V. Advertising and Other Business Activities
- General Internet Questions
For many Section 501(c)(3) charities,
the Internet presents not only the opportunity to advance their mission by enhancing
communications with existing members and reaching out to new constituents, but also the
opportunity to earn income through one of a variety of means. The Announcement refers to
certain of these potentially income-producing activities, including the following:
- banner exchanges
- hyperlinks to corporate sponsors
- links for which the exempt organization receives a payment based upon a
percentage of purchases made by the person who uses the hyperlink
- links for which the exempt organization receives a payment based on the
number of persons who use the hyperlink
- direct sales on a website
The Announcement states that the IRS is considering whether clarification is needed
regarding whether the income received from these activities is subject to UBIT. We address
each of these activities, and state our view regarding the advisability of specific
guidance, below.
- Banner exchanges
The Need for Guidance
This topic fits within Category Two (2) – an area where guidance can and should be
provided at this time regarding the manner in which current law applies in the Internet
context.
Existing Authority
Many organizations with websites include a list of links to other websites in which
their constituents might be interested. In a similar practice, an organization might agree
to provide information about and a link to another organization’s website on its own
website in exchange for a similar link on the other organization’s website.
Organizations may also trade banner or button space on their websites to promote each
other’s charitable activities. The IRS addressed banner exchanges informally in the
following article: Cheryl Chasin, Susan Ruth and Robert Harper, "Tax Exempt
Organizations and World Wide Web Fundraising and Advertising on the Internet," 2000
Exempt Organizations Continuing Professional Education Technical Instruction Program
Textbook, (hereinafter, "2000 CPE Text"). The IRS authors stated that it was
unclear whether banner exchanges should be treated like mailing list exchanges.
Under Section 513(h), the exchange of member lists among exempt organizations (i.e.,
organizations that are described in Section 501 and contributions to which are deductible
under paragraph (2) or (3) of Section 170(c)) is excepted from the definition of
"unrelated trade or business." Conceptually, a banner exchange between exempt
organizations is similar to a member list exchange. The reciprocal placement of hyperlinks
on each organization’s website allows members of one organization, who are the most
likely visitors to that organization’s website, to connect with another organization
which the first organization believes to be of interest and relevance to its members.
Recommendation
We recommend that the IRS issue guidance to clarify that banner exchanges between
Section 501(c)(3) organizations should, like membership list exchanges, be excluded
from the term "unrelated trade or business." Where banner exchanges are made
between a Section 501(c)(3) charity and an organization that is not a
Section 501(c)(3) charity, the determination of whether the activity produces
unrelated business taxable income will depend on the specific circumstances of the case.
In general, we believe that these types of banner exchanges are subject to the same
analysis as that applicable to links, discussed below.
- Hyperlinks to corporate sponsors
Recommendation
This issue was addressed in the Committee’s Comments on Notice of Proposed
Rulemaking: Prop. Treas. Reg. Section 1.513-4. In short, we agree that the IRS should
issue guidance clarifying that general corporate sponsorship principles will apply to an
organization’s Internet activities and that links to a sponsor’s website should
not be considered, in and of themselves, a substantial return benefit for purposes of that
Proposed Treasury Regulation. In addition, we believe this is an area where application of
the proposed “one link” safe harbor would be appropriate. Specifically, if it is
necessary for a viewer to make more than one link to reach a webpage containing
advertising or other information which would be considered a substantial return benefit,
then there should be no attribution with respect to the content on that page. If only one
link is required to reach a sponsor’s webpage, then there should be no negative
inference creating attribution.
- Links for which the exempt organization receives a percentage of purchases made by
the person linking over, and
- Links for which the EO receives a payment based on the number of persons who link
over
The Need for Guidance
These are Category Three (3) items — some guidance would
be helpful, such as through the development of one or more safe harbors, but definitive
guidance is not currently possible or advisable given the rapidly changing technology and
uses of the Internet. Because these two areas are closely related we discuss them
together.
Existing Authority
The treatment of payments received by an exempt organization as a result of links made
from its website poses a complicated question because of the variety of circumstances
under which a link could give rise to a payment. The characterization of the income
produced will therefore depend upon all of the facts and circumstances giving rise to the
payment. Under some circumstances, the item and thus the related income will be
substantially related to the mission of the exempt organization and will be characterized
as income from an exempt activity.
With respect to income from a purchase that cannot be considered substantially related
to an exempt organization’s mission, the 2000 CPE Text queries whether these types of
payments might be akin to the royalty payments received in the affinity credit card cases.
As this Committee discussed in our comments on the proposed corporate sponsorship
regulations, we believe this to be the appropriate characterization. In an affinity credit
card arrangement, a payment is made to the exempt organization for the use of its name and
logo on the credit card. The Tax Court has accepted the characterization of this payment
as a royalty, and therefore excluded from unrelated business income, in a series of cases,
most recently in Sierra Club, Inc. v. Commissioner, T.C. Memo 1999-86. Both the
payment of a percentage of purchases made by a person linking over from the exempt
organization’s website and the payment of a set amount based on the number of persons
linking over are akin to the payment of a percentage of purchases made on an affinity
credit card. In each case, the person reaches the retailer because of an interest in the
exempt organization that brings him or her to the organization’s website, and is
further induced to link to the retailer and/or to make a purchase based upon the fact that
the link or the purchase will result in income being directed to the exempt organization.
The click on the link and, where applicable, the subsequent purchase, are direct results
of the retailer’s connection to the exempt organization and therefore constitute a
use of the exempt organization’s name and logo. The fact that in some cases the
payment is based on a percentage of sales does not affect the treatment. A payment
calculated as a percentage of sales should be treated as a royalty in the same way that a
flat fee for the use of an intangible would be. GCM 38083 (Sept. 11, 1979).
Recommendation
As a result of the above, we believe that the proper treatment of such payments, if not
substantially related to the exempt organization’s mission, is as royalty payments.
While we believe that this result can be reached through the application of existing law,
we nonetheless classify this topic as a Category Three (3) item
and recommend that the IRS issue guidance, in order to avoid the uncertainty such as
existed regarding the appropriate treatment of income received in connection with affinity
credit cards.
- Direct sales on a website
The Need for Guidance
This fits within Category One (1), as an area where guidance
exists that can be generally applicable in the Internet context and no additional guidance
is necessary.
Recommendation
There is no reason that direct sales on an exempt organization’s website should be
treated differently from sales made in stores or through catalogues. Sales on a commercial
organization’s website that produce a payment of some sort to an exempt organization
should also be treated as under existing law.
- To what extent are business activities conducted on the Internet
regularly carried on under Section 512? What facts and circumstances are relevant in
determining whether these activities on the Internet are regularly carried on?
The
Need for Guidance
We view this as a Category Two (2) item — an area where
guidance can and should be provided regarding the manner in which current law applies in
the Internet context.
Existing Authority
The IRS has issued extensive guidance addressing the requirements for an activity to be
"regularly carried on" under Section 512. Overall, these rulings follow the
guidance contained in Treasury Regulation Section 1.513-1(c), in comparing the frequency
and continuity of the activity with the frequency and continuity with which the comparable
commercial activity is carried on "in light of the purpose of the unrelated business
income tax to place exempt organization business activities upon the same tax basis as the
nonexempt business endeavors with which they compete."
The facts and circumstances relevant in making that assessment with respect to on-line
unrelated trade or business activities might be slightly different than those for off-line
income producing activities, however. The IRS should consider the active involvement of
the organization with its website or, more specifically, any divisible portion of its
website that is income generating – how much time and energy is expended by the
organization and its staff members to update and monitor the income-producing portion of
its website? This activity should be aggregated with off-line activities to determine if
the activity is regularly carried on. For example, are staff members required to take
action to respond to website inquiries or fulfill orders placed on the website as a result
of the activity? There may be cases where the activity is merely to exercise quality
control over the use of the organization’s name, logo and website in, for example, an
affinity program. In that context, the activity should not be considered a regularly
carried on trade or business, regardless of whether the program remains posted on the
website for an extended period of time.
Recommendation
Because the facts and circumstances relevant to determining whether an Internet
activity is "regularly carried on" may differ from the facts and circumstances
relevant to off-line activities, we recommend that the IRS consider issuing precedential
guidance with examples targeted to whether Internet activities are "regularly carried
on."
- Are there any circumstances under which the payment of a percentage of
sales from customers referred by the exempt organization to another website would be
substantially related under Section 513?
The Need for Guidance
This very narrow question falls within Category One (1) —
an area where no guidance is necessary because guidance exists under current law that can
be generally applied in the Internet context.
Scope of Question and Recommendation
The specific question asked in the Announcement is very narrow, and can be answered
"yes." If the sale of an item "contributes importantly" to the exempt
organization’s mission or could be sold directly by the exempt organization without
the proceeds being characterized as unrelated business income, the fact that a payment is
based on a percentage of sales should not change the determination of whether the activity
is substantially related within the meaning of Treasury Regulation Section 1.513-1(d).
While guidance could be issued to clarify what is meant by "substantially
related" this is not specifically an Internet question.
- Are there any circumstances under which an on-line “virtual trade
show” qualifies as an activity of a kind “traditionally conducted” at trade
shows under Section 513(d)?
The Need for Guidance
This is a Category Two (2) item. Guidance can and should be
provided at this time regarding the manner in which current law applies in the Internet
context.
Existing Authority
Under Section 513(d)(3) and Treasury Regulation Section 1.513-3(b), a qualifying
organization (i.e., an organization described in Section 501(c)(3), (4), (5) or (6)) that
conducts qualified convention and trade show activities is not engaged in an unrelated
trade or business. The qualifying organization must regularly conduct a qualified
convention or trade show activity as one of its substantial exempt purposes. A qualified
convention or trade show activity is an activity of a kind "traditionally"
conducted by a qualifying organization in connection with an international, national,
state, regional or local convention or annual meeting or show if:
- One of the purposes of the organization in sponsoring the activity is promoting and
stimulating interest in, and demand for, the products and services of that industry, or
educating the persons in attendance regarding new products and services or new rules and
regulations affecting the industry, and
- The show is designed to achieve its purpose through the character of the exhibits and
the extent of the industry products that are displayed.
Some exempt organizations have attempted to replicate a traditional trade show in the
Internet context in connection with a convention or annual meeting. Such virtual shows are
conducted for a limited period contemporaneous with the associated event. There is no
reason why a virtual trade show that meets the specific criteria stated above should not
qualify for the exception to carrying on an unrelated trade or business under Section
513(d)(3). The existing law does not specifically address a virtual trade show, however,
and the statute’s reference to activities "traditionally" conducted creates
ambiguity.
Recommendation
Some form of guidance from the IRS on this issue would be of great assistance to
organizations seeking to engage in on-line convention or trade show activities.