IRS Ruling Provides Helpful Guidance on Ancillary Joint Ventures with For-Profits

Revenue Ruling 2004-51, released May 6, 2004, provides long-awaited IRS guidance on the tax impact of ancillary joint ventures between tax-exempt and for-profit parties. The ruling concludes that, under the facts below, the nonprofit participant retains tax-exempt status under Section 501(c)(3) and does not have unrelated business income (UBI) as a result of its participation in the joint venture.

The situation described in the ruling involves a Section 501(c)(3) university that offers summer seminars for teachers. The university enters into a joint venture with an unrelated for-profit company that conducts interactive video training programs. The two parties form a limited liability company (LLC) that will offer teacher training seminars at off-campus locations using interactive video technology. The university’s activities conducted through the LLC comprise only an insubstantial part of the university’s activities.

The university and the for-profit will each own 50 percent of the LLC, proportionate to the value of their capital contributions. Under the governing documents all returns of capital, allocations and distributions will be proportionate to the ownership interests. The LLC will be managed by a six-person board, with three chosen by the university and three by the for-profit. Under the governing documents the university has the exclusive right to approve the curriculum, training materials, and instructors, and to determine the standards for successful completion of the seminars. Seminars will cover the same content as the university’s on-campus programs.

The for-profit will arrange and conduct all of the seminars, including advertising, enrolling participants, arranging for facilities, distributing course materials and broadcasting the seminar to various locations. It also has the exclusive right to select the locations where participants can receive a video link, and to approve other personnel, such as camera operators.

The ruling reaches two conclusions: (1) the university continues to qualify under Section 501(c)(3); and (2) the university does not have UBI as a result of its activities through the LLC.

The ruling is very helpful in its separation of the tax-exempt status and UBI issues. In analyzing the impact on Section 501(c)(3) status the ruling relies on the fact that the activities are insubstantial, and does not consider whether they are related to exempt purposes. An exempt organization may engage in an insubstantial amount of activities that are unrelated to its purposes. When an organization engages in activities through an LLC, it is deemed for federal tax purposes to engage in them directly. The ruling accordingly confirms that it is immaterial whether an activity is carried on directly or through an LLC in which a for-profit is a member. If the activity is insubstantial, then it will not, taken alone, affect tax-exempt status.

The facts of the ruling are carefully drawn to avoid raising issues of private inurement and private benefit that could adversely affect exemption. The joint venture parties are apparently unrelated. The governing documents require that all the LLC’s arrangements be at arm’s length for fair market value, and the ruling assumes that the LLC’s activities are consistent with the documents. Real world fact patterns will not be so clear cut. The tax result could be quite different if the for-profit were controlled by university board members or if any arrangements were not at arm’s length for fair market value.

The UBI issue turns on the relatedness of the LLC activity to the university’s purposes. The ruling concludes that the seminar activity is related, based on the university’s power to control content and educational standards, and the fact that the content mirrors that of the university’s on-campus seminars. The fact that the for-profit partner controls the technological aspects does not affect whether the seminars are related to the university’s purposes. The new ruling clarifies that the nonprofit’s control need not extend to all aspects of the joint venture’s activities in order for them to be related – it seems to be sufficient that it control key programmatic content.

The ruling offers welcome encouragement for nonprofits seeking to enter into ancillary joint ventures with for-profits. Careful structuring and tax analysis will nevertheless remain essential to creating a viable nonprofit/for-profit joint venture.