PARTNERING WITH NON-PROFITS VENTURES INVOLVING FOR-PROFIT AND

Transcription

PARTNERING WITH NON-PROFITS VENTURES INVOLVING FOR-PROFIT AND
PARTNERING WITH NON-PROFITS
HOW TO MAXIMIZE THE TAX AND BUSINESS BENEFITS OF
VENTURES INVOLVING FOR-PROFIT AND
NON-PROFIT ENTITIES WHILE AVOIDING THE PITFALLS
John H. Gadon
Lane Powell Spears Lubersky LLP
June 14, 2000
This outline is provided for informational purposes only and is not intended as legal advice or to
create an attorney-client relationship.
999999.2000/277373.1
© JOHN H. GADON 2000
I.
INTRODUCTION
In recent years, collaborative business ventures between for-profit and tax-exempt
entities have increased dramatically. These ventures benefit the exempt organizations by
providing access to capital and resources that would not otherwise be available. These ventures
provide for-profit businesses with a number of benefits including tax benefits, access to
intellectual property, and regulatory credit for community involvement.
Joint ventures have been particularly prevalent in the healthcare and housing areas. In
the healthcare area, joint ventures have ranged from whole hospital joint ventures to joint
ventures involving the development and operation of ambulatory surgery centers, laboratories,
and similar facilities. In the housing area, joint ventures have typically involved multifamily
housing eligible for the federal low income housing and/or rehabilitation tax credit. Joint
ventures have also been formed to exploit certain intellectual or intangible property rights
developed by tax-exempt organizations.
This outline will review two issues with respect to the impact of such joint ventures on
exempt organizations. The first is whether participation by an exempt organization in a joint
venture with a for-profit entity endangers its exempt status. The second is whether the exempt
organization’s participation in such a venture will give rise to unrelated business taxable income.
This outline will also briefly review some of the current issues being raised by the
Internal Revenue Service (“IRS”) with respect to business relationships between tax-exempt and
for-profit entities.
II.
EFFECT OF JOINT VENTURES ON THE EXEMPT STATUS OF EXEMPT
ORGANIZATIONS
A.
The IRS’ Initial Position: Participation in a Joint Venture Incompatible with
Exempt Status.
Through the mid-1970’s, the IRS took the position that an exempt organization’s
participation in a partnership or joint venture with a for-profit entity was “inherently
incompatible” with the exempt organization’s exempt status. In particular, it held that serving as
a general partner in a limited partnership with a for-profit entity was incompatible with a
charitable organization being operated exclusively for charitable purposes within the meaning of
Section 501(c)(3) of the Internal Revenue Code (the “Code”). GCM 36293 (May 30, 1975). See
also GCM 37259 (Sept. 19, 1977).
In GCM 36293, the IRS concluded that by agreeing to serve as the general partner
of a partnership, an exempt organization would take on an obligation to further the private
financial interests of the limited partners, and this would necessarily conflict with its obligation
to be operated exclusively for charitable purposes.
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However, in 1979, the IRS acknowledged that not all joint ventures or
partnerships between an exempt organization and a for-profit entity were inconsistent with
exempt status. In that GCM, the IRS held that the proposed arrangement protected exempt
organizations from any potential conflict of interest.
B.
Plumstead Theatre Society, Inc. v. Commissioner, 74 T.C. 1324 (1980), aff’d per
curiam, 675 F.2d 244 (9th Cir. 1982).
The Plumstead case is the starting point for a discussion of the current state of the
law regarding joint ventures between for-profit and exempt entities.
The Plumstead case involved a non-profit corporation formed to promote and
foster the performing arts. The corporation entered into an agreement with the Kennedy Center
to produce a play. It also entered into a limited partnership with limited partner investors in
which the corporation was the general partner. The purpose of the partnership was to co-produce
the play. The corporation made no capital contribution to the partnership. The limited partners
contributed $100,000 to the partnership and were entitled to receive 63.5 percent of any profit or
loss.
The IRS denied the corporation exempt status under Section 501(c)(3).
In holding that the corporation qualified for exempt status as a charitable
organization, the courts rejected the IRS’ argument that the corporation’s participation in a
limited partnership caused the corporation to be operated for private rather than public benefit.
In affirming the Tax Court’s decision granting the organization status, the Ninth
Circuit cited the following facts:
(1)
Private investors were limited partners in one production only and were
not officers or shareholders or directors of the exempt organization itself;
(2)
The partnership agreements expressly reserved full management control to
the exempt organization; and
(3)
The sharing of profits did not provide an impermissible private benefit,
citing an earlier case in which a district court had held that a contract between an exempt theater
and booking agent under which the agent was paid a percentage of membership dues was not
incompatible with the theater’s exempt purpose.
C.
Development of the Two-Prong Test.
After its loss in the Plumstead case, the Internal Revenue Service issued a number
of general counsel memoranda and private letter rulings in which it found the structure of a joint
venture or partnership compatible with the exempt entities’ exempt status.
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1.
GCM 39005 (June 28, 1983). Two-Prong Test. In GCM 39005, the IRS
set forth a two-prong test for determining whether an exempt organization’s participation in a
partnership or joint venture is compatible with an exempt entity’s exempt status. The IRS
followed this test for the next 14 years.
Under the two-prong test, a partnership arrangement must be closely
scrutinized to ensure that the obligations of the exempt organization as a general partner do not
conflict with its ability to pursue its charitable goals.
First, it must be determined whether the organization is serving a charitable
purpose. Second, the partnership arrangement itself must be examined to determine whether the
arrangement permits the exempt organization to act exclusively in furtherance of the purposes
for which exemption may be granted and not for the benefit of limited partners.
In determining that an exempt organization’s participation as a general
partner in a particular partnership was compatible with its exempt status, the IRS cited the
following factors, among others:
(1)
There were other for-profit general partners;
(2)
The exempt organization had a right of first refusal if the property
owned by the partnership were offered for sale;
(3)
the property was subject;
The exempt organization had no liability on the mortgage to which
(4)
The obligation to protect the interests of the limited partners rested
solely with the non-exempt general partners; and
(5)
Because of federally imposed program limitations, the pursuit of
profit could not be established as a motivating factor for for-profit entities’ participation in the
venture.
2.
GCM 39444 (Nov. 13, 1985). In this GCM, the IRS concluded that the
exempt status of an organization would not be adversely affected by its participation as the sole
general partner in a limited partnership created to purchase and lease an office building. The
office building was acquired to provide office space for the exempt organization and a related
exempt organization. The limited partners included a number of past and present exempt
organization board members and officers.
In concluding that the partnership structure would not endanger the
exempt organization’s exempt status, the IRS focused on the following factors:
(1)
The exempt organization, as sole general partner, was vested with
control over the partnership’s business activities;
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(2)
The mortgage loan for the building was nonrecourse to the exempt
organization so the exempt organization had no liability with respect to the mortgage.
Furthermore, the related exempt organization had a net lease under which it assumed day-to-day
operational and management functions with respect to the property;
(3)
Income and deductions were to be allocated among the partners in
proportion to their capital contributions;
(4)
The exempt organization had a right of first refusal to purchase the
property at fair market value during the lease term; and
(5)
The exempt organization had the sole right to admit new limited
partners.
In approving the proposed structure, however, the IRS required the
formation of an independent committee composed of individuals who were neither board
members nor officers of the exempt organization. The committee was required to have authority
to monitor the exempt organization’s role as general partner and have other powers as necessary
to guarantee that its operations were exclusively for public purposes. The IRS was concerned
there was a potential for abuse where the limited partners were members of the exempt
organization’s control group and that control by the limited partners of the exempt organization
could create conflicts between the exempt organization’s partnership obligations and tax-exempt
objectives.
3.
GCM 39732 (May 19, 1988). In this GCM, the IRS determined that the
participation by an exempt hospital as a general partner in a joint venture with a non-exempt
entity to provide outpatient medical services would not conflict with its exempt status.
In this GCM, the IRS disavowed a “but for” test that would have required
a showing that the facility could not have been established but for participation by the exempt
organization in a limited partnership. The IRS concluded there was nothing per se objectionable
with an exempt organization entering into a limited partnership where it either lacked, or did not
wish to expend, all the funds necessary to build or purchase a facility which would further its
exempt purposes. In this case, the IRS focused on the following factors:
(1)
Profits and losses were to be allocated between the general partner
and the limited partners in accordance with their respective partnership interests based on capital
contributions and risks assumed. There were no special allocations of partnership profits, losses,
or credits.
(2)
length negotiations; and
All financing would be obtained at fair market rates through arm’s-
(3)
Each activity of the partnership would further the exempt
organization’s exempt purpose and would not result in inurement or private benefit to the limited
partners of the incidental benefit.
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The IRS also concluded that the same standard applicable to termination
of private benefits in other contexts should be applied to participation of exempt organizations in
limited partnerships. Thus, the IRS stated that the question in each case was whether the benefits
available to the limited partners, both quantitatively and qualitatively, were incidental to the
public purposes served by the exempt organization.
4.
GCM 39862 (Nov. 21, 1991). This GCM involved the question of
whether a tax-exempt hospital jeopardized its exempt status by forming a joint venture with
members of its medical staff and selling to the joint venture the gross or net revenue stream
derived from the operation of an existing hospital department or service for a definite period of
time.
In this GCM, the IRS held the transaction would jeopardize the hospital’s
exempt status for three reasons:
(1)
This transaction would cause the hospital’s net earnings to benefit
private individuals;
(2)
The private benefits stemming from the transaction could not be
considered incidental to the public benefits achieved; and
(3)
The transaction might violate federal law.
The IRS concluded that the transaction did little to further accomplish the
hospital’s charitable purpose. Implicit in the IRS’ analysis was that participation in such a joint
venture was not appropriate unless it resulted in expansion of services not already being
provided. The IRS also concluded that the transaction would give medical staff a proprietary
interest in the profits of the hospital, which would provide impermissible private inurement.
The IRS also concluded that the sale of the revenue stream from the
hospital activity benefited private interests more than incidentally. The IRS stated that to be
qualitatively incidental, a private benefit must occur as a necessary concomitant of the activity
that benefits the public at large, i.e., the benefit to the public cannot be achieved without
necessarily benefiting private individuals.
The IRS effectively held that qualitatively incidental benefit must be
insubstantial when viewed in relation to public benefit conferred by the activity to private
individuals. The private benefit conferred by an activity is balanced only against the public
benefit conferred by that activity and not by the overall good accomplished by the organization.
D.
Housing Pioneers v. Commissioner, T.C.M. 1993-120, aff’d, 58 F.3d 401 (9th Cir.
1995).
In the Housing Pioneers case, a non-profit corporation was formed to serve as a
co-general partner in limited partnerships that would acquire property eligible for the federal
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low-income housing tax credit. The corporation also entered into management agreements with
two partnerships. The president and a member of the exempt organization’s board had limited
partnership interests in one of the partnerships. They were also the sole shareholders of the cogeneral partner of that partnership. The exempt organization conceded that the management
agreement with that partnership was not negotiated at arms-length.
The court held that the corporation failed both the operational and private
inurement tests and therefore did not qualify for exempt status. The court noted that the
corporation had made no attempt to actually implement its stated charitable objective, and it
would not be operated exclusively for charitable purposes. Both the president of the
organization and a board member stood to benefit from the exempt organization’s activities. The
Ninth Circuit distinguished the Plumstead case on the grounds that, in that case, the investors
were not shareholders, officers, or directors of the exempt entity.
E.
IRS’ Current Position with Respect to Joint Ventures.
1.
Rev. Rul. 98-15, 1998-1 C.B. 718. Revenue Ruling 98-15 reflects the
IRS’ current position with respect to the types of joint ventures that exempt organizations may
participate in without jeopardizing their exempt status. The focus of this ruling is on whether the
exempt organization has the ability to control the joint venture so that it may ensure that the joint
venture’s activities will be consistent with the organization’s exempt purpose.
Revenue Ruling 98-15 presents two situations involving the formation of a
limited liability company (“LLC”) composed of two members, one of which is an organization
exempt under Code Section 501(c)(3) and one of which is a for-profit hospital corporation. The
exempt organization contributes all of its assets to the LLC. The for-profit corporation also
contributes assets to the LLC. The two entities receive ownership interests in the LLC
proportional to the value of the assets they contributed.
In situation 1, the organization qualifies for exempt status. In situation 2,
the organization does not. The differences between the two situations are as follows:
(1)
Control. In situation 1, the LLC’s governing board is controlled by
individuals selected by the exempt organization. In situation 2, the governing board is composed
of 6 individuals, 3 of which are selected by the exempt organization and 3 of which are selected
by the for-profit entity.
(2)
Board’s Fiduciary Duty. In situation 1, the LLC’s governing
instruments require it to be operating in a manner furthering its charitable purposes. In
situation 2, the LLC’s governing instruments lack any comparable provision.
(3)
Management Control. In situation 1, the parties enter into a
management agreement with an independent management company which is renewable by
mutual consent and can be terminated for cause. In situation 2, the board entered into a
management contract with a wholly owned subsidiary of the for-profit entity, which is renewable
in perpetuity solely at the management company’s discretion. In both situations, the other terms
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of the management agreement are reasonable and comparable to the terms of management
agreements entered into by other management companies in similar circumstances.
(4)
Related Officers. In situation 2, the parties agree that the LLC’s
Chief Executive Officer and Chief Financial Officer will be individuals who had previously
worked for the for-profit corporation in hospital management. These individuals will work with
the management company to oversee the LLC’s day-to-day operations. There are no such
related key employees in situation 1.
(5)
Minimum Distributions. In situation 1, the LLC’s board is
required to approve any distribution. In situation 2, a minimum level of distribution is required.
(6)
Large Contracts. In situation 1, the LLC’s governing instruments
require board approval of contracts which exceed a fixed dollar amount per year. In situation 2,
the governing instruments require a majority approval of only “unusually large contracts.” The
IRS appeared to consider this an adverse factor in the case of situation 2 as the board’s primary
source of information would be individuals who had an existing relationship with the for-profit
entity and the management company.
F.
Recent Private Letter Rulings.
Two private letter rulings that were issued shortly before Revenue Ruling 98-15
are consistent with its approach.
1.
PLR 9731038. In this ruling, an exempt organization served as developer,
property manager, and general partner of limited partnerships that would develop and own
multifamily housing projects eligible for the federal low-income housing tax credit.
In holding that the partnership arrangement was consistent with the
exempt organization’s exempt status, the IRS required the organization to change the terms of an
environmental indemnification agreement and tax credit adjuster provision that would be
triggered in the event the anticipated tax credits were not fully available. The IRS required that
the environmental indemnification be amended to exclude losses resulting from the possible
recapture of low-income housing tax credits unless the loss resulted from gross negligence or
willful misconduct of the exempt organization. In approving the indemnity agreement as
amended, the IRS noted that the organization had completed a Phase I environmental assessment
on each property, limiting the likelihood of any environmental problems.
With respect to the tax credit adjuster provisions, the IRS required that the
adjuster be restructured as a capital contribution to the partnership rather than a payment directly
to the limited partner investors. The IRS stated it was concerned that credit adjustment
provisions could overly benefit investors by placing charitable assets at risk to protect the
investment of private investors.
In this case, the IRS characterized the credit adjustment provision as
returning the investors’ “overpayment” of its capital contribution rather than paying investors
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their anticipated return on investment. Furthermore, by making the credit adjuster a capital
contribution, the arrangement retained the use of charitable assets for charitable purposes. The
IRS also noted that the capital contribution would increase the exempt organization’s capital
account and therefore increase its share of partnership assets upon dissolution.
Finally, the IRS concluded that a construction completion guarantee would
not overly benefit investors, both because a number of the projects were already completed and
because, as developer, the exempt organization could control the date on which projects were
completed.
2.
PLR 9736039. In this ruling, the IRS required an exempt organization that
was the co-general partner of a low-income housing tax credit partnership to amend its existing
partnership agreement to greatly strengthen the exempt organization’s control over partnership
operations. The other co-general partner was a for-profit developer.
As the partnership agreement had been initially drafted, the exempt
organization was managing general partner but its duties would be determined by both general
partners, and both general partners would jointly control substantive functions of the partnership.
In addition, since the for-profit general partner had the greater share of general partner interests,
in the IRS’ view, it had control over the partnership.
The IRS required that the exempt organization be delegated substantive
authority formerly reserved to the general partners collectively. The IRS determined that this
amendment would ensure that the partnership operated for charitable purposes and that the
exempt organization pursuant to this amendment had the authority to use partnership resources to
operate in a manner that would comply with regulatory agreements that required that the housing
project be used for low-income housing.
The parties also agreed to terminate a pledge and security agreement
pursuant to which the exempt organization had pledged its interest in the partnership, including
its capital contribution and future fees for performance of services to the partnership, as security
in case of a default under the partnership agreement, including a failure of the for-profit general
partner to return funds to the investor or acquire the entire interest of the investor. The IRS
determined that this pledge would have benefited not only the for-profit investor but also the forprofit general partner because it could be exercised upon the failure of the for-profit general
partner to make good on its guarantees to the investor.
G.
Redlands Surgical Services v. Commissioner, 113 T.C. No. 47 (1999), on appeal
to the Ninth Circuit.
The Redlands Surgical case was the first court test of the position taken by the
Service in Revenue Ruling 98-15. In agreeing with the Internal Revenue Service that Redlands
Surgical Services (“RSS”) was not entitled to exempt status under Code Section 501(c)(3), the
Tax Court concurred in the IRS’ focus on who controlled the joint venture. The court held that
RSS had ceded effective control over the partnership’s activities to for-profit entities, thereby
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conferring upon them significant private benefits. The court held that RSS was therefore not
operated exclusively for charitable purposes.
Briefly, RSS is a subsidiary of Redlands Health Systems, Inc. (“RHS”), a Code
Section 501(c)(3) corporation. Although the overall organizational structure in question was
complex, generally, RSS and a for-profit entity known as Redlands-SCA Surgery Centers served
as co-general partners of a general partnership (the “General Partnership”), which served as the
general partner of a limited partnership (the “Operating Partnership”) that operated an
ambulatory surgery center. This activity was RSS’ sole activity.
The General Partnership entered into a management contract with an affiliate of
the for-profit partner. This contract was for a 15-year term renewable at the management
company’s option.
RSS argued that it met the operational test under Code Section 501(c)(3) because
its surgical center activities furthered its purpose of promoting health for the benefit of the
community by providing access to an ambulatory surgery center for all members of the
community based on medical need rather than ability to pay. Furthermore, RSS argued that its
dealings with its for-profit partners had been arms-length and that it retained sufficient influence
over the activities of the surgery center to further charitable goals. Alternatively, RSS argued
that it qualified for exemption under the “integral part theory” because it was organized and
operated to perform services that were integral to the exempt purposes of its parent.
The court rejected RSS’ arguments that it had retained sufficient control. The
court concluded that the Operating Partnership was not operated exclusively in a charitable
manner and that it made no difference that none of RSS’ income was applied to private interests.
The court held that RSS’ activities and the activities of the operating partnership were
“indivisible” and “no discreet part of the operating partnership’s income producing activities
were severable.”
The court found a significant profit-making objective present in the surgery
center’s operations. The court also focused on the management contract, which in the court’s
view, ceded inappropriate control to a for-profit entity.
The court also concluded that the management contract was not negotiated at
arms-length.
The court listed five factors that, in their totality, supported the conclusion that
RSS was not entitled to exempt status:
(1)
No charitable obligation. Nothing in the General Partnership agreement or
any of the other documents relating to the operation of the partnership or the surgery center
established any obligation that charitable purposes be put ahead of economic objectives.
(2)
RSS’ lack of voting control over the General Partnership;
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(3)
RSS’ lack of other formal or informal control sufficient to ensure
furtherance of charitable purposes;
(4)
The long-term management contract giving the affiliate of the for-profit
general partner control over day-to-day operations and incentive to maximize profits; and
(5)
The market advantages and competitive benefits secured by the for-profit
entity’s affiliates as a result of their arrangements with RSS.
H.
Recommendations.
(1)
Follow the roadmap laid out by the courts and the IRS.
(2)
Include a provision in any partnership agreement or LLC operating
agreement acknowledging the exempt organization’s exempt status and that the partnership/LLC
will do nothing incompatible with that status. An explicit statement to the effect that this will not
result in a breach of the exempt organization’s fiduciary duties as general partner or manager is
also helpful.
(3)
Exempt organization should be the general partner/manager (control
issue).
(4)
Structure indemnity payments by the exempt organization as capital
contributions to the partnership/LLC rather than as direct payments to for-profit investors.
(5)
Avoid pledges of exempt organization’s partnership/LLC interests and
fees. Both are considered to be charitable assets.
(6)
Consider use of single member LLC’s rather than single purpose exempt
organizations.
III.
TAXATION OF INCOME DERIVED FROM JOINT VENTURES
A.
General Rule.
Generally, if an entity is classified a partnership for federal income tax purposes,
the entity does not pay taxes at the entity level but rather the partner/members are subject to tax
on their allocable share of an entity profit or loss.
However, the determination of whether income allocated by a partnership to an
exempt entity is unrelated business taxable income (“UBTI”) depends on whether the trade or
business of the partnership is substantially related to the exempt purpose of the partner. This is
true whether the exempt entity serves as a general partner or limited partner. Code Section 512.
Income is not exempt merely because the exempt entity played a passive role in
the venture.
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The IRS has issued numerous favorable private letter rulings to organizations
involved in a wide variety of partnerships and limited liability companies. Most of these rulings
concern organizations that are involved in the housing or healthcare fields. See, e.g.,
PLR 9349032 (development, social service, and property management fees received by exempt
organization for managing low income housing owned by a limited partnership of which it is the
general partner will not constitute UBTI). See also PLR 9736039 (fees received by exempt
organization who serves as a co-general partner of a limited partnership for development and
management of a low income housing project are not UBTI).
B.
Dividends and Royalties.
Generally, an exempt organization’s allocable share of partnership dividend,
interest, or royalty income that would be exempt if it had been received directly by the exempt
organization should be exempt if passed through from a partnership.
Generally, income is UBTI if it arises from a trade or business that is regularly
carried on and that is not substantially related to the organization’s exempt purpose. Code
Section 512(a).
IV.
AFFINITY CREDIT CARDS
A.
Overview
1.
UBTI.
Generally, tax-exempt organizations with unrelated business taxable
income are subject to an unrelated business income tax. Section 511(a)(1) of the Internal
Revenue Code of 1986, as amended (the “Code”).
2.
Royalty Exception.
“Royalties” are specifically excluded from UBTI.
Neither the Code nor applicable Treasury regulations define “royalty” for
purposes of computing UBTI. However, in Rev. Rul. 81-178, 1981-2 C.B. 135, the IRS ruled
that:
To be a royalty, a payment must relate to the use of
a valuable right.
Payments for the use of
trademarks, trade names, service marks, or
copyrights, whether or not the payment is based on
the use made of such property, are ordinarily
classified as royalties for federal tax purposes….
On the other hand, royalties do not include
payments for personal services.
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The U.S. Ninth Circuit Court of Appeals has held that for UBTI purposes,
“royalties” are payments for the right to use intangible property. The court further held that a
royalty is by definition passive and cannot include compensation for services rendered by the
owner of the property. Sierra Club, Inc. v. Commissioner, 86 F.3d 1526 (1996).
B.
Judicial Decisions.
1.
Sierra Club, Inc. v. Commissioner, T.C.M. 1999-86.
2.
Mississippi State University Alumni, Inc. v. Commissioner, T.C.M. 1997-
397.
3.
Alumni Association of the University of Oregon, Inc. v. Commissioner,
T.C.M. 1996-63, aff’d. sub. nom., Oregon State University Alumni Association, Inc. v.
Commissioner, 193 F.3d 1098 (9th Cir. 1999).
4.
Oregon State University Alumni Association, Inc. v. Commissioner,
T.C.M. 1996-34, aff’d., 193 F.3d 1098 (9th Cir 1098).
C.
Summary of Judicial Holdings.
In each of the above-cited cases, the Tax Court held that payments received by the
exempt organization in connection with an affinity credit card program were royalties within the
meaning of Section 512 and therefore excluded from UBTI.
Based on the Ninth Circuit’s opinion in the Sierra Club case, the relevant question
is whether the payments that the exempt organizations received were payments merely for the
use of intangible property or whether they were at least in part compensation for services
provided by, or on behalf of, the exempt organization.
In the Oregon State case, the Ninth Circuit rejected the IRS’ argument that if any
portion of the payments were for services provided by the exempt organization, the entire
payment would be taxable. Rather, the court implied that, under some circumstances, an
allocation of the payments between royalty income and compensation for services would be
appropriate. (As the IRS had not sought allocation, the court had no occasion to address whether
allocation would have been appropriate in this case.) The Tax Court found that the school’s
efforts in support of the affinity credit program had been de minimis, and the Ninth Circuit held
that this finding was well supported by the record.
In each of the above cases, the court undertook a detailed analysis of the facts,
including a review of the contractual arrangements between the parties and the activities
undertaken by the exempt organization.
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Some of the relevant facts included:
1.
Purpose for which exempt organization entered into the arrangement.
The court generally found that the exempt organization’s purpose for
entering into the arrangement was to keep its members aware of the organization (and, in the
case of alumni associations, of their ties to the institution), to keep the exempt organization’s or
institution’s name before the public, to provide its members with a low-cost credit card and to
raise revenue without placing an undue demand on its staff.
2.
License. The list of members or alumni remained the property of the
organization or the institution. The credit card issuer was merely licensed to use the names and
addresses on the list for the specific purpose of mailing credit card solicitations.
A logo and/or picture was also licensed to the credit card issuer for
inclusion on the face of the credit card.
3.
Royalty payments. Payments were based on gross, not net, revenues. The
organization bore no risk of loss with respect to the credit card program. The cost of operating
the credit card program was borne entirely by the credit card issuer.
4.
Costs of solicitation. Generally, the credit card issuer bore all the costs of
solicitation.
5.
Organizational control generally limited to approval rights that protected
the organization’s trademark and reputation. Although the organizations often had approval
rights over solicitation materials, such materials were prepared by the credit card issuer. The
time spent on these activities by organization personnel were de minimis.
6.
Staff time. Organization staff time spent on the program was de minimis.
Cf: Disabled American Veterans v. United States, 650 F.2d 1178 (1981) (DAV performed
extensive business services with respect to mailing list rentals and employed full-time staff
dedicated to that activity; mailing list rental income held to be UBTI.)
7.
Solicitation efforts. Although the organization may have been required to
cooperate with the issuer’s solicitation efforts, the credit card solicitations were generally
undertaken by the credit issuer. All inquiries were generally referred to the credit card issuer.
Credit card issuer was billed for any advertisements in any organization
publications. Such advertisements were generally prepared by the credit card issuer.
8.
Occasional assistance to cardholders.
The organization would
occasionally assist cardholders by forwarding complaints to the card issuer. The organization
had no authority with respect to determining credit card or credit limit eligibility.
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9.
Promotion of organization activities.
Generally, the agreements
authorized the organization to include information regarding the organization’s activities in
mailings by the credit card issuer a few times a year.
D.
Recommendations.
1.
Structure program so as to fall within facts presented in one of litigated
2.
Limit role of exempt organization and its staff.
3.
Structure agreement as license agreements in form and substance.
cases.
4.
Structure payments to the exempt organization as royalties for licensing
use of intangible property such as name, logo, picture, and mailing lists.
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999999.2000/277373.1