Tax-Exempt Organizations Advisory Bulletin
IRS Ruling Provides Helpful Guidance on Ancillary
Joint Ventures
with For-Profits
By LaVerne
Woods
[May 2004]
Revenue Ruling 2004-51, released May 6, 2004, provides long-awaited
IRS guidance on the tax impact of ancillary joint ventures between
tax-exempt and for-profit parties. The ruling concludes that, under
the facts below, the nonprofit participant retains tax-exempt status
under Section 501(c)(3) and does not have unrelated business income
(UBI) as a result of its participation in the joint venture.
The situation described in the ruling involves a Section 501(c)(3)
university that offers summer seminars for teachers. The university
enters into a joint venture with an unrelated for-profit company
that conducts interactive video training programs. The two parties
form a limited liability company (LLC) that will offer teacher training
seminars at off-campus locations using interactive video technology.
The university’s activities conducted through the LLC comprise
only an insubstantial part of the university’s activities.
The university and the for-profit will each own 50 percent of the
LLC, proportionate to the value of their capital contributions.
Under the governing documents all returns of capital, allocations
and distributions will be proportionate to the ownership interests.
The LLC will be managed by a six-person board, with three chosen
by the university and three by the for-profit. Under the governing
documents the university has the exclusive right to approve the
curriculum, training materials, and instructors, and to determine
the standards for successful completion of the seminars. Seminars
will cover the same content as the university’s on-campus
programs.
The for-profit will arrange and conduct all of the seminars, including
advertising, enrolling participants, arranging for facilities, distributing
course materials and broadcasting the seminar to various locations.
It also has the exclusive right to select the locations where participants
can receive a video link, and to approve other personnel, such as
camera operators.
The ruling reaches two conclusions: (1) the university continues
to qualify under Section 501(c)(3); and (2) the university does
not have UBI as a result of its activities through the LLC.
The ruling is very helpful in its separation of the tax-exempt
status and UBI issues. In analyzing the impact on Section 501(c)(3)
status the ruling relies on the fact that the activities are insubstantial,
and does not consider whether they are related to exempt purposes.
An exempt organization may engage in an insubstantial amount of
activities that are unrelated to its purposes. When an organization
engages in activities through an LLC, it is deemed for federal tax
purposes to engage in them directly. The ruling accordingly confirms
that it is immaterial whether an activity is carried on directly
or through an LLC in which a for-profit is a member. If the activity
is insubstantial, then it will not, taken alone, affect tax-exempt
status.
The facts of the ruling are carefully drawn to avoid raising issues
of private inurement and private benefit that could adversely affect
exemption. The joint venture parties are apparently unrelated. The
governing documents require that all the LLC’s arrangements
be at arm’s length for fair market value, and the ruling assumes
that the LLC’s activities are consistent with the documents.
Real world fact patterns will not be so clear cut. The tax result
could be quite different if the for-profit were controlled by university
board members or if any arrangements were not at arm’s length
for fair market value.
The UBI issue turns on the relatedness of the LLC activity to the
university’s purposes. The ruling concludes that the seminar
activity is related, based on the university’s power to control
content and educational standards, and the fact that the content
mirrors that of the university’s on-campus seminars. The fact
that the for-profit partner controls the technological aspects does
not affect whether the seminars are related to the university’s
purposes. The new ruling clarifies that the nonprofit’s control
need not extend to all aspects of the joint venture’s activities
in order for them to be related – it seems to be sufficient
that it control key programmatic content.
The ruling offers welcome encouragement for nonprofits seeking
to enter into ancillary joint ventures with for-profits. Careful
structuring and tax analysis will nevertheless remain essential
to creating a viable nonprofit/for-profit joint venture.
For more information, please contact:
This TEO Advisory Bulletin is a publication
of the Tax-Exempt Organizations Practice Group of Davis Wright Tremaine
LLP. Our purpose in publishing this Advisory is to inform our clients
and friends of recent developments in tax-exempt and nonprofit organizations
law. It is not intended, nor should it be used, as a substitute
for specific legal advice as legal counsel may be given only in
response to inquiries regarding particular situations.
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