SALE OF DEFERRED ANNUITIES WILL NOT PRODUCE IN UBTI
REFERENCE: Section 514 -- Unrelated Debt-Financed Income
FULL TEXT:
Date: April 10, 1995
Refer Reply to: CP:E:EO:T
Dear Sir or Madam:
This is in reference to a ruling request dated October 19, 1994 concerning the federal tax consequences of the proposed transactions described below.
The information provided indicates that you (the "College") are exempt from federal income tax as an organization described in section 501(c)(3) of the Internal Revenue Code and have been classified as other than a private foundation as an organization described in sections 509(a)(1) and 170(b)(1)(A)(ii) of the Code. The College has been operating as an institution of higher learning since its incorporation more than 100 years ago.
The College intends to engage in the sale of deferred gift annuities ("Tuition Plan") to benefit the recipients of deferred gift annuities from various donors (respectively, "Recipient(s)," and "Donor(s)") as well as itself.
Each Donor will make a contribution of cash or property to the College in return for a deferred gift annuity based on the life of the child. The Donor will designate a primary Recipient and may designate one alternate. The Recipient is entitled to a lifetime payout but has the option to sell or assign his or her annuity to you or to a third party in return for a lump sum payment or installment payments over several years. It is contemplated that recipients will use funds generated by the annuity to attend college at the College. However, this is not required and Recipients may in fact use the funds for any purpose.
You have requested rulings that income received by the College as the result of the sale of these deferred gift annuities will not be considered income from an unrelated trade or business as defined in sections 511-513 of the Internal Revenue Code and that income received by you from these annuities will not be considered debt- financed income within the meaning of section 514 of the Code.
Section 511 of the Code imposes a tax upon the unrelated trade or business income of tax-exempt organizations. Activities shall be treated as an insurance company for purposes of applying Subchapter L (Insurance Companies) with respect to such activity.
The Technical and Miscellaneous Revenue Act of 1988, Pub. L. 100-647 (1988) amended section 501(m) by adding 501(m)(3)(E) which adds the term "charitable gift annuities" to the list of exceptions from commercial-type insurance. Section 501(m)(5) provides that for purposes of 501(m)(3)(E) the term "charitable gift annuity" means an annuity if (A) a portion of the amount paid in connection with the issuance of the annuity is allowable as a deduction under section 170 or 2055, and (B) the annuity is described in section 514(c)(5) (determined as if any amount paid in cash in connection with such issuance were property).
The legislative history accompanying the 1988 Act provides that "[t]he present-law exception to the debt-financed property rules has historically exempted from tax any income resulting from the issuance of charitable gift annuities." H.R. Rep. No. 795, 100th Cong., 2d Sess. 116 (1988) emphasis supplied.
Historically it appears that the issuance of "charitable gift annuities" has been treated as a borrowing of money by the issuing organization and the sales aspect of the transaction has been ignored. Section 514(c)(5) of the Code specifically exempts "charitable gift annuities" from being considered "acquisition indebtedness" and thereby ensures that the interest, rents or dividends secured by the educational institution from the investment of the proceeds it receives from issuing these annuities will not be subject to unrelated business income tax. This exception from the debt-financed income provisions of the unrelated business income tax would be virtually useless if the proceeds themselves were subject to the unrelated business income tax. Accordingly, we believe that the issuance of charitable gift annuities described in section 514(c)(5) does not result in unrelated business income.
Based on the above, we rule that:
1. Income from your sale of annuities is not subject to the tax on unrelated business income under sections 511-513 of the Code.
2. Interest income derived from investments of the annuity funds is excludable from the computation of unrelated trade or business tax under the provisions of section 512(b)(1) of the Code.
Section 513(a) of the Code provides that the term "unrelated trade or business" means any trade or business, the conduct of which is not substantially related (aside from the need of an organization for funds) to the exercise or performance by such organization of its charitable, educational or other function which constitutes the basis for its exemption.
Section 1.513-1(d)(2) of the Income Tax Regulations provides that a trade or business is related to exempt purposes in the relevant sense, only where the conduct of the business activity has a causal relationship to the achievement of exempt purposes (other than through production of income) and is "substantially related" only if the causal relationship is a substantial one. The activity from which income is derived must contribute importantly to the accomplishment of exempt purposes.
Section 512(b)(1) of the Code excludes interest income from the computation of the tax on unrelated trade or business income.
Section 514(a)(1) of the Code states that in computing the unrelated business income tax under section 512, income derived from debt-financed property should be included.
Section 514(c)(5) provides that the rules concerning debt- financed property should not apply to the sale of annuities where (1) the annuity is the sole consideration issued in exchange for the property if, at the time of the exchange, the value of the property is less than 90 percent of the value of the property received in the exchange, (2) the annuity is payable over the life of one individual in being at the time the annuity is issued or over the life of two individuals in being at such time, and (3) the annuity is payable under a contract which does not guarantee a minimum amount of payments and does not provide for any adjustment of the amount of the annuity payment by reference to the income received from the transferred property or any other property.
Section 501(m) was added to the Code by the Tax Reform Act of 1986, Pub. L. 99-514 (1986). The section states that an organization described in section 501(c)(3) or section 501(c)(4) of the Code may be exempt from tax under section 501(a) only if no substantial part of its activities consists of providing "commercial-type insurance." Section 501(m)(3) sets forth a list of items deemed not to be "commercial-type insurance." Section 501(m)(4) provides that the issuance of annuity contracts shall be treated as providing insurance.
Section 501(m)(2) of the Code provides that an organization that provides insurance as an insubstantial part of its * * *.
Our holdings are contingent upon your meeting all of the requirements under section 501(m) and 514(c)(5) of the Code, including the requirement that a deduction be allowed under section 170 or 2055.
Your ruling requests concerning deductibility of contributions and other matters have been forwarded to the appropriate offices within the service. These offices will respond directly to you.
This letter is directed only to the organization that requested it. Section 6110(j)(3) of the Internal Revenue Code provides that it may not be used or cited by others as precedent.
We are informing your key District Director of this ruling. Because this letter could help resolve any questions about your exempt status and foundation status, you should keep it in your permanent records.
If you have any questions about this ruling, please contact the person whose name and telephone number are shown in the heading of this letter.
Sincerely,
Jeanne S. Gessay
Chief, Exempt Organizations
Technical Branch 2
