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This is an area of concern when an university enters into research contracts with governmental agencies and commercial entities. Such a research contract will almost always be treated as a trade or business activity, and usually the test is applied to the sum total of all the university's research projects. This also holds true for the regularly carried on prong of the UBTI test. The most difficult is the third prong, whether the activity is substantially related to the university's exempt purposes. Certain types of activities are clearly related such as those educational in nature if significant involvement by students in the activity or scientific research in the public interest under 501(c)(3) status.
Under the second type, scientific research in the public interest, a three prong test has developed. Each prong will be discussed in the paragraphs following. The activity must be (1) scientific research; (2) not conducted incident to commercial or industrial operations; and (3) conducted in the public interest. Scientific research is defined under Reg. §1.501(c)(3)-1(d)(5) as including practical and applied, fundamental, or theoretical research, even social sciences research. GCM 39,883 stated scientific research is present if the activity has three elements: project supervision and design by professionals, a specific design to solve a problem through use of a scientific method and a research goal that consists of discovering a demonstrable truth. Under Reg §1.501(c)(3)-1(d)(5)(ii) examples of commercial or industrial operations include the ordinary testing or inspecting of materials or products, and the designing or constructing of equipment and buildings. Two subsequent cases have held research can encompass a wider range of activities than those listed in the regulations.
Testing was defined as when "a standard procedure is used, no intellectual questions are posed, the work is routine and repetitive, and the procedure is merely a matter of quality control." under GCM 39883. Research is conducted in the public interest when it meets the following factors listed in Reg. §1.501(c)(3)-1(d)(5)(iii) –
- a. the results of research are made available to the public on a nondiscriminatory basis, or
b. the research is performed for a governmental entity, or
c. the research is directed towards benefiting the general public. Ex -- aiding in the scientific education of college and university students; obtaining scientific information published in a form that is available to the interested public; discovering the cure for a disease; aiding a community by attracting new industry to the community or encouraging the development or the retention of an industry in that location.
It should be noted that an university can also use one of two other statutory provisions to avoid UBTI treatment for the research activity. Under IRC §512(b)(7), income derived from research for the U.S. government or any of its agencies/instrumentalities, or for any state/political subdivision is exempt from UBTI. Under IRC §512(b)(8), "In the case of a college/university/hospital, income derived from research performed for any person" is not UBTI. The only restriction here is the word research, meaning the activity cannot be carried on for commercial or industrial operations, and the same "testing" rules will apply. (Top)
This issue arises when an university operates a restaurant on or near campus for students, faculty, visitors, and the general public. If a school can demonstrate a restaurant is used as an integral part of its educational activities, such as cooking school, then it will be judged as substantially related to the school's exempt purposes. It is very difficult to show restaurant operation is a substantially related activity. For example, in GSC 38,060, the Chief Counsel proposed the following situation: a college operates a restaurant located adjacent to the school's campus year round and general public patronage is gained through magazine advertisements, brochures and meeting guides. Prices charged are comparable to area commercial establishments. The restaurant is not operated for providing practical, on-the-job training as part of a course of instruction. No substantial causal connection between the restaurant operation and the college's exempt purposes was found, particularly where other commercial facilities were available. However, the IRS also stated if a school is isolated and lacking in reasonably available food facilities, a restaurant's income from persons have a demonstrable connection to students, faculty or staff could escape taxation under the convenience exception.
As another example, PLR 9720002 held a museum which operated a restaurant, café, and cafeteria on its premises was partially subject to UBIT. The restaurant was located on the museum's second floor and only accessible through its front entrance. However, patrons were allowed to enter without paying the museum's general admission. The museum contracted with a commercial enterprise to operate the restaurant, and the prices charged were comparable with area finer dining establishments. In addition, the museum advertised the restaurant in a local magazine, its own advertisements, and the yellow pages. At least one of the ads noted admissions was waived for patrons. Under the fragmentation rule, the IRS held sales to museum's visitors and employees were substantially related and not subject to UBIT. However, sales to the public (who did not visit the museum) were subject to UBIT.
Finally, PLR 8248074 featured an exempt organization that oversaw certain universities and established a hotel, conference center, administration building, and a restaurant and lounge. The restaurant and lounge were open to the general public and during normal business days was frequented primarily by conference members and faculty. In the evenings and during Sunday brunch, the general public primarily comprised the diners. Use for in-house training and conferences, board meetings, and other college sponsored events promoted the exempt purposes of the university and did not qualify for UBIT. However, use for sponsored conferences with contracted clients, commercial business conferences with or without university instructors, social activities, and other organizations for their private purposes was not substantially related and was subject to UBIT. This included banquets, weddings, and anniversaries. (Top)
There are two categories under which this issue arises: (1) camp is conducted by the university using its own facilities and employees, or (2) camp is conducted by third party leasing facilities from University. In Rev. Ruling 80-297, the IRS analyzed the following two situations for a university:
- a. School used its tennis facilities, including locker rooms, for 10 weeks during the summer to conduct a tennis camp for the general public. Attendees were charged a fee. Two school employees operated the camp, collecting fees and scheduling court time. The IRS held any income generated was UBIT because the school provided more than just facilities; the two employees provided substantial services to the camp members.
b. Same facts as above except the school made its facilities available to an unrelated individual for a fixed fee not dependent on the profit from the camp's operation. The individual and two others operated the camp. The IRS held income generated was UBTI, but was exempt under the rental income exclusion, because it was not dependent upon the camp profit, and the school did not provide any services to the third party individual.
The IRS has also found the following to be related to a school's exempt purpose: a university who operated a summer sports camp featuring tennis, swimming, and basketball lessons and instruction for disadvantaged youth; a university who operated a summer hockey camp for children up to high school age; a university sponsoring several athletic summer camps for boys and girls supervised by employees of the university because they provided instruction in sports skill; and an association formed by a parent university for promoting, managing, and conducting all forms of athletics at the university sponsoring a sports camp for the purposes of improving the athletic ability of the participants, encouraging them to attend the university in the future and providing experience for the camp counselors who were primarily college students.
However, when a university allowed a corporation wholly owned by the college's nationally recognized coach to conduct a summer sports camp using the college's athletic facilities, UBTI was generated because the camp was not part of the educational program offered by the school. In addition, when a school (operating primary and secondary) rented its facilities in the summer to various sports-related camps it generated UBTI because it negotiated between the camps and the food service, essentially providing a substantial service. (Top)
This occurs when the university makes a sale of some item to a former student. This needs to be viewed in conjunction with the area of the item sold. For example, many affinity card programs use university alumni as their primary targets. IRS holdings regarding alumni have been conflicting and depend on the circumstances involved. In example, under PLR 8340102, the IRS held golf course operation for the student golf team and students, faculty, staff and alumni did not generate UBIT. The IRS made a distinction between the alumni and the general public, stating providing the golf course to the alumni and sustaining university contributors was an inducement for them to provide continuing support. Therefore the activity contributed importantly to the university's exempt purposes. However, under PLR 9645004, the IRS held income received from alumni usage of a university held golf course was UBIT. These individuals were held not to be sufficiently distinguishable from the public and the IRS rejected the argument the university was providing an inducement for financial contributions or other involvement.
Three different scenarios were presented in TAM 8020010. The university offered memberships to alumni for its recreational facility during the months of June, July, and August when the university was not in session. The IRS grouped alumni with the general public and held the membership sales provided the alumni the opportunity to engage in personal recreational activities, unrelated to the university's exempt purpose of education. The same was held for a university sponsored ice skating rink. However, the IRS held catering and the renting of university facilities for alumni dinners and class reunions were traditional and commonplace functions universities nationwide and facilitated the university's interactions with other schools. These were activities which kept the alumni abreast of current developments on the campus and as such were related to the exempt purposes of the university. (Top)
An university might have facilities it allows students and faculty and staff to use for free or for a reduced fee and allows the general public to use without the fee reduction. Facility usage by students, faculty and staff is related to a university's exempt purpose, although the discount value provided to an employee may be treated as additional compensation. Rev. Ruling 78-98 provides the example of a university operating a ski facility located several miles from campus. The university's physical education program used the facility, as well as students and general public for recreational purposes. Operation and fees were substantially similar to commercial ski facilities. It was held providing a recreational facility to the general public was not an exempt purpose of the school, and so generated UBTI. The IRS has reached identical conclusions with respect to: health club operation for the general public with comparable fees to commercial establishments; recreational facility memberships to the general public and alumni including use of a golf course; and ice time rental in a school's hockey rink to the general public. However, TAM 8020010 states activities such as wedding receptions, receptions for faculty or students from other schools, and alumni dinners and class reunions are substantially related and do not generate UBTI. These activities allowed alumni to stay abreast of current developments on campus and further the educational purpose.
It should be noted this depends greatly on the entity's exempt purposes. In PLR 200051049, the IRS held a hospital's operation of a fitness center was related because it served the community's health care needs. The health care center members consisted of the general public, hospital employees and former cardiac rehabilitation patients. The joiner fee paid was set, the IRS held, so that an "economic cross-section" of the community could join. In PLR 9732032 the IRS held a university which operated a health and fitness facility open to students, faculty, and staff (both active and retired), trustees, alumni, a fundraising group on campus and family members of each of these groups generated related business income as regards to the "wellness" programs offered. The IRS did not offer an opinion as to the other activities available because the question was not raised. (Top)