PLR 1221024: IRS approves museum, assistance, vending, and trademark rulings

Plain-English summary

The IRS ruled that a tax-exempt foundation operating a sports history museum could run a financial-assistance program for eligible members of an affiliated coaching association without jeopardizing its § 501(c)(3) status. The IRS also ruled that the museum was not debt-financed property under § 514 because it was used for exempt purposes at least 85 percent of the time, and private-event income was treated separately under the debt-financed property rules. Income from vending machines while the museum was open to the general public was not unrelated business taxable income. Payments for third-party use of the foundation's trademarks were royalties excluded under § 512(b)(2).

Ruling snapshot

• Question: How would the foundation's assistance program, museum debt, vending machines, and trademark licensing affect its federal tax treatment?
• Outcome: Approved
• Key authorities: IRC §§ 501(c)(3), 512(b)(2), 513, and 514; Treas. Reg. §§ 1.512(b)-1(b), 1.513-1(d)(1), 1.514(b)-1, and 1.514(c)-1

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Contact Person:
Release Number: 201221024

Release Date: 5/25/2012
Date: February 29, 2012 Telephone Number:

Identification Number:

UIL Code: 501.03-13
512.01-01
513.04-00
514.06-00
Employer Identification Number:

Legend:

Date1 =
Date 2 =
Date 3 =
Foundation =
Association =
Museum =
m =
City =
Management =
x =
y =

Dear ,

Facts:

This letter is in reference to the letter of Date1, as amended, from the authorized
representative of Foundation. As amended, Foundation is requesting four rulings respecting
certain issues arising under §§ 501(c)(3), 512, 513, and 514 of the Internal Revenue Code.

Foundation is an organization recognized by the Internal Revenue Service (Service) on
Date 3 as exempt from federal income tax under § 501(c)(3), and was originally determined to
be not a private foundation within the meaning of § 509(a) because it was described in
§ 509(a)(3). Foundation was a supporting organization of only one supported organization,
Association. Association is a membership organization for m coaches at the collegiate and high
school levels. It is recognized as exempt from federal income tax under § 501(c)(6). On Date
2, Foundation’s public charity status was modified to §§ 509(a)(1) and 170(b)(1)(A)(vi).
Foundation states that it was formed at the behest of Association to carry out charitable
activities, from time to time, of interest to Association and its members.

Foundation states that its primary activity is operating Museum. Museum is located in the
heart of City, adjacent to and connected with a new multi-purpose sports arena. Museum is a
centerpiece in efforts that are being made to rejuvenate City central area. The mission of
Museum is to educate and inform the public about amateur m and m coaching, and their history,
and to inculcate in the public the values inherent in certain character traits. Foundation hopes
that visitors to Museum, through contact with its interactive displays, will acquire increased
knowledge and appreciation for the game of amateur m (particularly men’s college m), its rich
heritage and tradition, and the values and life lessons that it teaches.

Foundation states that Museum building is owned by City. City delegated the
management of both the sports arena and Museum to a development/management company,
Management. Foundation built Museum in Museum building and operates Museum under a
contract with Management. Under this contract, Foundation does not pay rent either to
Management or City, but Foundation is responsible for all Museum operating expenses and
capital improvements.

The funding necessary to construct Museum came from a variety of resources including a
grant from City that was financed through bonds issued by City, private donations, and loans
from City and a private banking institution. With respect to the loans, City loaned Foundation
money with an interest rate of percent, which is due to be paid no later than years after
the date the loan was made. The bank provided a _-year line of credit bearing an interest
rate of percent. Foundation drew on the line of credit in order to complete construction of
Museum. Other than repayment of the loans owed to City and the bank, Foundation does not
have any outstanding debt related to the construction and improvement of Museum.
Foundation states that it is not required to repay the grant received from City.

Foundation states that it rents Museum to businesses, clubs, and other groups and
individuals for business meetings, retreats, weddings, parties, and other private events. During
Foundation’s 2008 through 2010 fiscal years, Museum was available to the general public from
83 to 89 percent of the time it was open, and was available to private parties from 11 to 17
percent of the time it was open.

Foundation states that it provides a lounge and snack bar in Museum allowing patrons to
watch college m games on television sets located throughout the area. Visitors can purchase
drinks and snacks from several vending machines located in this area. Foundation is entitled to
receive a percentage of the price for each item sold from the vending machines. The
percentage varies depending on the product sold. The vending machines themselves are
owned by an unrelated third party who is responsible for making sure the vending machines
properly work and are stocked with food and drink.

Foundation states that it has entered into a licensing agent agreement (Licensing
Agreement) that grants authority to a third party to act as agent on behalf of Foundation in
licensing the trademarks owned by Foundation. The agent has the exclusive right under the
Licensing Agreement to develop a public relations, advertising, and marketing program for
Foundation’s trademarks and to implement a plan using third party licensees to commercialize,
license, and/or sell various products or services which bear or otherwise incorporate

Foundation’s trademarks, except in City, and the area within a —-mile radius of City. As part of
the Licensing Agreement, the agent negotiates on behalf of Foundation the business terms and
conditions of agreements between Foundation and any third party licensee, who is subject to the
same restrictions as the agent on the use of Foundation’s trademarks. The terms of an
agreement entered into between Foundation and a third party licensee varies depending on the
agreement reached among the parties. However, in general, the payments received by
Foundation from the agreements for the use of its trademarks are based on either a percentage
of the gross sales of the licensed products or services using Foundation’s trademarks or a flat
sum that is paid on at least an annual basis. The agent collects the amounts due from the third
party licensees and then remits the amounts collected to Foundation. In addition, Foundation is
not required to provide any goods or services in connection with any agreement entered into
with a third party licensee. The Licensing Agreement provides Foundation with the right of final
approval as to any particular arrangement with a third party licensee, including the terms and
conditions of such arrangement. Also, the agent is required to review each third party licensee’s
use of Foundation’s trademarks, including (if necessary) visiting a third-party licensee's
manufacturing facilities, to insure the quality control of Foundation’s trademarks. In exchange
for receiving these services, Foundation has agreed to pay the agent a percentage of the gross
revenues collected from the third party licensees.

Foundation states that Management annually receives sponsorship payments from the
initial sponsors (Founding Partners) of the sports arena. Foundation is entitled initially to
receive $x from these sponsorship payments from Management, with such amount increased by

percent each year. This amount will also be increased by an amount agreed to by
Foundation and Management for each new sponsor of the sports arena. Foundation also
receives sponsorship payments from various colleges and universities in exchange for
Foundation displaying each school’s logo.

Foundation states that it receives sponsorship payments for and revenue from ticket sales
to attend the annual honor induction ceremonies. Each sponsor's name and/or logo is
displayed on signs, programs, and pamphlets associated with the ceremonies.

Foundation states that it is commencing a financial assistance program to benefit
Association members, who are also coaches or retired coaches. Foundation states that it will
provide financial assistance and may provide other assistance, such as crisis referral and
counseling services, to Association members who have demonstrated financial or emotional
need, including but not limited to need, due to job loss, serious illness, death of a family
member, disaster, or other appropriate circumstances. Foundation states that it intends to
pursue this program to the extent its human and financial resources permit it to do so. The
program is particularly aimed at helping the members of the high school and college m coaching
profession who suffer severe economic strain due to job loss. For example, Foundation states,
when a college head m coach loses his job, all of the assistant coaches customarily lose their
jobs as well. The head coach may get a lucrative buyout package or a severance package.

The assistant coaches, however, normally get little or no notice that they are going to lose their
jobs and receive few if any severance benefits. As a result, the assistant coaches in this kind of
situation, which is not unusual, frequently encounter severe difficulty in meeting their living
needs and paying their financial obligations. In this situation, even a modest amount of financial

assistance to the assistant coach might be quite meaningful to him and the members of his
family.

Foundation states that Association currently has approximately members, although
the exact number changes from time to time. However, Foundation expects that this number
will remain reasonably constant in the future. Foundation believes that the number of such
persons who would meet the assistance criteria at any given time would likely be small.
Foundation’s financial assistance program will be set forth in writing and will include appropriate
criteria to assure that assistance is provided only to individuals who are eligible members of the
charitable class. Such criteria will include demonstrable financial or emotional need.

Foundation states that assistance will be granted by a committee established by
Foundation consisting, at least in part, of persons with a social work or other relevant
background, and less than a majority of the committee will, at any time, be individuals who are
directors or officers or key employees of Foundation. No director or officer or key employee of
Foundation, while serving in such capacity, or any family member of a director of officer or key
employee of Foundation, while the director or officer of key employee is serving in such
capacity, may be granted financial assistance by Foundation.

Foundation states that the amount of financial assistance that it is able to provide to any
given recipient of aid will be determined by the committee. The amount of aid will vary from
time to time depending upon Foundation’s financial resources. Foundation states that the
amount of aid that will be available to be given to any individual under the program is $y, a
relatively small amount.

Foundation states that Association will not in any of its membership literature characterize
or tout or publicize Foundation’s financial assistance program as a benefit of Association
membership. Thus, the operation of Foundation’s program will not confer upon or result in any
benefit accruing to Association. However, in order to make potential recipients of assistance
from Foundation aware of the program, at Foundation’s request Association will from time to
time include in Association’s magazine, and in other materials disseminated by Association,
basic information about the availability of assistance through the program. This information will
make it clear that the program is operated by Foundation and will refer interested persons to
Foundation.

Rulings Requested:

Specifically, Foundation is requesting the following rulings:

1. Foundation’s status under § 501(c)(3) will not be jeopardized or adversely affected by
   the activities of the Foundation as described in this ruling request, including in
   particular Foundation’s implementation and operation of its financial assistance
   program.

2. Museum is not debt-financed property under § 514.

3. Income generated by the vending machines in Museum is not unrelated business
   taxable income under § 512.

4. The payments received by Foundation pursuant to the Licensing Agreement are
   royalties within the meaning of § 512(b)(2).

Law:

Section 170(b)(1)(A)(vi) describes, in part, an organization which normally receives a
substantial part of its support (exclusive of income received in the exercise or performance by
such organization of its charitable, educational, or other purpose or function constituting the
basis for its exemption under § 501(a)) from direct or indirect contributions from the general
public.

Section 501(c)(3) provides for the exemption from federal income tax of organizations
organized and operated exclusively for religious, charitable, or educational purposes so long as
no part of the organization's net earnings inures to the benefit of any private shareholder or
individual.

Section 501(c)(6) provides, in part, for the exemption from federal income tax of business
leagues, chambers of commerce, real-estate boards, boards of trade, not organized for profit
and no part of the net earnings of which inures to be benefit of any private shareholder or
individual.

Section 509(a) provides, in part, that the term “private foundation” means a domestic or
foreign organization described in § 501(c)(3) other than organizations described in §§ 509(a)(1),
(2), (3), and (4). Section 509(a)(1) is defined as an organization described in § 170(b)(1)(A)
(other than in clauses (vii) and (viii).

Section 512(b)(2) provides that there shall be excluded from the definition of unrelated
business taxable income all royalties (including overriding royalties) whether measured by
production or by gross or taxable income from the property and all deductions directly
connected with such income.

Section 513(a) provides, as a general rule, that the term "unrelated trade or business:
means, in the case of any organization subject to the tax imposed by § 511, 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 its charitable, educational, or other purpose or function
constituting the basis for its exemption under § 501.

Section 514(a) provides for the taxation of unrelated debt-financed income in computing
under § 512 the unrelated business taxable income for any taxable year.

Section 514(b)(1) defines the term “debt-financed property” as any property which is held
to produce income and with respect to which there is an acquisition indebtedness (as defined in
§ 514(c)) at any time during the taxable year.

Section 514(b)(1)(A)(i) provides that the term “debt financed property” does not include
any property substantially all the use of which is substantially related (aside from the need of the
organization for income or funds) to the exercise or performance by such organization of its
charitable, educational, or other purpose or function constituting the basis for its exemption

under § 501.

Section 514(b)(1)(B) provides, in part, that the term “debt-financed property” does not
include any property to the extent that the income from such property is taken into account in
computing the gross income of any unrelated trade or business.

Section 514(c) defines the term “acquisition indebtedness,” with respect to any debt-
financed property, as the unpaid amount of (A) the indebtedness incurred by the organization in
acquiring or improving such property; (B) the indebtedness incurred before the acquisition or
improvement of such property if such indebtedness would not have been incurred but for such
acquisition or improvement: and (C) the indebtedness incurred after the acquisition or
improvement or such property if such indebtedness would not have been incurred but for such
acquisition or improvement and the incurrence of such indebtedness was reasonably
foreseeable at the time of such acquisition or improvement.

Section 1.512(b)-1(b) of the Income Tax Regulations provides that royalties, including
overriding royalties, and all deductions directly connected with such income shall be excluded in
computing unrelated business taxable income. However, for taxable years beginning after
December 31, 1969, certain royalties from and certain deductions in connection with either
debt-financed property (as defined in § 514(b)) or controlled organizations (as defined in
paragraph (1) of this section) shall be included in computing unrelated business taxable income.

Section 1.513-1(d)(1) provides, in general, that gross income derives from “unrelated
trade or business,” within the meaning of § 513(a), if the conduct of the trade or business which
produces the income is not substantially related (other than through the production of funds) to
the purposes for which exemption is granted. The presence of this requirement necessitates an
examination of the relationship between the business activities which generate the particular
income in question — the activities, that is, of producing or distributing the goods or performing
the services involved — and the accomplishment of the organization's exempt purposes.

Section 1.514(c)-1(a)(1) defines “acquisition indebtedness,” with respect to debt-financed
property, as the outstanding amount of (i) the principal indebtedness incurred by the
organization in acquiring or improving such property, (ii) the principal indebtedness incurred
before the acquisition or improvement of such property if such indebtedness would not have
been incurred but for such acquisition or improvement, and (iii) the principal indebtedness
incurred after the acquisition or improvement of such property if such indebtedness would not
have been incurred but for such acquisition or improvement and the incurrence of such
indebtedness was reasonable foreseeable at the time of such acquisition or improvement.

Section 1.514(b)-1(b)(1)(i) provides, in part, that to the extent that the use of any property
is substantially related (aside from the need of the organization for income or funds or the use it
makes of the profits derived) to the exercise or performance by an organization of its charitable,

educational, or other purpose or function constituting its basis for exemption under § 501, such
property shall not be treated as “debt-financed property.” See § 1.513-1 for principles
applicable in determining whether there is a substantial relationship to the exempt purpose of
the organization.

Section 1.514(b)-1(b)(1)(ii) provides that if substantially all of any property is used in a
manner described in § 1.514(b)-1(b)(1)(i), such property shall not be treated as “debt financed
property.” In general, the preceding sentence shall apply if 85 percent or more of the use of
such property is devoted to the organization's exempt purpose. The extent to which property is
used for a particular purpose shall be determined on the basis of all the facts and
circumstances. These may include a comparison of the portion of time such property is used for
exempt purposes with the total time such property is used.

Rev. Rul. 74-399, 1974-2 C.B. 172, describes the operation of a dining room, cafeteria,
and snack bar by an exempt art museum for use by the museum staff, employees, and
members of the public visiting the museum. The patronage of the eating facilities by the general
public is not directly or indirectly solicited, and the facilities contemplated are not designed to
serve as a public restaurant but merely to serve the exempt purposes of the museum. The
facilities are not directly accessible from the street. The operation of the eating facilities within
the museum premises helps to attract visitors to the museum exhibits. The revenue ruling holds
that the operation of the eating facilities by the museum under the particular circumstances is
substantially related to the museum’s exempt purposes and consequently is not unrelated trade
or business within the meaning of § 513 of the Code.

Rev. Rul. 81-178, 1981-2 C.B. 135, holds that payments an exempt organization receives
from various business enterprises for the use of the organization's trademark and similar
properties are royalties within the meaning of § 512(b)(2). The revenue rulings states that to be
a royalty, a payment must relate to the use of a valuable right. Payments for as the use of
trademarks, trade names, service marks, or copyrights, whether or not payment is based on the
use made of such property, are ordinarily classified as royalties for federal tax purposes.
Similarly, payments for as the use of a professional athlete’s name, photograph, likeness, or
facsimile signature are ordinarily characterized as royalties. On the other hand, royalties do not
include payments for personal services. However, the revenue ruling states that the mere
retention of quality control rights by a licensor in a licensing agreement situation does not cause
payments to the licensor under the agreements to lose their characterization as royalties.

Analysis:

An activity carried on by an organization described in § 501(c)(3) that is “substantially
related” to the exercise or performance of its exempt purpose, within the meaning of § 1.513-
1(d), will not constitute unrelated trade or business under § 513a.

Foundation's financial assistance program is designed to provide modest financial
benefits and services such as crisis referral and counseling to Association members who have
demonstrable financial or emotional need, and who have suffered severe economic strain due
to various circumstances, including job loss in particular. A committee of persons, consisting at

least in part of persons with social work or other relevant backgrounds, will grant the assistance.
Less than a majority of the committee will be composed of directors or officers or key
employees of Foundation. Association’s members constitute a large and indefinite number or
persons and are not considered to be a closed class. For these reasons, Foundation’s financial
assistance program is considered to be charitable within the meaning of § 501(c)(3).

Foundation used a variety of funding to construct Museum, including grants financed
through bond issuance, private donations, and loans from City and a private banking institution.
Other than repayment of the loans owed to City and the bank, Foundation does not have any
outstanding debt related to the construction and improvement of Museum. Since such debt,
however, constitutes “acquisition indebtedness” under § 514(c), Museum would be considered
debt-financed property under § 514(b) unless an exception applied.

Under § 514(b)(1)(A)(i), the term “debt-financed property” does not include any property
substantially all of the use of which is substantially related to the exercise or performance by an
organization of its exempt purpose. Section 1.514(b)-1(b)(1) provides that “substantially all of
the use” of a property is substantially related to exempt purposes if 85 percent or more of the
property is devoted to the organization's exempt purpose. With regards to Foundation,
Museum, the property for which Foundation incurred the debt, is generally available to the
general public for more than 85 percent of the total time it is open. Therefore, comparing the
portion of time the Museum is used for exempt purposes with the total time it is used, the facts
show that 85 percent or more of the Museum is devoted to Foundation’s tax exempt purposes.
But even if Museum were open to the general public less than 85% of the time, Museum would
still not be considered debt-financed property. Under § 514(b)(1)(B), “debt-financed property”
does not include any property to the extent that the income from such property is taken into
account in computing the gross income of any unrelated trade or business. Since the income
from the rental of Museum to private parties would be taken into account in computing
Foundation’s gross income from unrelated trade or business, Museum would not be considered
debt-financed property to the extent it is open for private events. Consequently, no part of
Museum would be considered debt-financed property.

Pursuant to Rev. Rul. 74-399, supra, and under the circumstances presented,
Foundation's income from its vending machines in Museum at times when Museum is open to
the general public would be considered to be substantially related to Foundation’s exempt
purpose, and would not be considered as unrelated business income.

Pursuant to Rev. Rul. 81-178, supra, payments that an exempt organization receives from
various business enterprises for the use of the organization's trademark and similar properties
are royalties within the meaning of § 512(b)(2). In this case, the payments received by
Foundation pursuant to agreements for the use of its trademarks are based on either a
percentage of the gross sales of the licensed products or a flat sum paid on at least an annual
basis. Foundation is not required to provide any goods or services in connection with any
agreement entered into with a third party licensee. Foundation has the right of final approval as
to any particular arrangement with a third party licensee, including the terms and conditions of
such arrangement. Foundation's income in this manner is therefore considered to be royalties
within the meaning of § 512(b).

Conclusions:
Accordingly, based on the facts and circumstances as stated above, we rule as follows:

1. Foundation’s status under § 501(c)(3) of the Code will not be jeopardized or adversely
   affected by the current activities of the Foundation as described in this ruling letter,
   including, in particular, Foundation’s implementation and operation of its financial
   assistance program.

2. Museum is not considered to be debt-financed property of Foundation under § 514.

3. Income generated by the vending machines in Museum at times when Museum is
   open to the general public is not unrelated business taxable income under § 512.

4. The payments received by Foundation pursuant to the Licensing Agreement are
   royalties within the meaning of § 512(b)(2).

These rulings are based on the facts as they were presented and on the understanding
that there will be no material changes in these facts. Any changes that may have a bearing
upon Foundation’s tax status should be reported to the Service. Because it could help resolve
questions concerning Foundation’s federal income tax status, this ruling should be kept in
Foundation’s permanent records. Pursuant to a Power of Attorney on file in this office, a copy of
this letter is being sent to Foundation’s authorized representative.

Except as we have specifically ruled herein, we express no opinion as to the
consequences of these transactions under the cited provisions or under any other provision of
the Code.

These rulings will be made available for public inspection under § 6110 after certain
deletions of identifying information are made. For details, see enclosed Notice 437, Notice of
Intention to Disclose. A copy of this ruling with deletions that we intend to make available for
public inspection is attached to Notice 437. If you disagree with our proposed deletions, you
should follow the instructions in Notice 437.

These rulings are directed only to the organization that requested it. Section 6110(k)(3)
provides that they may not be used or cited as precedent.

If there are any questions about this ruling, contact the person whose name and telephone
number are shown in the heading of this letter.

Enclosure Sincerely yours,
Notice 437

Ronald J. Shoemaker
Manager, Exempt Organizations
Technical Group 2