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Royalty from sale of interest in scholarly journal not taxable.

The Service ruled that an exempt educational and literary organization's sale of a half-interest in its scholarly journal to a commercial publisher (P) did not affect the organization's exempt status under Sec. 501(c)(3), and the royalties do not constitute unrelated business taxable income (UBTI).


A is a nonprofit organization under a Sec. 501(c)(3) tax-exemption ruling since 1976. Its principal aim is to honor, preserve, study and disseminate scholarship about the life and works of the author B. Its primary activity is publishing a scholarly journal, C. Other activities include educational conferences, a newsletter, a scholarly archive and educational outreach. In the past, all of A's operations have been in writing, publishing and distributing C. Advertising revenues have been de minimis.

To more efficiently publish and distribute C, A proposes entering into an agreement to sell a one-half interest in C to P, a for-profit corporation. Under the agreement, A would receive a onetime payment for the one-half interest; A would be responsible for virtually all C's editorial functions, and P would be responsible for all printing and dissemination costs. P would pay A a 15% royalty on revenues from institutional subscriptions and a 25% royalty on nonsubscription revenue earned, including rights and permissions to copy or republish.

None of A's officers and directors has any financial interest in P, and none is related to any P officers or directors. According to A, the directors have performed due diligence in negotiating the proposed agreement with P, and believe the agreement is a fair market value (FMV) transaction.

Exempt Status

In the rifling, the IRS stated the sale and joint publication agreement is similar to a joint venture between A and P. Under Rev. Rul. 98-15, a Sec. 501(c)(3) organization may form and participate in a partnership and meet the operational test of the statute if (1) participation in the partnership furthers a charitable or educational purpose and (2) the partnership arrangement permits the exempt organization to act exclusively in furtherance of its exempt purpose and only incidentally for the benefit of the for-profit partners.

In Rev. Rul. 2004-51, the Service applied this test and approved a joint venture when a large university provided educational material to a for-profit partner that disseminated the material through interactive video technology. However, in that case the partnership activity was only an insubstantial part of the university's activities. Here, the publishing of the literary journal and the other activities under the agreement are a substantial part of A's activities.

The activities under the agreement satisfy the first test of Rev. Rul. 98-15, in that the agreement furthers A's charitable educational purpose. A retains full control over the editorial content of the publications. It also receives compensation for the use of this content which it represents as FMV. The agreement allows A to concentrate on the core educational component of the journal and other publication, while leaving P to conduct the more mechanical aspects of publication and dissemination.

The activities under the agreement also satisfy the second part of the Rev. Rul 98-15 test. They permit A to act exclusively in furtherance of its exempt purpose by creating C's editorial content. P's benefit is only incidental to this exempt purpose, giving it a negotiated share of the revenues as fair market compensation for the printing, publishing and dissemination services it provides. Given the somewhat esoteric nature of C, the limited demand for such material and the due diligence negotiation for a FMV agreement, there is realistically no way P would obtain substantial monetary benefits.


The second issue in the ruling is whether A's royalties and advertising income would constitute UBTI. Sec. 512(a)(1) defines UBTI 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. Under an exception, Sec. 512(b)(2) excludes all royalties whether measured by production or by gross or taxable income from the property, and all deductions directly connected with such income.

According to the Service, the royalties and advertising activities constitute business regularly carried on. Thus, the issue is whether the advertising is substantially related to A's exempt purposes, and whether the royalties are excludible under Sec. 512(b)(2).

A conducts all or most of the activities involved in soliciting and designing the advertising. There is no contention the advertising is substantially related to A's exempt educational activities. Accordingly, under The American College of Physicians, US Ct. Cl. (2/18/76), the advertising income is taxable unrelated gross income. By contrast, A receives royalties solely for use of its copyrighted materials. A performs no other services in return for such royalties. Under Sec. 512(b)(2) and Rev. Rul. 81-178, such royalties are thus excluded from gross unrelated business income.

IRS LETTER RULING 200610022 (12/12/05)

David O'Driscool, J.D, LL.M.
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Article Details
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Author:O'Driscoll, David
Publication:The Tax Adviser
Date:May 1, 2006
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