Commercial Uses of Intellectual Property by Colleges and Universities June 2000

Transcription

1 Commercial Uses of Intellectual Property by Colleges and Universities June 2000 I. WHAT INTELLECTUAL PROPERTY CAN BE COMMERCIALLY UTILIZED? A. Name and logo (tradename, trademark, tradedress, etc.). 1. Affinity group merchandising. 2. Athletic merchandising. 3. Event merchandising. B. Mailing lists. 1. Students and parents. 2. Faculty and staff. 3. Alumni. 4. Donors. C. Name and Reputation or Goodwill. 1. AExclusive sponsor or Aexclusive supplier arrangements. 2. ASponsored arrangements, such as travel programs. 3. Approval/certification. 4. Goods and services, e.g., hotels and retirement housing. D. Inventions, Discoveries and Trade Secrets. 1. Internally generated. 2. Contributed. a) Major corporations are reportedly giving patented and unpatented

2 E. Copyrights. F. Collections. technology to universities in hopes the grantees can expand the use of those inventions or discoveries. AA Gift Not of Cash, but of The Chronicle of Higher Education (March 3, 2000), at A-36. b) Issues for donor: Donative intent, valuation, substantial return benefit. c) Issues for donee: Obligations to donor or inventor, conflict with taxexempt financing rules, effect on patent policy. G. Intellectual Capacity of Faculty and Staff. 1. Healthcare - a unique asset? E.g., Harvard=s contract with major insurer for Internet information. 2. Consulting. 3. Management. 4. Information processing. II. HOW CAN INTELLECTUAL PROPERTY BE COMMERCIALLY UTILIZED? A. Sale of Intellectual Property. B. License of Intellectual Property. C. Contract for Services. D. Sale of Goods or Services Embodying the Intellectual Property. III. HOW FAR CAN COLLEGES AND UNIVERSITIES GO WITHOUT GENERATING UNRELATED BUSINESS INCOME TAX LIABILITIES? A. Applicability: Unrelated business income tax (AUBIT@) may be imposed on unrelated business income (AUBI@) of both governmental and non-governmental universities and research affiliates. Section 511(a)(2) of the Internal Revenue Code. (All section references hereafter are to the Internal Revenue Code unless otherwise

3 noted.) However, a governmental research organization not formed as a nonprofit corporation and wholly independent of a state college or university should not be subject to UBIT, since only state colleges, universities and corporations Awholly owned@ by one or more state colleges or universities are addressed by the Code. B. Reliance upon the Research Exceptions to Protect Research Grants and Contract Revenues. 1. Applicability of exceptions. a) University and hospital exception: Payments from a commercial or governmental sponsor for the conduct of research activities by a college, university or hospital are protected from UBIT by section 512(b)(8). b) Research institute exception: Independent research institutes with non-governmental sponsors must claim protection under section 512(b)(9). (1) A separately incorporated research organization controlled by a university may not rely on the university exception. GCM (3/20/84). (2) A separately-incorporated research organization may have to qualify for section 501(c)(3) exemption as a Ascientific@ organization, bringing into play the Ascientific research@ regulations as well as section 512(b)(9). Reg.' (c)(3)-1(d)(5). c) Governmental research exception: Payments for research by any exempt organization done for a governmental sponsor are protected by section 512(b)(7). 2. The importance of the different exceptions. a) Type of research. The Afundamental research@ and Afreely available@ conditions of section 512(b)(9) do not apply to the section 512(b)(7) or (b)(8) exclusions. b) Use of research results. c) Publicity of research results.

4 d) The research exceptions also protect against debt-financed income. Section 514(b)(1)(C). 3. The limits on the term a) Research vs. testing distinction: Revenues from testing services are not protected from UBI by the research exceptions. Reg. ' 1.512(b)- 1(f)(4) provides in part that for purposes of section 512, the term does not include activities of a type ordinarily cared on as an incident to commercial or industrial operations, for example, the ordinary testing or inspection of materials or products or the designing or construction of equipment, buildings, etc.. b) Rev. Rul , C.B c) Rev. Rul , C.B d) Rev. Rul , C.B e) PLR The limits on the type of income protected by the research exceptions. a) Payments for research services to be provided. b) Payments for adaptation services? c) Payments for prototype development? d) Payments for trial utilizations? e) Payments for manufactured goods? Edward Orton, Jr. Ceramic Foundation v. Commissioner, 56 T.C. 147 (1971), non-acq C.B. 4 (acq. on section 502 issue). C. Reliance on ARelatedness@ to Protect Payments for Research or for the Use of Intellectual Property. 1. Even if the section 512(b) research exceptions do not apply, the revenue will not be taxable if it is generated by an activity related to the exempt purposes of the university or research institute. To avoid UBIT by reason of the related nature of the income, the activity producing the income must be related to the exempt purposes of the university or research institute in

5 a way that contributes importantly to achieving its exempt purposes -- educational, scientific or charitable. Reg. ' (d)(2). 2. Common grounds for establishing relatedness in a university context are: a) Furthering the teaching mission by using the activity to train students. (1) In St. Luke=s Hospital of Kansas City v. U.S., 494 F.Supp. 85 (W.D. Mo. 1980), the Court held that an exempt hospital=s performance of diagnostic laboratory testing upon specimens taken from patients of the hospital=s staff physicians was not an unrelated trade or business under section 513. The Court found that the hospital needed the specimens to carry on its educational activities. The court also stated that the hospital=s staff physicians were Amembers@ of the hospital within the meaning of section 513(a)(2), and that testing was performed by the hospital primarily for the convenience of the hospital=s members. (2) In Rev. Rul , C.B. 165, the IRS stated that it will not follow that portion of the St. Luke=s Hospital of Kansas City decision, supra, holding that private patient specimen testing is for the convenience of the hospital=s members. The Service=s position is that hospital staff physicians are neither Amembers@ nor Aemployees@ of the hospital. However, since the laboratory testing services provide a supply of specimens needed in the hospital=s teaching program, those services are substantially related to the hospital=s exempt purpose. b) Furthering the scientific mission by using the activity to conduct scientific research. (1) Midwest Research Institute v. United States, 554 F.Supp. 1379, (W.D.Mo. 1983), aff=d. 744 F.2d 635 (8th Cir. 1984). (2) IIT Research Institute v. United States, 9 Cl.Ct. 13 (1985). c) Furthering the healthcare mission by using the activity to provide healthcare services. (1) Compare Carle Foundation v. United States, 611 F. 2d 1192 (7th Cir. 1979), cert. denied, 449 U.S. 824 (1980), with Hi- Plains Hospital v. United States, 670 F. 2d 528 (1982),

6 regarding prescription drug sales. (2) PLR D. Reliance on the Royalty Exception to Protect Payments Made for the Use of Intellectual Property. 1. The royalty vs. services debate: "royalty" is defined as a payment for the right to use intangible property rights; does not include payment for services. Sierra Club v. Commissioner, 86 F. 3d 1526 (9th Cir. 1996). a) Services provided by licensor to licensee can invalidate the royalty exception. Rev. Rul , C.B b) Services provided by exempt sponsor of group insurance programs will negate protection of the royalty exception. Texas Farm Bureau v. United States, 53 F.3d 120 (5th Cir. 1995); National Water Well Assn. v. Commissioner, 92 T.C. 75 (1989). c) Taxpayers successfully overcame IRS challenges to taxation of their income from affinity credit card arrangements in multiple judicial actions, e.g., Sierra Club v. Commissioner, T.C. Memo , on remand from 86 F. 3d 1526 (9th Cir. 1996), aff=g. in part, rev=g in part and remanding 103 T.C. 307 (1994) and T.C. Memo ; Oregon State University Alumni Association v. Commissioner, 193 F. 3d 1098 (9th Cir. 1999), aff'g T.C. Memo and T.C. Memo ; Mississippi State University Alumni, Inc. v. Commissioner, T.C. Memo In each case, the court held that the payments were royalties and were not payment for services. d) As a result of the judicial losses, the IRS has withdrawn its challenge to the affinity credit card revenues. December 16, 1999 Memorandum, reproduced at 2000 TNT 46-4 (March 8, 2000). e) The affinity card case results should also support the position that incidental services necessary to transfer Aknow-how@ along with patent rights to a licensee do not destroy the ability to rely on the royalty exception. See Cloward Instrument Corporation v. Commissioner, 52 T.C.M. 34 (1986), aff=d 842 F. 2d 1294 (9th Cir. 1988). f) Other affinity group merchandising should be protected by the

7 reasoning of the judicial opinions, but the IRS has not so conceded. g) The generation of taxable advertising income from periodicals cannot be disguised as a non-taxable royalty. Fraternal Order of Police, Illinois State Troopers v. Commissioner, 833 F. 2d 717 (7th Cir. 1987); PLRs , The mailing list debate. (1) There is no specific law or formal IRS position regarding payments for listings of commercial activities on an exempt organization=s website, with or without links to the commercial entity=s website. Some have argued that such listings are advertising; others that they are not. (2) IRS is preparing a request for public comment on Internetrelated issues. a) The IRS won the initial case involving extensive marketing of an organization=s mailing list. Disabled American Veterans v. United States, 650 F. 2d 1178 (Ct. Cl. 1981). b) Sierra Club and other taxpayers have won in cases involving the use of independent list brokers. Sierra Club v. Commissioner, 86 F. 3d 1526 (9th Cir. 1996), aff=g T.C. Memo ; Common Cause v. Commissioner, 112 T.C. 332 (1999); Planned Parenthood Federation of America, T.C. Memo The partnership debate. a) The Code says that the royalty exception applies to net as well as gross income royalties, but the IRS took the position in Sierra Club and other affinity card cases that a royalty measured by net income evidenced a partnership. b) PLR extended royalty treatment to both net and gross income percentages. c) Utilization of a website bearing university=s name for the sale of merchandise unrelated to the university readily lends itself to a partnership attack by the IRS. E. ACapital gains@ from the sale of intellectual property. Section 512(b)(5).

8 1. Exception generally thought to be available. 2. Concern over classification for intellectual property assets of a technology transfer organization. F. Reliance on the corporate sponsorship exception. 1. Section 513(i) protects a Aqualified sponsorship payment@ from UBIT. It expressly does not apply to payments for use of the payor=s name or logo in published materials that are not event-specific. 2. Reproposed regulations were published on March 1, Prop.Reg. ' They distinguish Aexclusive sponsor@ from Aexclusive provider@ payments. IV. EXEMPT STATUS FOR TECHNOLOGY TRANSFER ORGANIZATIONS. A. Importance (or not) of exemption. B. Importance (or not) of ownership of intellectual property. 1. Contrast Rev. Rul , C.B. 262, with Rev. Rul , C.B Ownership of both legal and beneficial interests in intellectual property by EO is essential to royalty treatment. 2. Compare PLR C. Integral part analysis. 1. PLR says, without defining, Atechnology transfer@ is an exempt activity in the context of other exempt activities. D. Limits on Acommercialization@ by a technology transfer organization. 1. Development. 2. Market research. 3. Prototype production. 4. Marketing.

9 5. Manufacturing. V. EXEMPT FINANCING ISSUES. A. A Afederally guaranteed@ bond is not an exempt bond. Section 149(b)(1). A bond is Afederally guaranteed@ if payment of principal or interest is directly or indirectly guaranteed by the federal government or an agency or instrumentality. Section 149(b)(2). 1. PLR : The receipt by an EO of federal appropriations does not constitute a federal guarantee in circumstances in which federal law prohibits the use of the federal funds to pay any expenses of constructing the facility in question, including the payment of debt service on the bonds. 2. PLR : Payments by the federal government for research services under research contracts do not constitute a federal guarantee prohibited under section 149(b)(1). B. Sponsored research. 1. No more than 10% of the proceeds of an issue for a state governmental body, and no more than 5% of the net proceeds of an issue for the benefit of a section 501(c)(3) organization, may be directly or indirectly Aused for any private business use.@ Sections 141(b)(1), 145(a)(2)(B). 2. Under relevant regulations, if a non-exempt, non-governmental sponsor of research conducted by a state governmental body or a section 501(c)(3) organization is treated as an owner, lessee, manager or other beneficial user of the research facility, private business use results. Reg. ' (b)(6). a) Rev. Proc , C.B. 634, establishes operating guidelines for certain basic research agreements. Basic research for this purpose is defined as Aoriginal investigation... not having a specific commercial objective. b) Rev. Proc approves as not private business use certain corporate-sponsored basic research where the sponsor must pay a competitive price for any license, and cooperative basic research performed for multiple sponsors who are entitled to no more than non-exclusive, royalty-free licenses. c) PLR : Research under several governmental research

10 contracts was found to comply with the terms of Rev. Proc , i.e., (1) the research contracts are for basic research with no specific commercial objective, (2) the price to be paid by any of the contracting federal agencies for the use of the research would be not less than the price payable by any non-federal government party, and (3) the license to use the research would be nonexclusive and royalty-free. Therefore, the use of the bondfinanced facility to provide research services would not constitute private business use under sections 141(b) or 145(a). 3. Cost of research facility allocated between exempt use and private business use by commercial sponsors on basis of proportion of discounted revenues. PLR This article is intended to provide the reader with general information and should not be considered a substitute for legal advice or opinion. Readers are advised not to act upon this information without seeking professional counsel. For further information, please contact: James K. Hasson, Jr. Sutherland Asbill & Brennan LLP 999 Peachtree Street, NE Atlanta, GA jkhasson@sablaw.com Phone: