IRS Tackles Exclusive Provider Arrangements and UBIT

In an Aug. 14, 2001 field memorandum, the IRS discussed several scenarios in which exclusive provider arrangements might not give rise to unrelated business income tax (UBIT). An exclusive provider arrangement is an arrangement under which an exempt organization agrees that products or services that compete with the payor's products or services will not be sold or provided in connection with one or more of the organization's activities. The Service issued the memo because of an "incorrect assumption" that the corporate sponsorship regulations create an implication that exclusive provider contracts are automatically subject to UBIT because they fall outside Sec. 513(i).

The IRS noted out that, although the income from some exclusive provider arrangements may be includible in unrelated business taxable income (UBTI), not all arrangements meet the criteria for inclusion in UBTI under Secs. 511513. For example, a university may enter into a multiyear contract with a soft drink company to be the exclusive provider of soft drinks on campus in return for an annual payment. If the university does not have to provide services or conduct activities in connection with the enterprise, it may not have the requisite level of activity to be a trade or business under Sec. 513(a).

However, the Service noted that when determining the level of activity, promotional and marketing efforts by the university under the contract should be considered. For example, if the university guarantees that coaches will make promotional appearances on behalf of the company and assists the company in creating marketing plans, the income from the exclusive provider arrangement would be included in UBTI under Rev. Rul. 81-178.

The IRS also explained that discounts and rebates are adjustments to the purchase price and not gross income to the purchaser. Therefore, a negotiated discount would not be includible in UBTI. Further, the Service noted that, under Regs. Sec. 1.511-2(a)(2), public elementary and secondary schools are not subject to UBIT. Accordingly, there would be no UBIT consequences from those schools when entering into an exclusive provider arrangement.

From Phillip Royalty, Washington, DC