School may issue endowment units to charitable trusts without UBTI

Plain-English summary

A tax-exempt school served as trustee and sole charitable remainder beneficiary of a charitable remainder unitrust. It proposed issuing contractual units tied to its pooled endowment so the trust could share the endowment's investment returns without directly owning the underlying assets or forming a partnership. The school would charge no management or trustee fee, although it could recover actual endowment-management and trust-administration costs. The IRS ruled that issuing and making payments on the units and receiving those cost reimbursements would not generate unrelated business taxable income to the school. The same conclusion would apply to similarly structured units issued to other charitable remainder trusts for which the school served in the same roles and charged no fees.

Ruling snapshot

• Question: Would issuing endowment-linked units to charitable remainder trusts and recovering actual costs create unrelated business taxable income for the school?
• Outcome: approved
• Key authorities: IRC §§ 501(c)(3), 512, and 513; Treas. Reg. § 1.513-1; Rev. Rul. 69-528

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201730019 Third Party Communication: None
Release Date: 7/28/2017 Date of Communication: Not Applicable
Index Number: 512.00-00, 512.04-00,
513.00-00, 513.01-00 Person To Contact:
-------------------------, ID No. --------------
-------------------------------------- Telephone Number:
------------------------- ----------------------
---------------------------------------- Refer Reply To:
------------------------------------------------------------ CC:TEGE:EOEG:EO1
---------------------------------------------- PLR-139754-16
Date:
April 26, 2017

School = --------------------------------------
Trust = ------------------------------------------------------

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

This letter responds to a letter from your authorized representative dated December 22,
2016, and subsequent correspondence, requesting a ruling that the issuance of units
from School to Trust, the making or receipt of payments with respect to the units, and
the holding and redemption of units, all as described in this ruling letter, will not
generate unrelated business taxable income to School. School represents the facts as
follows.

FACTS

School is an educational institution recognized as a tax-exempt organization described
in §§ 501(c)(3) and 170(b)(1)(A)(ii) of the Internal Revenue Code.1 School’s Investment
Committee has the responsibility for managing School’s pooled endowment (the
"endowment"), in accordance with policies established by the Board of Trustees with
day-to-day recording responsibilities maintained by School’s business office. School
seeks to invest the endowment to receive maximum long-term benefits to support the
education of future School students in perpetuity.

Trust is a charitable remainder unitrust described in § 664(d)(2). School is the sole
charitable remainder beneficiary of Trust. Under the terms of the trust agreement,
Trust’s donor is entitled to an annual payout of a unitrust amount generally equal to a
percentage of the net fair market value of Trust’s assets. Upon the death of donor or a

1
The Internal Revenue Code of 1986, as amended, to which all subsequent “section” references are
made unless otherwise indicated.
PLR-139754-16 2

term of years, the remainder interest in Trust will be distributed to School as the
remainder beneficiary for its general charitable purposes.

School is the sole trustee, and in that capacity is the legal owner of the assets of Trust.
Aside from fees, paid to third parties, for services such as investment management and
tax preparation, School itself does not, and will not charge any fee for administrative
services and management of Trust. However, it may recover actual costs of
administering Trust as a charge against Trust.

School is concerned that it cannot deliver investment results matching those of the
endowment and that Trust cannot be diversified sufficiently unless they can be
commingled alongside all endowment assets. As trustee and remainder beneficiary,
School wants to achieve greater economies of scale in the management of Trust’s
assets, a potentially higher and more stable investment return for Trust, and increased
diversification of Trust’s investments. To this end, School intends to enable Trust to
participate indirectly in the return on School’s endowment.

In lieu of a partnership or a direct commingling, School proposes to create a contractual
obligation pursuant to which School would issue a contract right to Trust for its
endowment units ("units"). The value of the units, both at the time of acquisition and
redemption, will be based on the value of all underlying investment assets held in the
endowment. Each unit has a value of one dollar. The number of units is adjusted on a
quarterly basis, either upwards or downwards, to reflect changes to the value of the
endowment, so that the value of a unit is always set at one dollar.

Each unit will give Trust a contractual right to receive periodic payments based on the
number of units owned that would adjust based on the underlying value of the
endowment, allowing Trust to receive an investment return equal to that of the
endowment. Trust can choose to either reinvest part of the distribution in additional
units, or redeem units, depending on Trust’s cash requirements for meeting its minimum
distribution. Trust will treat payouts to its beneficiaries up to the endowment payout
amount and any additional distributions as ordinary income, regardless of the character
of the underlying income of the endowment (whether capital gain, ordinary income, or
return of capital).

The units will give Trust a contractual right to receive periodic payments from the
endowment, as determined by School, but no interest whatsoever in the underlying
investment assets of the endowment or with respect to other trusts also invested in units
with respect to the endowment. Except for the right to review the payout computation,
Trust will have no power or right of any kind to control, direct, supervise, recommend, or
review School’s business activities, operations, or decisions with respect to the
endowment. Trust will not have the right to veto or opt out of any of the underlying
endowment investments. The proposed contract provides that, with respect to the
issuance of units, School is neither a partner nor an agent of Trust. Trust will not be
PLR-139754-16 3

liable for any cost, expense, or payment incurred or due by School, or for which School
is liable or responsible, relating to the endowment (or the underlying endowment
assets). School will indemnify and hold Trust harmless from and against any liability
arising out of any action or inaction by School with respect to the endowment (or the
underlying assets). School also will pay any tax owed on unrelated business taxable
income earned by the endowment’s portfolio.

School will not charge a fee for internal management costs of Trust assets, although it
may recover its actual costs of management of the endowment as a charge against the
total investment return of the endowment. These charges will decrease the value of
Trust’s units. School also does not assess a trustee's fee or any other charge for the
administrative services it provides to Trust. However, it may recover the actual costs of
administration of Trust as a charge against Trust.

Trust is representative of a number of charitable remainder annuity trusts and charitable
remainder unitrusts with respect to which School has and will have the sole charitable
remainder interest and for which School will be the trustee. School will make units
available to these other trusts on the same terms as described in this letter for Trust,
including that it will not assess a trustee’s fee or any other charge for the administrative
services it will provide as trustee of any of these trusts.

LAW AND ANALYSIS

Section 501(c)(3), in part, describes as exempt from federal income tax entities
organized and operated exclusively for charitable, educational, scientific, and certain
other purposes.

Section 512(a)(1) 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 the allowable deductions which are directly connected with the
carrying on of such trade or business, both computed with the modifications provided in
§ 512(b).

Section 513(a) 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 the organization
for income or funds or the use it makes of the profits derived) to the exercise or
performance by such organization of its exempt purpose or function.

Section 513(c) provides 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. An activity does not lose its 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.
PLR-139754-16 4

Section 1.513-1(a) of the Income Tax Regulations (“regulations”) includes gross income
of an exempt organization subject to the tax imposed by § 511 in the computation of
unrelated business taxable income if: (1) it is income from a trade or business; (2) such
trade or business is regularly carried on by the organization; and (3) the conduct of such
trade or business is not substantially related (other than through the production of
funds) to the organization’s performance of its exempt functions.

Section 1.513-1(b) of the regulations provides that, for purposes of § 513, the term
“trade or business” has the same meaning it has in § 162, and generally includes any
activity carried on for the production of income from the sale of goods or performance of
services.

Rev. Rul. 69-528, 1969-2 C.B. 127, describes an organization that was formed to
provide investment services on a fee basis exclusively to organizations exempt under
§ 501(c)(3). The organization received funds from unrelated exempt organizations and
invested the proceeds in stocks, reinvested the income and realized appreciation, and
upon request, liquidated participant's interests and distributed the proceeds to the
participant. The Service held that providing investment services on a regular basis for a
fee is a trade or business ordinarily carried on for profit. The Service further held that
the activity would constitute an unrelated trade or business even if the services were
regularly provided by one tax-exempt organization for other tax-exempt organizations.

School’s situation is distinguishable from the entity in Rev. Rul. 69-528, which provided
investment services on a regular basis for a fee. School will not charge any fees for
managing Trust’s assets; it will only recover the actual costs of managing its
endowment as a charge against total investment return and any actual costs of
administering Trust as a charge against Trust.

School will receive no income from providing management services to Trust.
Accordingly, School’s services provided under the contractual agreement, as
represented, will not generate any income that could be characterized as unrelated
taxable income within the meaning of § 513.

CONCLUSION

Based solely on the facts and representations submitted, we rule that the contractual
arrangement described herein, under which School will issue units to Trust, make
payments on the units, and be reimbursed for costs allocable to the management of the
endowment or administration of Trust, will not generate unrelated business taxable
income to School. The same result will occur with respect to the issuance of any other
endowment units to any other charitable remainder trust or charitable remainder unitrust
with respect to which School has and will have the sole charitable remainder interest,
for which School will be the trustee, and to which School makes units available on the
PLR-139754-16 5

same terms as described in this letter for Trust, including that it will not assess a fee for
managing its endowment or for the administrative services it provides as trustee.

The ruling contained in this letter is based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an individual with authority to bind the taxpayer. This office has not verified any of
the material submitted in support of the request for rulings, and such material is subject
to verification on examination.

This letter does not address the applicability of any section of the Code or Regulations
to the facts submitted other than with respect to the sections specifically described, and,
except as expressly provided in this letter, no opinion is expressed or implied
concerning the federal income tax consequences of any aspects of any transaction or
item of income discussed or referenced in this letter. In particular, no opinion is
expressed or implied concerning whether income or loss from a surrender or
redemption of units is treated as ordinary income or loss or as gain or loss from the sale
or exchange of a capital asset. Additionally, no ruling is granted as to whether School
qualifies as an organization described in § 501(c) and/or § 509(a)(1), (2), or (3).

The Associate office will revoke or modify a letter ruling and apply the revocation
retroactively if there has been a misstatement or omission of controlling facts; the facts
at the time of the transaction are materially different from the controlling facts on which
the ruling was based; or, in the case of a transaction involving a continuing action or
series of actions, the controlling facts change during the course of the transaction. See
Rev. Proc. 2017-1, § 11.05.

Because it could help resolve questions concerning federal income tax status, this letter
should be kept in School’s permanent records.

This ruling letter is directed only to the taxpayer that requested it. Section 6110(k)(3)
provides that it may not be used or cited as precedent by anyone else.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.
PLR-139754-16 6

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

                                Sincerely,



                                David L. Marshall
                                Assistant Branch Chief
                                Exempt Organizations Branch 1
                                (TEGE Associate Chief Counsel)

Enclosure