IRS Issues Guidance on Exclusive Provider Arrangements and UBIT

On March 2000, the IRS issued Prop. Regs. Sec. 1.513-4, dealing with corporate sponsorships. Consistent with Sec. 513(i), the proposed regulations distinguish between advertising and the mere use or acknowledgment of a sponsor's name or logo. Prop. Regs. Sec. 1.513-4 also distinguishes between exclusive sponsorship arrangements (which qualify for the safe harbor of Sec. 513(i)) and exclusive provider arrangements (which do not and are subject to the normal unrelated business income tax (UBIT) rules).

Taxpayers are concerned that the proposed corporate sponsorship regulations create an implication that exclusive provider contracts are automatically subject to UBIT because they fall outside the scope of Sec. 513(i). This assumption is incorrect. There are various ways an exclusive provider arrangement may not give rise to UBIT.

Although the income from some exclusive provider arrangements may be includible in unrelated business taxable income (UBTI), not all contracts will meet the criteria for inclusion in UBTI under Secs. 511–513. For example, a university enters into a multi-year contract with a soft drink company to be the exclusive provider of soft drinks on campus in return for an annual payment. If the company agrees to provide, stock and maintain on-campus vending machines as needed (leaving little or no obligation on the university's part to perform any services or conduct activities in connection with the enterprise), the university (based on this contract alone) might not have the requisite level of activity to constitute a trade or business under Sec. 513(a).

In determining the level of activity, however, any promotional or marketing efforts by the university under the contract should be considered. If the contract grants the company a license to market its products using the university's name and logo, the portion of the total payment attributable to the value of the license might be excludible as a royalty under Sec. 512(b)(2). In some cases, payments in connection with the grant of an exclusive concession (such as for the operation of a campus bookstore or cafeteria) may be treated as rental income under Sec. 512(b)(3).

When an exempt organization agrees to perform substantial services in connection with an exclusive provider arrangement, income received by the organization may be includible in UBTI. For example, a university enters into a multi-year contract with a sports drink company under which the company will be the exclusive provider of sports drinks for the university's athletic department and concessions. As part of the contract, if the university agrees to perform various services for the company (such as guaranteeing that coaches make promotional appearances on behalf of the company (e.g., attending photo shoots, filmed commercials and retail store appearances), assisting the company in developing marketing plans and participating in joint promotional opportunities), the university's activities are likely to constitute a regularly carried on trade or business. These activities are unlikely to be substantially related to the university's exempt purposes. Further, the income received by the university for those services is not excludible as a royalty under Sec. 512(b)(2); see Rev. Rul. 81-178, Situation 2.

When a university negotiates discounted rates for the soft drinks it purchases for its cafeterias, snack bars and concessions as part of a larger exclusive provider arrangement, the question arises as to whether the amount of the discount is includible in UBTI. Generally, discounts (and rebates) are considered an adjustment to the purchase price and do not constitute gross income to the purchaser. Thus, the amount of the negotiated discount is not includible in UBTI.

Finally, public elementary and secondary schools have inquired about the tax consequences of entering into exclusive provider arrangements similar to those entered into by colleges and universities. Under Regs. Sec. 1.511-2(a)(2), public elementary and secondary schools, in contrast to colleges and universities, are not subject to UBIT. Therefore, there are no UBIT consequences from these schools entering into an exclusive provider arrangement.

IRS Memorandum, 8/14/01