Corporate Sponsorship Payment: Taxable or Not?
A bank underwrites a charity's fundraising lunch and receives a package of sponsorship benefits in exchange. Is the bank's payment a contribution that is not taxable to the charity, an advertising fee that is taxable, some of both, or something else entirely?
Final regulations on corporate sponsorship payments, issued by the Internal Revenue Service ("IRS") on April 25, 2002, provide some of the answers. The final regulations replace proposed regulations issued in 2000. They affect a wide range of organizations, including universities and alumni associations, arts organizations, social service and health care organizations, and trade associations. In many cases the precise language of an organization's sponsorship acknowledgement or its agreement with the sponsor will determine whether a sponsorship payment is taxable to the organization.
"Qualified Sponsorship Payments"
A tax-exempt organization that receives a "qualified sponsorship payment" ("QSP") is not taxed on the payment. The organization may treat the QSP as a non-taxable contribution.
The devil is in the details, however. In order for the payment to be a QSP, the sponsor must not receive any "substantial return benefit" in exchange for the payment. The determination of whether a payment is a QSP accordingly requires an analysis of every benefit that the organization provides to the sponsor in return.
"Substantial Return Benefit"
An organization's acknowledgement of a sponsor by stating its name, displaying its logo, products or Internet address is not a substantial return benefit. The language used in sponsor acknowledgements can dramatically affect the tax treatment of the sponsorship payment, however.
Any endorsement by an exempt organization of a sponsor or its products, any use of qualitative or comparative language in a sponsor acknowledgement, or any inducement to purchase the sponsor's products or services is a substantial return benefit to the sponsor. An organization that provides such benefits in exchange for sponsorship funding may be converting a non-taxable QSP into a taxable payment for advertising without realizing it.
Example: An organization acknowledges a sponsor's payment only with an announcement, "Proudly sponsored by Joe's Coffee." The payment is a QSP and the organization therefore is not subject to tax on it. A second organization acknowledges the sponsor's payment with an announcement, "Buy Joe's Coffee - it's the best." The payment is not a QSP. Instead, some or all of the payment may constitute taxable advertising income to the recipient organization.
When a sponsor receives a substantial return benefit, the full sponsorship payment does not necessarily fall outside the QSP safe harbor. Any portion of the payment that exceeds the value of the substantial return benefit provided to the sponsor may still qualify as a QSP, but the charity has the burden of demonstrating that the payment exceeds the value of the benefits to the sponsor. These rules place a heavy premium on careful drafting of sponsorship agreements to maximize the amount of a sponsorship payment that may qualify as a QSP.
Under the final regulations, if the total value of benefits provided to the sponsor does not exceed 2% of the sponsorship payment, then the benefits are disregarded and do not constitute substantial return benefits. The entire payment may therefore be a QSP. The final regulations eliminate a rule in the proposed regulations that placed a $79 ceiling on the value of sponsor benefits that could be disregarded.
Example: An auto manufacturer sponsors a golf tournament for a charity. The charity recognizes the sponsor by displaying its name and logo on signs and printed material in connection with the tournament. It also provides four playing passes for the sponsor's employees. The name and logo display is not a substantial return benefit. If the total value of the playing passes does not exceed 2% of the sponsorship payment, then there is no substantial return benefit and the full sponsorship payment may be a non-taxable QSP. If, on the other hand, the value of the playing passes does exceed 2%, the only portion of the sponsorship payment that may be a QSP is the amount that the charity can demonstrate exceeds the value of the playing passes.
Hyperlinks to Sponsor Websites
Exempt organizations commonly provide hyperlinks on their websites to sponsor websites as part of a package of sponsor benefits. The final regulations provide new guidance concerning the tax impact of such hyperlinks.
In an example in the regulations, a symphony orchestra acknowledges a sponsor on its website by providing the sponsor's name and its Internet address in the form of a hyperlink. The symphony's provision of the hyperlink is not a substantial return benefit and does not prevent the sponsor payment from being a QSP.
Another example with slightly different facts leads to a very different result. A charity again provides a hyperlink on its website to a sponsor's website, but a statement appears on the linked website in which the charity endorses the sponsor's product. The charity reviewed and approved the endorsement before it was posted. In this situation, the endorsement constitutes advertising. Only the portion of the sponsor's payment, if any, that the charity can demonstrate exceeds the value of the advertising, may be a QSP.
The final regulations do not explicitly address whether there is any difference between providing a hyperlink in the form of the sponsor's Internet address, or in the form of a banner. The IRS had previously indicated informally that it might consider a banner to constitute advertising, so that a sponsor payment in exchange for a banner might be taxable. While there seems to be no principled basis for distinguishing between sponsor acknowledgements in the form of Internet address hyperlinks and banners, there is not yet any specific guidance as to whether a banner linking to a sponsor's website constitutes a substantial return benefit.
The final regulations provide that a charity's guarantee that a sponsor will be the only sponsor of an activity representing a particular business or industry (e.g., the only bank sponsor, or the only soft drink sponsor) is generally not a substantial return benefit. The situation changes, however, if the exempt organization agrees that it will not allow products or services that compete with the sponsor's products or services to be sold or provided in connection with the exempt organization's activities. An exclusive provider arrangement will constitute a substantial return benefit, and a payment for any such arrangement will not be a QSP. There may be other tax planning options that will avoid unrelated business income tax on such payments, however.
The final regulations are effective April 25, 2002, and apply to payments solicited or received after December 31, 1997.