Organization that Gifts Rebates from Providing Membership List is Subject to UBIT

Organization that Gifts Rebates from Providing Membership List is Subject to UBIT

TAM 9223002
Story posted in Technical Advice Memoranda on 22 October 2001
audience: PGDC Network | last updated: 15 June 2011
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Summary

The Service has ruled in technical advice that a rebate received by a public charity from an insurance company that sells insurance to its members and issues a rebate to the organization is subject to unrelated business income tax.
TAM 9223002 

Full Text:

Date: February 13, 1992

District Director: * * *
Taxpayer's Name: * * *
Taxpayer's Address: * * *
Taxpayer's Identification Number: * * *
Year(s) Involved: * * *
Date of Conference: * * *

LEGEND:
M = * * *
N = * * *

ISSUE

Whether an insurance rebate to M is subject to the unrelated business income tax under sections 511 through 513 of the Internal Revenue Code.

FACTS

M was incorporated in 1945 and is recognized as exempt from federal income tax as an organization described in section 501(c)(6) of the Code. According to its Articles of Incorporation, M's purposes are to promote and encourage new and additional uses of N.

In 1983, M was approached by an insurance underwriter with a proposal that it would offer a group rate on "Ocean Shipping Insurance Coverage" to the membership of M, and would share the net profits of the program with M. The members of M who had a need for this kind of coverage saw the proposal as attractive, not only because of the group rates, but because of the difficulty they had in obtaining such coverage. The managing director of M is aware of only three underwriters that currently offer such coverage. Prior to this program, a member of M interested in getting involved with the import of N would invariably call the managing director of M with the question of how to obtain ocean shipping insurance because their individual business insurance agents did not offer this type of coverage.

The staff of M compiles a list of new members and submits the list to the insurance company. The staff of M also advises new members of the availability of the ocean freight insurance program in an initial membership package it sends to all new members. All other matters are handled by the insurance company. Currently, approximately 5% of M's membership utilizes the ocean freight insurance program.

As endorsed by the insurance company, the insurance policy is subject to a profit-sharing plan applicable to the premium and loss figures. M participates in profits, if any, based on gross cargo premiums billed by the insurance company during each policy year, less 50% of the gross cargo premiums (for insurance company expenses) and less all paid and outstanding claims occurring on shipments made during the policy year (reduced by the amount of recoveries made, if any). The balance remaining is deemed to be the profit and M is entitled to participate in this profit on a 50/50 basis. From 1983 through 1987, there was no rebate. The fiscal year ending September 30, 1988, was the first year of receiving a rebate, and M also received a rebate in the fiscal year ending September 30, 1989.

APPLICABLE LAW

Section 501(c)(6) of the Code provides for the exemption from federal income tax of business leagues not organized for profit and no part of the net earnings of which inures to the benefit of any private shareholder or individual.

Section 1.501(c)(6)-1 of the Income Tax Regulations provides that a business league is an association of persons having some common business interest, the purpose of which is to promote such common interest and not to engage in a regular business of a kind ordinarily carried on for profit. Thus, its activities should be directed to the improvement of business conditions of one or more lines of business as distinguished from the performance of particular services for individual persons. An organization whose purpose is to engage in a regular business of a kind ordinarily carried on for profit, even though the business is conducted on a cooperative basis or produces only sufficient income to be self-sustaining, is not a business league.

Section 511(a) of the Code imposes a tax on the unrelated business taxable income of organizations described in section 501(c).

Section 512(a)(1) of the Code defines the term "unrelated business taxable income" as the gross income derived by any organization from any unrelated trade or business regularly carried on by it, less certain allowable deductions and modifications.

Section 513(a) of the Code defines the term "unrelated trade or business" as any trade or business the conduct of which is not substantially related (aside from the need of such organization for income or funds or the use it makes of the profits derived) to the exercise or performance by such organization of the functions constituting the basis for its exemption.

Section 513(c) of the Code provides, in part, that the term "trade or business" includes any activity which is carried on for the production of income from the sale of goods or the performance of services. For purposes of the preceding sentence, 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 1.513-1(d)(2) of the regulations provides that trade or business is "related" to exempt purposes, in the relevant sense, only where the conduct of the business activities has causal relationship to the achievement of exempt purposes; and it is "substantially related" only if the causal relationship is a substantial one. The regulation continues that for the conduct of trade or business from which a particular amount of gross income is derived to be substantially related to purposes for which exemption is granted, the production or distribution of the goods or the performance of services from which the gross income is derived must contribute importantly to the accomplishment of those purposes.

Section 513(h)(1)(B) of the Code provides, in part, that in the case of an organization which is described in section 501 of the Code and contributions to which are deductible under paragraph (2) or (3) of section 170(c), the term "unrelated trade or business" does not include any trade or business which consists of exchanging with another such organization names and addresses of donors to (or members of) such organization, or renting such names and addresses to another such organization. This section of the Code was enacted as a part of section 1601 of the Tax Reform Act of 1986 (P.L. 99-514), effective October 22, 1986.

Rev. Rul. 60-228, 1960-1 C.B. 200, holds that an organization otherwise exempt under section 501(c)(5) of the Code is subject to tax under section 511 on the income resulting from services rendered to certain insurance companies in connection with the life, casualty, and fire insurance program for members.

Rev. Rul. 66-151, 1966-1 C.B. 152, holds that the management of health and welfare plans by an organization exempt under section 501(c)(6) of the Code, including the performance of services connected with such management, constitutes a business not substantially related to the functions forming the basis for the exemption of the organization.

Rev. Rul. 67-176, 1967-1 C.B. 140, describes an organization that, among other activities, sponsors a variety of insurance programs for its members. In holding that the organization does not qualify for exemption under section 501(c)(6) of the Code because it is not primarily engaged in section 501(c)(6) activities, the revenue ruling states that the insurance plans constitute the performance of particular services to members as opposed to the improvement of a line of business.

Rev. Rul. 72-431, 1972-2 C.B. 281, holds that the regular sale of membership mailing lists by an exempt educational organization constitutes unrelated trade or business under section 513 of the Code. The revenue ruling states that the sale of mailing lists by the organization to facilitate the mailing of advertising to its members does not contribute importantly to the accomplishment of the organization's exempt purposes.

In Disabled American Veterans v. United States, 650 F.2d, 1178, 1189 (Ct.Cl. 1981), the Court of Claims considered the organization's practice of renting names on its mailing list to both tax-exempt and commercial organizations. The court found, in part, that the rental of the organization's donor list constituted a trade or business that was regularly carried on and that was not substantially related to the accomplishment of its tax exempt purposes.

RATIONALE:

Before an activity may be taxed as unrelated business income, the following three conditions must be satisfied: (1) the activity must constitute a trade or business; (2) the trade or business must be regularly carried on; and (3) the trade or business must not be substantially related to the organization's exempt purpose.

The activity engaged in by M and the insurance underwriter is clearly "trade or business" within the meaning of section 513(c) of the Code, in that the activity is carried on for the production of income from the performance of services. M does not refute this position.

Concerning the second part of the test, whether the activity is regularly carried on by M, there can be no doubt that the activities are regularly carried on within the meaning of 512 of the Code. New members are advised of the availability of the insurance, their names are provided periodically to the insurance company, and insurance is provided on a year-round basis whenever a member determines that it is needed. M does not refute this position.

Finally, for an activity to produce unrelated business taxable income, the trade or business must not be substantially related to the organization's exempt purpose. M argues that the activity is related to its exempt purpose within the meaning of section 501(c)(6) of the Code because the program furthers M's goal of promoting the uses of N by making it easier for its members to "bring the product to market." M believes that in the past adjudicated cases where insurance rebates were considered as unrelated business income, such insurance programs were concerned with life, group health, workmen's compensation, or general liability, all of which are easily obtainable and which are designed to provide a direct benefit to the individual members through rate reduction. M believes that its members which utilize the ocean shipping insurance program recognize that this coverage is necessary (as opposed to a health insurance program) and the group rate is an insignificant benefit in relation to the relative ease or difficulty in obtaining such coverage.

In order for an activity to be substantially related to exempt purposes, it must contribute importantly to the accomplishment of the exempt purposes of the organization. Although Rev. Rul. 60-228, supra, refers only to life, casualty, and fire insurance, and Rev. Rul. 66-151, supra, refers only to health and welfare plans, and Rev. Rul. 67-176, supra, refers only to a "variety" of insurance plans, the inference is clear that any insurance provided or endorsed to members is not considered to be a "related" activity within the meaning of section 501(c)(6) of the Code, and any income derived from such activity is taxable as unrelated business income. Additionally, with respect to the question concerning relatedness in this case, there is a question whether the organization is performing a particular service to members as opposed to the improvement of a line of business when it provides or endorses insurance to its members.

We conclude that the facts in this case indicate that M is providing or endorsing an insurance program to its members that constitutes an economy or convenience in the operations of the businesses of the members, and thus is providing a particular service to its members. Consequently, the activity does not promote the common business interest. There is a line of cases that conclude, in general, that the provision or endorsement of insurance to members of section 501(c)(6) organizations is not an exempt activity, but rather constitutes a particular service to the individual members, and therefore income from such activity is unrelated business taxable income. See, e.g., Professional Insurance Agents of Michigan v. Commissioner, 78 TC 246 (1982) (providing insurance benefits to members was "a convenience and economical service").

In addition, by compiling and providing a list of its new members to the insurance company, the organization has made its membership list an inseparable part of its program to endorse or provide insurance for its members. As described in Rev. Rul. 72-431, supra, this activity is not substantially related to the accomplishment of M's tax exempt purposes of promoting and encouraging new and additional uses of N.

Further, in Disabled American Veterans, supra, the court held that the rental of an exempt organization's donor list constituted a trade or business that is regularly carried on and that is not substantially related to the accomplishment of its tax exempt purposes. In response to this decision, Congress enacted section 513(h)(1)(B) of the Code. The legislative history of section 513(h)(1)(B) indicates that Congress intended to overturn ONE aspect of the holding in Disabled American Veterans -- that the rental and exchange of mailing lists between certain exempt organizations was income from an unrelated trade or business. In the legislative history, Congress stated that the U.S. Court of Claims held in 1981 that income received by the Disabled American Veterans from other exempt organizations and commercial businesses for the use of its mailing lists constituted unrelated business income, and did not constitute "royalties" expressly excluded from the tax under section 512(b)(2). The committee believed that the unrelated business income tax should not be imposed on income from exchanges or rentals of donor or member lists among tax-exempt organizations eligible to receive charitable contributions. H.R. Rep. No. 426, 99th Cong., 1st Sess. 867 (1986), 1986-3 C.B. (Vol. 2) 867; S. Rep. No. 313, 99th Cong., 1st Sess. 884-885 (1986), 1986-3 C.B. (Vol. 3) 884-885.

The Conference Report stated that section 513(h)(1)(B) of the Code provides an exception from the unrelated business income tax, available only to tax-exempt organizations for income from the exchanging or renting of membership lists with or to such other tax- exempt organizations. H.R. Conf. Rep. No. 1 841, 99th Cong., 2d Sess. II-822 (1986), 1986-3 C.B. (Vol. 4) II-822.

The Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986, stated that no inference is intended as to whether or not revenues from mailing list activities other than those described in section 513(h)(1)(B) of the Code constitute unrelated business income.

Congress recognized that Disabled American Veterans, supra, held that mailing list rentals to commercial firms were not royalties, as defined in section 512(b)(2) of the Code. Section 513(h)(1)(B) and the committee reports manifest Congress' intent that the rental of mailing lists to commercial firms continue to be taxed as income from unrelated trade or business. Therefore, section 513(h)(1)(B) is the sole exemption from taxation of mailing list income.

In light of the legislative history of section 513(h)(1)(B) of the Code, it is clear that Congress acquiesced in the taxation of mailing list income not covered by section 1601 of the Tax Reform Act of 1986. Therefore, the revenues derived by an exempt organization from the use of its membership or donor lists, other than as a result of use specifically sanctioned by section 513(h)(1)(B), constitutes unrelated business taxable income.

In this case, M's activity clearly does not constitute the "exchange" or "rental" of members' names and addresses within the meaning of the section 513(h)(1)(B) exception and therefore the income derived therefrom is subject to taxation as unrelated business income.

CONCLUSION

The insurance rebate to M is subject to the unrelated business income tax under section 511 through 513 of the Code.

A copy of the technical advice memorandum is to be given to the organization. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent.

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