Greenberg Traurig Alert

IRS Issues Corporate Sponsorship Regs
  Proposed Regulations Address Exclusivity Arrangements;
IRS Director Notes New Trends in Healthcare

March 2000
By Harry J. Friedman, Greenberg Traurig, Miami Office

  View or download the PDF version of this Alert here.

Revised Corporate Sponsorship Regulations

The IRS has issued Proposed Treasury Regulations (the "2000 Regulations") addressing the income tax treatment of sponsorship payments received by exempt organizations from businesses. Sponsored activities may be a single event, a series of related events or an exempt organization’s general activities. The 2000 Regulations replace Proposed Regulations promulgated in January 1993 (the "1993 Regulations") that dealt with the same subject. The 2000 Regulations were necessitated by the enactment of Section 513(i) of the Internal Revenue Code that codifies the unrelated trade or business income tax ("UBIT") consequences of corporate sponsorships of exempt organization activities.

Generally, exempt organizations must pay tax on their income arising from activities unrelated to their exempt purposes. Income is subject to tax even if the proceeds are used for the organization’s exempt purposes. The intent is to prevent tax-exempt organizations unfairly utilizing their tax-exempt status in competing with for-profit businesses. Income from advertising services provided by a tax-exempt organization, for example, ads in a periodical published by the organization, is subject to UBIT. Income from a trade or business is subject to tax even if it is carried on as part of other activities which may be related to the exempt purpose of the organization.

The issues surrounding corporate sponsorship payments originally arose out of an audit of the Mobil Cotton Bowl in the early 1990’s. The organization that operates the Cotton Bowl is a Section 501(c)(3) organization. The Cotton Bowl received a substantial sum annually from Mobil Corporation. In exchange for this payment, the Cotton Bowl agreed to use Mobil’s name in its title as well as display Mobil’s logo in various places. On audit, the IRS concluded that the payments made by Mobil to the Cotton Bowl constituted payments for the purchase of advertising services from the Cotton Bowl. Consequently, all of the payments made by Mobil constituted income subject to UBIT.

Treating sponsorship payments by corporations to college football bowl games as subject to UBIT became a controversial issue in Washington. The Cotton Bowl’s acceptance of a payment for adding a corporate sponsor’s name to its event is not uncommon. Similar payments are received by professional golf tournaments, commonly operated by tax-exempt organizations. Some commentators suggested the same reasoning could be applied to expenditures by sponsors of Little League Baseball teams. As a result of the controversy, the IRS promulgated the 1993 Regulations, finding a way to allow some corporate sponsorship payments to avoid taxation (as well as, in all likelihood, to diffuse the pressure from Congress).

The 1993 Regulations focused on the nature of the services provided by the exempt organization rather than the benefit received by the corporate sponsor making the payments. The 1993 Regulations distinguished advertising, an activity subject to UBIT, from acknowledgements by the exempt organization that recognized the payment by a corporate sponsor. Under the 1993 Regulations, income received in exchange for an acknowledgement would not be subject to UBIT. The 1993 Regulations defined acknowledgements as a "mere recognition of sponsorship payments or identification rather than promotion of products, services or facilities." Acknowledgements include sponsor logos and slogans that do not contain comparative or qualitative descriptions, locations and telephone numbers, value-neutral descriptions, and sponsor brand or trade names and product or service listings. The 1993 Regulations provided that if any payment constituted, in part, a payment for advertising services and, in part, an acknowledgement, then all services provided by the exempt organization would be considered advertising, even if alone the service would constitute a mere acknowledgement.

Subsequently, in 1997, Congress added a provision to the Internal Revenue Code governing the treatment of corporate sponsorship payments. For the most part, the new law codifies the 1993 Regulations. Under the statute, "qualified sponsorship payments" are not subject to UBIT. The distinction between acknowledgements, not subject to UBIT, and advertising, subject to UBIT, is retained in the Code provision. The acknowledgement may not contain qualitative or comparative language, price information or other indications of savings or value, an endorsement or any inducement to purchase the product or services of the sponsor. Qualified sponsorship payments do not include a payment if the amount of the payment is contingent upon the level of attendance at an event sponsored by the exempt organization, broadcast ratings or other factors that would related to the public’s exposure to the event. Payments in exchange for "substantial benefits," a benefit other than an acknowledgement or goods or services with an insubstantial value, do not constitute qualified sponsorship payments.

Qualified sponsorship payments do not include payments in connection with periodicals that are not published as part of a specific event or in connection with qualified convention and trade show activities. (Therefore, acknowledgements in a game program are not advertising; an acknowledgement in monthly magazines may be advertising.) The 2000 Regulations specifically provide that a display or distribution of the product at the sponsored activity is not considered an inducement to purchase or use the product and, thus, do not affect the determination. In contrast to the 1993 Regulations, the Code as well as the 2000 Regulations permit an allocation of a sponsorship payment if a portion of the payment is for an acknowledgement and a portion of the payment is for "advertising."

The 2000 Regulations address a new issue, exclusivity arrangements. Two situations are addressed. First, a payment may be made in exchange for the business being the exclusive sponsor of an event, or the only sponsor in a particular line of business. These payments may constitute qualified sponsorship payments if the acknowledgements otherwise are in compliance with the 2000 Regulations.

The second situation involves payment by a business in exchange for the business’ product being the exclusive product sold at an event sponsored by the exempt organization or at the exempt organization’s facility. This rule is in response to some well publicized arrangements between major universities and beverage producers to limit the brands of soft drinks sold on campus. Similar arrangements with respect to athletic equipment have been reported. The 2000 Regulations provide that payments for these exclusive rights will be subject to UBIT.

The 2000 Regulations do not address internet activities of exempt organizations. As has been reported previously (See, GT Alert, August 1999), the IRS has been reviewing the application of existing tax laws governing exempt organizations to internet activities, such as links to sponsors on the websites of exempt organizations. The IRS has requested comments on the application of rules governing periodicals to internet sites of exempt organizations. We anticipate further guidance on internet activity of exempt organizations.

Healthcare Issues

Marcus Owens, the outgoing director of the IRS Exempt Organization Division, spoke at the recent American Bar Association’s Tax Section meeting. At the meeting of the Exempt Organization Committee, he addressed a number of issues of importance to tax exempt healthcare organizations.

Owens indicated that the IRS has received a number of ruling requests from healthcare organizations seeking rulings on various types of compensation programs for their employees. The intent of many of these proposals, according to Owens, is to create compensation arrangements that will provide revenue sharing between the tax exempt healthcare organization and its employees. The revenue sharing proposals do not contain the gainsharing proposals that have been rejected by the Department of Health and Human Services. (See, GT Alert, August, 1999.) Revenue sharing arrangements may have implications under Intermediate Sanctions. Intermediate Sanction Proposed Regulations provide that revenue sharing arrangements that would constitute private inurement will be subject to the penalties imposed by Intermediate Sanctions. As a result, he does not anticipate that these requests will be handled quickly.

Owens observed that the IRS has received a large number of exemption applications and ruling requests from tax exempt hospitals seeking to acquire nursing homes. Many of these requests involve purchases of for-profit nursing homes by the exempt hospital. The IRS is particularly concerned with situations where residual control of the activity will be retained by its former owners. This creates the opportunity to cash-out the investment but keep an income stream from the operations. These types of transactions may also implicate Intermediate Sanctions with respect to the purchase price and management contracts.

Owens also reported on IRS audits of joint ventures between tax exempt and for-profit healthcare organizations. These audits have found, in some situations, that the operations of the joint venture did not match the agreements documented by the parties. Owens suggests that this evidences the correctness of the conclusions reached by the IRS in Revenue Ruling 98-15. The Revenue Ruling emphasizes the need for the tax-exempt organizations that are partners in joint ventures to control the activities of the venture. If the tax exempt organization’s sole activity is participation in such a venture where operations do not match the charitable objectives, the exempt organization’s status may be jeopardized.

Owens also advised that the IRS has seen ruling requests involving unwinding of joint ventures, presumably in response to Revenue Ruling 98-15. Owens cautioned that the IRS will be concerned about the valuations presented by such transactions.

© 2000 Greenberg Traurig