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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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