the payments normally would be considered re-grants by the Mott grantee. Thus, they would ordinarily be subject to the list-checking requirement. We believe that, under certain circumstances, payments for travel, lodging, and tuition expenses may qualify for an exception to the list-checking requirement. However, the exception to the list-checking requirement must have our approval. Therefore, please contact your Mott program officer for further information.