Corporate Sponsorship Payments Final Regulations Concerning Taxation of Tax-Exempt Organizations

On April 24, the Internal Revenue Service (the “Service”) released final regulations under section 513(i) of the Internal Revenue Code (the “Code”) concerning the tax treatment of corporate sponsorship payments received by tax-exempt organizations.  The final regulations are substantially similar to the proposed regulations that were released on March 1, 2000.  This Alert summarizes the final regulations and highlights the differences between the final and the proposed regulations.  The final regulations are applicable retroactively for payments solicited or received after December 31, 1997.

Section 511(a)(1) of the Code generally imposes a tax (an unrelated business income tax or “UBIT”), at regular corporate rates, on the unrelated business taxable income (“UBTI”) of tax-exempt organizations described in sections 401(c) and 501(c) of the Code.  Income from advertising is generally treated as UBTI.  Under section 513(i) and the regulations thereunder, qualified sponsorship payments are not treated as UBTI.  The purpose of section 513(i) is to allow tax-exempt organizations to receive gifts from corporate sponsors and to acknowledge such support from their sponsors.  If the guidelines of section 513(i) and the regulations thereunder are followed, corporate sponsorships are not treated as income from advertising and thus are not taxable as UBTI.

What is UBTI?
Section 512(a)(1) defines UBTI as the gross income derived by a tax-exempt organization from any regularly carried on unrelated trade or business, less the deductions that are directly connected with the carrying on of the trade or business.

What constitutes an unrelated trade or business?
Section 513(a) defines the term “unrelated trade or business” as any trade or business the conduct of which is not substantially related (aside from the organization’s need for income or funds) to the exercise or performance by such organization of its exempt function.  Section 513(c) provides that the term “trade or business” includes any activity carried on for the production of income from the sale of goods or the performance of services, and that an activity does not lose identity as a trade or business merely because it is carried on within a larger aggregate of similar activities or within a larger complex of other endeavors which may or may not be related to the exempt purposes of the organization.  Section 513(i), added by the Taxpayer Relief Act of 1997, Pub. L. 105-34, §965, provides that the term “unrelated trade or business” does not include the activity of soliciting and receiving qualified sponsorship payments from any person engaged in a trade or business, provided that there is no arrangement or expectation that such person will receive any substantial return benefit in exchange for the sponsorship payments.  The purpose of section 513(i) is to distinguish between an acknowledgment of support from a sponsor, which is not an unrelated trade or business activity, and advertising on behalf of the sponsor, which is.

What constitutes a qualified sponsorship payment?
A qualified sponsorship payment is a payment made by a person engaged in a trade or business with respect to which there is no arrangement or expectation that such person will receive any substantial return benefit other than the use or acknowledgement of the name or logo or product lines of the person’s trade or business in connection with the exempt organization’s activities.  See Code §513(i)(2)(A); Treas. Reg. §1.513-4(c)(1).  In determining whether a payment is a qualified sponsorship payment, it is irrelevant whether the sponsored activity is related or unrelated to the recipient organization’s exempt purpose or whether the sponsored activity is temporary or permanent  Treas. Reg. §1.513-4(c)(1).  The term “payment” means the payment of money, transfer of property, or performance of services.  Id.

What is a substantial return benefit?
A substantial return benefit is any benefit other than (1) use or acknowledgement of the payor’s name or logo in connection with the organization’s activities, or (2) certain goods or services that have an insubstantial value (“disregarded benefits”).  Treas. Reg. §1.513-4(c)(2).

What constitutes use or acknowledgement?
Use or acknowledgment of the name or logo or product lines of the payor’s trade or business may include:

• exclusive sponsorship arrangements;
• logos and slogans that do not contain qualitative or comparative descriptions of the payor’s products, services, facilities or company;
• a list of the payor’s locations, telephone numbers, or internet address;
• value neutral descriptions, including displays or visual depictions of the payor’s product lines or services; and
• the payor’s brand or trade names and product or service listings.

Treas. Reg. §1.513-4(c)(2)(iv).  The final regulations stress that exclusive sponsorship arrangements may qualify as acknowledgment rather than advertising.  Id.

Use or acknowledgement does not include advertising.  Id.  The term “advertising” includes messages containing qualitative or comparative language, price information or other indications of savings or value, or an endorsement or other inducement to purchase, sell or use a sponsor’s products or services.  See Code §513(i)(2)(A); Treas. Reg. §1.513-4(c)(2)(iv) and (v).

A single message that contains both advertising and an acknowledgment is advertising.  Treas. Reg. §1.513-4(c)(2)(v).  Mere display or distribution, whether for free or for a fee, of a payor’s product by the payor or by the exempt organization to the general public at the sponsored activity is not considered an inducement to purchase, sell or use the payor’s product.  Treas. Reg. §1.513-4(c)(2(iv).

Unlike the proposed regulations, the final regulations address the UBIT implications of the use of hyperlinks.  Hyperlinks from exempt organization websites to sponsors’ websites constitute a tax free acknowledgement rather than advertising, provided that the link is not accompanied by any endorsements, qualifications or comparisons involving the sponsor’s product or services, or by incentives to visit the sponsor’s site.  For example, if an exempt organization posts a list of its sponsors on its website and includes each sponsor’s internet address which appears as a hyperlink from the exempt organization’s website to the sponsor’s website, the posting of the sponsor’s website address constitutes a tax-free acknowledgement rather than advertising.  Treas. Reg. §1.513-4(f), Ex. 11.  However, if a hyperlink to a sponsor’s website leads to a page where an endorsement by the charity for the sponsor’s products or services appears, and the charity approved the endorsement before it was posted online, the hyperlink constitutes advertising rather than a mere acknowledgement.  Treas. Reg. §1.513-4(f), Ex. 12.  It should be noted that the analysis of particular internet issues, such as the use of hyperlinks, may be different for purposes of section 513(i) than for purposes of other sections of the Code.  See Treasury Decision (“T.D.”) 8991.

What return benefits may be disregarded?
Goods or services provided to the payor in return for a sponsorship payment are disregarded if they have an insubstantial value.  Treas. Reg. §1.513-4(c)(2)(ii).  Benefits that may be disregarded under this provision may include:

• advertising;
• exclusive provide arrangements;
• goods, facilities, services or other privileges; or
• exclusive or nonexclusive rights to use an intangible assets (e.g., trademark, patent, logo or designation) of the exempt organization. Treas. Reg. §1.513-4(c)(2)(iii). 

Goods or services are considered to have an insubstantial value if their fair market value does not exceed 2% of the payment.  Treas. Reg. §513-4(c)(2)(ii).

Under the proposed regulations, return benefits could be disregarded if their fair market value did not exceed 2% of the payment, or $74 ($79 adjusted for 2002).  Prop. Reg. §1.513-4(c)(2)(ii)(A)(1).  Certain token items such as bookmarks, calendars, key chains, mugs, t-shirts and the like were also treated as disregarded benefits.  Prop. Reg. §1.513-4(c)(2)(ii)(A)(2).  In response to comments from the exempt organizations and tax practitioners, the final regulations eliminated the $79 ceiling on the amount of return benefits that can qualify as disregarded benefits.  The special rule for token items was also eliminated.

How are the return benefits valued?
The final regulations retain the valuation standard contained in the proposed regulations.  The fair market value of any substantial benefit provided as part of a sponsorship arrangement is defined as the price at which the benefit would be provided between a willing recipient and a willing provider of the benefit, neither being under any compulsion to enter into the arrangement and both  having reasonable knowledge of the relevant facts.  Treas. Reg. §1.513-4(d)(1)(ii).

When are the return benefits valued?
Under the proposed regulations, the fair market value of the substantial benefit was determined on the date the parties entered into the sponsorship agreement.  Prop. Reg. §1.513-4(d)(1).  The final regulations retain this rule for binding, written sponsorship contracts.  Treas. Reg. §1.513-4(d)(1)(iii).  For situations where no binding, written contract exists the final regulations provide a different rule. Under the final regulations, if there is no written, binding contract, the fair market value of the substantial return benefit is determined when the benefit is provided.  Id.

The binding, written contract rule provides exempt organizations the advantage of having to value substantial return benefits only once, at the execution of the contract, even if the value of the return benefits increases over time.  See Treas. Reg. §1.513-4(d)(iv), Ex. 1.  If the parties make a material change to a sponsorship contract, the contract is treated as a new contract as of the date the material change is effective.  Id.  A material change is defined as an extension or renewal of the contract or a more than incidental change to any amount payable (or other consideration) under the contract.  Id.

What is not a qualified sponsorship payment?
The term “qualified sponsorship payment” does not include:

• any payment if the amount of such payment is contingent upon the level of attendance at one or more sponsored events, broadcast ratings, or other factors indicating the degree of public exposure to one or more sponsored events, although the fact that a payment is contingent upon whether a sponsored event will take place at all does not, by itself, disqualify the payment;
• any payment which entitles the payor to the use or acknowledgement of the name or logo of the payor’s trade or business in exempt organization periodicals; and
• any payment made in connection with any qualified convention or trade show activity. Code §513(i)(2)(B)(i) and (ii); Treas. Reg. §§1.513-4(b); 1.513-4(e)(2). 

For purposes of section 513(i), the term “periodicals” means regularly scheduled and printed material published by or on behalf of the exempt organization that is not related to and distributed in connection with a specific event conducted by the exempt organization.  Treas. Reg. §1.513-4(b).

The final regulations clarify that material published electronically can qualify as a periodical.  Id.  Sale of advertising in exempt organization periodicals is governed by section 1.512(a)-1(f) of the Treasury Regulations. Payments received in connection with convention or trade show activities are governed by section 513(d) of the Code and section 1.513-3 of the Treasury Regulations.

How are exclusive provider agreements treated?
An arrangement that acknowledges the payor as the exclusive sponsor of an exempt organization’s activity, or the exclusive sponsor representing a particular trade, business or industry, generally does not, by itself, result in a substantial return benefit.  Treas. Reg. §1.513-4(c)(2)(vi)(A).  An arrangement that limits the sale, distribution, availability, or use of competing products, services or facilities in connection with an exempt organization’s activity generally results in a substantial return benefit. Treas. Reg. §1.513-4(c)(2)(vi)(B).

If the payor receives a substantial return benefit with respect to a sponsorship payment, does the entire sponsorship payment fail to qualify as a qualified sponsorship payment?
No. If there is an arrangement or expectation that the payor will receive a substantial return benefit with respect to any payment, only the portion of the payment equal to the fair market value of the substantial return benefit will fail to qualify as a qualified sponsorship payment.  Treas. Reg. §1.513-4(d)(1).  The portion of the payment, if any, that exceeds the fair market value of the substantial return benefit will qualify a qualified sponsorship payment, provided that the recipient organization establishes that the payment exceeds the fair market value of the substantial return benefit. Id.  The Commissioner has the authority to redetermine the portion of a payment allocable to such substantial return benefit and may treat two or more related payments as a single payment.  Treas. Reg. §1.513-4(d)(2).

Is a payment automatically taxable as UBTI if it does not qualify as a qualified sponsorship payment?
No. A payment will not be taxable, whether or not it constitutes a qualified sponsorship payment, if such payment is excluded from the definition of UBTI under other provisions of the Code.  For example, a university that 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 is not necessarily subject to UBIT on that payment.  If the soft drink company agrees to provide, stock and maintain on-campus vending machines as needed, leaving little or no obligation on the part of the university to perform any services or conduct any activities in connection with the enterprise, then based on this contract alone, and assuming no agency relationship between the company and the university exists, the university may not have the requisite level of activity to constitute a trade or business under section 513(a).  Under these facts and assumptions, the university would not be subject to UBIT on the payment received from the soft drink company.  See T.D. 8991.

Are qualified sponsorship payments treated as public support?
Yes. Qualified sponsorship payments in the form of money or property (but not services) are treated as contributions from the general public for purposes of determining whether the recipient organization qualifies as a public charity or a private foundation.  Treas. Reg. §§1.513-4(e)(3); 1.509(a)-3(f).

If you have any questions regarding any of these issues please contact Catherine Wilkinson at 202.429.6262.