Pre-existing IP licenses qualify for indirect-self-dealing exception

Plain-English summary

A private foundation inherited intellectual-property rights in a long-running television show together with licensing agreements granting a company owned by Y exclusive rights to exploit those assets. The foundation proposed transferring the rights and agreements to a controlled limited partnership and appointing Y as a director and officer. That appointment would ordinarily make Y and his wholly owned company disqualified persons, potentially turning payments under the agreements into self-dealing. The IRS ruled that the agreements would instead qualify for the regulatory exception for indirect self-dealing because the business relationship predated any self-dealing status, an independent study showed terms at least as favorable as an arm's-length transaction, and Y's knowledge and the company's services were uniquely valuable. Accordingly, after the transfer to the partnership, Y could serve as a director and officer without the agreements violating section 4941.

Ruling snapshot

• Question: After the intellectual-property rights and agreements are transferred to the controlled partnership, may Y serve as a foundation director and officer without the partnership's agreements with Y's company becoming prohibited self-dealing?
• Outcome: approved
• Key authorities: IRC §§ 4941 and 4946; Treas. Reg. §§ 53.4941(d)-1 and 53.4941(d)-2

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201703004 Third Party Communication: None
Release Date: 1/20/2017 Date of Communication: Not Applicable
Index Number: 4941.04-00
Person To Contact:
-------------------------- -----------------------, ID No. --------------
-------------------------------- Telephone Number:
-------------------------------- ----------------------
Refer Reply To:
CC:TEGE:EOEG:EO1
PLR-112871-16
Date:
October 14, 2016

Organization = --------------------------------------
X = ----------------------
State1 = --------------
Corporations = -------------------------
Y = ---------------------
Company = -------
Show = ----------------------------------------------------------

Dear ----------------:

This is in response to Y’s letter dated April 4, 2016, in which Y requested a ruling with
respect to § 4941of the Internal Revenue Code.

FACTS

Organization is an exempt organization described in § 501(c)(3) and classified as a
private foundation under § 509(a). Organization is a foundation under the laws of
State1 dedicated to supporting children, education, and health services.

X, hosted Show for many years on television, during which he became an American
icon. During X’s career he was able to negotiate an agreement with the television
network for the copyrights, name and likeness rights, and publicity rights to Show and
other special shows. During X’s life these copyrights, name and likeness rights, and
publicity rights were held by two corporations (collectively Corporations), S corporations
held entirely by a taxable trust in X’s name.

X and Y, are family members that are not described in § 4946(d). X and Y had an
employment relationship that spanned several decades. Over the decades, Y was
employed on Show and started as a summer intern and worked his way up to producer.
PLR-112871-16 2

During the years that Y was employed on Show, he traveled closely with X and became
his confidant, trusted advisor, and creative partner.

After X’s retirement, Y continued to work with X to manage the licensing of the episodes
of Show and evaluate other projects. Y worked with X to help distribute episodes of
Show. Y gained a deep understanding over time of the content of the episodes of Show
and other intellectual property (licenses and copyrights) associated therewith, and
therefore acquired an encyclopedic knowledge of all of the episodes of Show.

Based upon their long-term relationship, X decided to grant the exclusive right to market
Show to Company, an organization wholly owned by Y, by entering into license
agreements between Corporations and Company. The license agreements between
Corporations and Company gave Company the sole and exclusive rights to license,
rent, lease, exhibit, distribute, reissue, and deal in the episodes of Show (and the
movies created therefrom) as well as all ancillary rights, including merchandising and
music rights of Show. The license agreements between the companies provided a
profit share in the revenue from the use of these rights with a majority to Corporations
and the remainder to Company. The license is just over half way beyond the term of
the license. The agreement could have been terminated by X at any time prior to his
death, and the agreement would be terminated if Y lost control of 100 percent of
Company or no longer otherwise controlled Company.

Upon X’s death and through the administration of his estate, the rights and privileges
associated with the episodes of Show owned by Corporations were distributed to
Organization by the terms of the trust that owned Corporations. Additionally, the license
agreements between Corporations and Company were transferred to Organization.

After Organization received the rights and privileges associated with the episodes of
Show, a separate agreement was entered into between Organization and Company as
to publicity rights. This agreement provides Company the exclusive right to license any
publicity rights for X’s name and likeness.

Y has been an advisor to Organization. Organization has represented that at no point
has this advisory role risen to the level of managing Organization as described in
4946(b)(1).1 Y does not participate in governance or financial decisions regarding
Organization, including, but not limited to investment or operational expenses. Y’s long
and close relationship with X enables Y to advise Organization about the types of
charitable work that X desired with regard to Organization. Additionally, Y’s presence
as an advisor enables Y to support Organization’s charitable work by providing access
to nonpublic stories about X to share with donees. For these reasons, Organization

1
While Y has never acted as a director for Organization, Y had been appointed as a director of
Organization’s predecessor foundation by X. Y resigned as the director of the predecessor foundation
during the administration of X’s estate. Subsequently, the predecessor foundation merged into
Organization.
PLR-112871-16 3

represents that Y provides unique attributes that would be beneficial to furthering
Organization’s exempt purpose. Organization also states that appointing Y as an officer
and a director is consistent with X’s wishes. Therefore, Organization wants Y to serve
as a director and officer of Organization.

Further, Organization has reviewed its assets and thinks it is in its best interest to
transfer the license agreements, copyrights, publicity rights agreement and
name/likeness rights from the episodes of Show into a limited partnership, LP. The
transfer of the intellectual property rights into LP will provide greater liability protection to
Organization and its other assets in the event of any litigation related to the intellectual
property rights. LP will receive passive income in the form of royalties and license fees
and will not engage in any other activities or earn income from any other source.
Organization plans on creating a wholly owned corporation that will then be the general
partner of LP and hold a one percent share of the interest of LP. The remaining ninety-
nine percent of the ownership of LP would belong to Organization as a limited partner.
LP would engage in no activities other than holding and managing all of the intellectual
property rights associated with the episodes of Show and would retain the license
agreements and publicity rights agreement for those rights with Company.

Organization commissioned a report produced by a third party entertainment consulting
firm that shows that Company holds a unique advantage over others for licensing rights
to these episodes. The report’s conclusion relies on the long relationship between X
and Y, the long and continuous work on the episodes of Show that make up the basis of
the intellectual property, and the trust X put in Y over multiple decades. The report also
provides information on a proprietary system used by Company to search and access
the numbers of interviews, skits, or general themes present in the episodes. Finally, the
report provides that Y, due to his experience with X, has an encyclopedic knowledge of
the episodes providing a real time response to the types of clips and videos that might
be available to a potential user. For these reasons, the consulting firm concludes that
Company, as run by Y, provides a unique service for the sell, licensing, and distribution
of Organization’s intellectual property rights in X’s episodes that could not be matched
by other firms or systems without substantial harm to Organization’s income from
licensing the rights to the episodes. The report also concludes that Company can
perform the services at a much lower cost of operations because of Y’s deep knowledge
and ability to catalogue, find, and describe the necessary clips on his own, providing
much lower overhead than other firms in that industry. The lower overhead leads to a
return that is at least as favorable as can be found from other firms offering similar
services.

Company’s sole business is to license, rent, lease, exhibit, distribute, reissue, and deal
in the Show episodes (and the movies created therefrom) as well as all ancillary rights,
including merchandising and music rights for these episodes of Show. Company has
no other business and is not in a position to perform similar services for other
entertainment material. Y’s knowledge of X’s work makes Y uniquely capable of
PLR-112871-16 4

handling these rights for those episodes, and he could not perform the same services
for other materials as he lacks the requisite knowledge and experience.

RULINGS REQUESTED

The following ruling has been requested:

   Following the transfer of the license agreements, copyrights, publicity rights
   agreement and name/likeness rights to the LP, Y, sole owner of Company, will
   be able to serve as a director and officer of Organization without violating the
   provisions against direct or indirect self-dealing transactions with Organization
   within the meaning of IRC § 4941 and Treas. Reg. § 53.4941-1(b)(1).

LAW & ANALYSIS

Section 4941(a) of the Code, in part, imposes a tax on each act of self-dealing between
a private foundation and a disqualified person. The tax is imposed on the disqualified
person and, in certain situations; a tax is also imposed on the foundation manager(s)
participating in the act or acts.

Section 4941(d)(1) of the Code provides in part, that the term self-dealing includes the
direct or indirect sale, exchange, or leasing of property between a private foundation
and a disqualified person; furnishing of goods, services, or facilities between a private
foundation and a disqualified person; payment of compensation (or payment or
reimbursement of expenses) by a private foundation to a disqualified person; and
transfer to, or use by or for the benefit of, a disqualified person of the income or assets
of a private foundation.

Section 4946(a)(1) of the Code provides that the term “disqualified person” means with
respect to a private foundation, a person who is …(B) a foundation manager (within the
meaning of subsection (b)(1))… (E) a corporation of which persons described above
(including foundation manager) own more than 35 percent of the combined voting
power.

Section 4946(b)(1) of the Code provides that the term foundation manager means with
respect to a private foundation (1) an officer, director, or trustee of a foundation (or an
individual having powers or responsibilities similar to those officers, directors, or
trustees of the foundation).

Section 53.4941(d)-1(a) of the Foundation and Similar Excise Tax Regulations provides
in part that the term “self-dealing” means any direct or indirect transaction described in
section 53.4941(d)-2 of the Regulations.
PLR-112871-16 5

Section 53.4941(d)-1(b)(1) of the Regulations provides in part that the term “indirect
self-dealing” shall not include transactions described in section 53.4941(d)-2 between
a disqualified person and an organization controlled by a private foundation if-

(i) The transaction results from a business relationship which was established before
such transaction constituted an act of self-dealing (without regard to this paragraph),

(ii) The transaction was at least as favorable to the organization controlled by the
foundation as an arm's length transaction with an unrelated person, and

(iii) Either-

    (a) The organization controlled by the foundation could have engaged in the
    transaction with someone other than a disqualified person only at a severe
    economic hardship to such organization, or

    (b) Because of the unique nature of the product or services provided by the
    organization controlled by the foundation, the disqualified person could not have
    engaged in the transaction with anyone else, or could have done so only by
    incurring severe economic hardship.

RULING:

Barring any exceptions, appointing Y as an officer or director of Organization would
result in a situation whereby payments under the license agreements would be acts of
self-dealing that are prohibited by Chapter 42 of the Internal Revenue Code. Section
4941 imposes a tax on an act of self-dealing between a private foundation and a
disqualified person. Section 4946 defines a disqualified person as any foundation
manager, which the code defines as any officer, director, or trustee of the foundation,
and any company that is at least thirty-five percent owned by a foundation manager. If
Y were appointed as an officer or director of Organization, then Y would become a
disqualified person as a foundation manager and his wholly owned corporation,
Company, would also become a disqualified person.

Section 4941(d)(1)(D) provides that self-dealing includes, in part, the compensation by a
private foundation for the services of a disqualified person. Congress initially created
the prohibition on self-dealing so as to prevent any need for costly and ambiguous fair-
market evaluations between the private foundations and insiders that Congress saw as
creating opportunities for avoiding taxes. General Explanation of the Tax Reform Act of
1969, p. 31 (December 3, 1970). Currently, Organization is a private foundation that
owns the intellectual property rights to the various episodes featuring X, and it grants to
Company the exclusive right to license, lease, and otherwise exploit the copyrights,
name and likeness rights, and publicity rights in exchange for a majority interest in the
profits therefrom through the license agreements and publicity rights agreement. If Y
PLR-112871-16 6

and Company become disqualified persons through Y’s appointment as a director of
Organization, transactions under the license agreements and the publicity rights
agreement would constitute acts of self-dealing between a private foundation and its
disqualified persons, unless one of the self-dealing exceptions apply, such as the
exception described in § 53.4941(d)-1(b)(1).

Based on the information provided, after the transfer to LP, the license agreements and
the publicity rights agreement between LP and Company will satisfy the exception to
self-dealing found in § 53.4941(d)-1(b)(1). Section 53.4941(d)-1(b)(1) requires three
findings for a transaction to be excepted from indirect self-dealing: (1) the transaction
must stem from a business relationship that was established before the transaction
constituted an act of self-dealing; (2) the transaction must be at least as favorable to the
organization controlled by a private foundation as an arm’s length transaction; and (3)
either the organization controlled by the private foundation would suffer an extreme
economic hardship if it could not do business with the disqualified person, or the
products or services provided by the organization controlled by the private foundation
are so unique that it would cause extreme economic hardship for the disqualified
person.

First, the transactions under the agreements must be indirect acts of self-dealing
between a subsidiary organization of a private foundation and a disqualified person.
Organization’s proposed transaction will transfer its copyrights, license agreements,
publicity rights agreements and name/likeness rights to LP, creating an indirect
relationship between a subsidiary organization of the Organization and disqualified
person to which the exception may apply.

Second, the three requirements of the exception in § 53.4941(d)-1(b)(1) are met. Under
these facts, Organization’s business relationship with Y and Company related to the
licensing of the rights to the Show episodes began more than five years prior to
Organization’s ownership of the rights to the episodes. The original license agreement
did not involve any private foundations thus Chapter 42 of the Internal Revenue Code
did not apply; the business relationship was established long before the possible
applicability of any self-dealing rules. Further, the publicity rights agreement stems
directly from the license agreement and the business relationship established therein.
Organization has also provided an independent study showing that the gains from the
agreements are at least as favorable as could be achieved through an arm’s length
transaction and that the services provided by Company and Y are highly unique, and
could not be obtained elsewhere without a significant loss in economic value for
Organization and could not be provided by Company to others. The fact that
Organization is transferring these rights to LP, such that the transactions at issue will be
between an organization controlled by Organization and the disqualified persons, does
PLR-112871-16 7

not alter the finding of the requisite prior business relationship and the showing of
economic harms within the meaning of § 53.4941(d)-1(b)(1)(i)-(iii).2

Accordingly, based on the representations, the license agreements and publicity rights
agreement between Company and LP will not result in indirect acts of self-dealing for
purposes of section 4941 due to the exception in § 53.4941-1(b)(1), if Organization
appoints Y as a director and officer.

CONCLUSION

In light of the foregoing, we rule as follows:

    Following the transfer of the license agreements, copyrights, publicity rights
    agreement and name/likeness rights to the LP, Y, sole owner of Company, will
    be able to serve as a director and officer of Organization without violating the
    provisions against direct or indirect self-dealing transactions with Organization
    within the meaning of IRC § 4941 and Treas. Reg. § 53.4941-1(b)(1).

This ruling will be made available for public inspection under section 6110 of the Code
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.
This ruling is directed only to the organization that requested it. Section 6110(k)(3) of
the Code provides that it may not be used or cited by others as precedent.

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for rulings, it is subject to verification on examination.

No ruling is granted as to whether Organization qualifies as an organization described in
§ 501(c), and except as expressly provided herein, no opinion is expressed or implied
concerning the tax consequences of any aspect of any transaction or item discussed or
referenced in this letter.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

2
In this regard we note that an indirect relationship between subsidiary organizations and disqualified
persons would have existed without the formation of LP if X’s estate had transferred the Corporations
owning the rights and privileges to the Show to Organization, rather than the rights and privileges
separately.
PLR-112871-16 8

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

                                   Sincerely,



                                   Theodore Lieber
                                   Senior Tax Law Specialist
                                   (Tax Exempt & Government Entities)

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