13 January 2017 Charitable foundation's charging of fee for services does not result in unrelated business taxable income In Private Letter Ruling 201701002, the IRS has ruled that a charitable foundation's charging of fees for certain technical assistance services provided to other tax-exempt and governmental organizations does not constitute an unrelated trade or business. In its ruling, the IRS considered significant factors to be that the services provided are in furtherance of the charitable foundation's exempt charitable purposes and that the foundation sets its fees at a reasonable rate, at a charge based on each entity's ability to pay. On a case-by-case basis, it will charge fees at less than cost. Foundation, a tax-exempt private operating foundation, was formed for the charitable purpose of improving the lives of low-income families and children. It furthers its charitable purpose, in part, through collecting, analyzing and sharing neighborhood data in its region of operation to improve community decision-making. The Foundation has data usage agreements with local government agencies and school districts to obtain information not publicly available. Combining this information with publicly available information from the US Census and other sources, Foundation is able to analyze various community issues and trends. It maintains on its website a free, user-friendly database of some portions of the neighborhood information that allows users to get information on key social issues. The Foundation also offers technical assistance to social sector organizations (including nonprofits, foundations, government agencies and community organizations) when the information an organization needs is not readily available on Foundation's website and the organization does not have the expertise to do the analysis on its own. Such organizations request these services from Foundation, and Foundation ensures that each project it agrees to undertake supports its own charitable purposes. Unless there are privacy restrictions, the Foundation also makes certain information from the projects publicly available. In addition, the information gained from such projects also directly helps Foundation to identify community needs and pursue its charitable purpose. Foundation historically has absorbed the costs of providing such technical assistance. Doing so, however, has severely limited the number of projects it can undertake. Foundation now proposes to charge a reasonable fee for such technical assistance requests. It will not charge for smaller requests (requiring less than four hours of staff time) and will tailor its fee to clients' ability to pay — charging fees, in some cases, at less than cost. In addition, the contract between Foundation and the requesting organizations will provide that the information cannot be used for purposes other than the exempt purposes agreed to by Foundation. Foundation requested rulings on whether its provision of technical assistance services for a fee, as described, would constitute an unrelated trade or business under Section 513, subjecting Foundation to unrelated business income tax under Section 511, and whether this would constitute a business enterprise under Section 4943(d)(3), subjecting Foundation to excise taxes on excess business holdings under Section 4943. In its analysis, the IRS compared Foundation's circumstances to those presented in Revenue Ruling 72-369 and B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 (1978). In Revenue Ruling 72-369, the IRS ruled that an organization's regular provision of certain managerial and consulting services to tax-exempt organizations at cost was not a charitable activity under Section 501(c)(3). Similarly, in B.S.W. Group, the Tax Court concluded that an organization formed to provide consulting services to nonprofit organizations was not exempt under Section 501(c)(3), because the organization was not substantially different from similar commercial businesses, it had no plans to charge fees below cost, and it failed to limit its clientele to Section 501(c)(3) organizations. Unlike the organizations in Revenue Ruling 72-369 and B.S.W. Group, the IRS concluded Foundation's technical assistance services are substantially related to its own charitable purpose. The IRS noted that the technical assistance services fit with Foundation's community data analysis activities, with the additional projects giving Foundation access to new data and research. In addition, the IRS noted that Foundation ensures that the projects it undertakes will further its charitable purpose. Furthermore, Foundation makes the results publicly available and ensures clients do not sell the results or use them for non-exempt activities. Finally, Foundation will provide its services below cost on a case-by-case basis. Accordingly, the IRS ruled that Foundation's technical assistance services will not constitute an unrelated trade or business nor be subject to unrelated business income tax. The IRS added that the term "business enterprise" in Section 4943(d)(3) does not include a functionally related business as defined in Section 4942(j)(4). Under Section 4942(j)(4), a functionally related business includes a trade or business that is not an unrelated trade or business under Section 513. Accordingly, because Foundation's activities do not constitute an unrelated trade or business, the IRS ruled they do not constitute a business enterprise subject to the tax on excess business holdings under Section 4943. While this is not necessarily a new application of law, this ruling serves as a good synopsis of basic unrelated business income concepts relevant to not only private foundations, but all tax-exempt organizations. As the ruling points out, tax exempt organizations may be able to offer certain consulting or related services for a fee to unrelated non-profit organizations and the services will not constitute an unrelated trade or business if they contribute importantly to the accomplishment of the organization's exempt purpose. Moreover, these services ought to be distinguishable from those offered by commercial enterprises. In this ruling, the IRS cited several factors in its determination that the services furthered the Foundation's mission, and was therefore not taxable as an unrelated trade or business. Prior to providing the services, the Foundation used a screening process to evaluate the potential project to ensure it would provide information and insight to advance the Foundation's tax-exempt mission. Additionally, the Foundation took steps to ensure its clients would not use the services to further any commercial purpose. Further, the Foundation distinguished its services from commercial businesses in several ways. The Foundation's pricing structure was based partially on its clients' ability to pay, and at all times was reasonably priced. In some cases this meant that services were provided at less than cost, as determined on a case-by-case basis. Moreover, the Foundation would continue to provide other information to the public without charge. Finally, whenever possible, the Foundation would make the results of each project publicly available on its website, including both information gained from publicly available sources as well as information learned during the project work. A private letter ruling is a written statement issued to a particular taxpayer that interprets and applies tax laws to the taxpayer's specific, represented set of facts, and may not be used or cited as precedent by other taxpayers or by IRS personnel. Although the ruling is instructive on how the IRS might rule regarding a particular matter, organizations are cautioned not to rely on the ruling as authority, and to consult with their tax advisors to determine the tax consequences of their own facts and circumstances. — For more information about EY's Exempt Organization Tax Services group, visit us at www.ey.com/ExemptOrg
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