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Exclusive Provider Arrangement within Qualified Sponsorship Agreements

An exclusive provider arrangement limits the sale, distribution, availability, or use of competing products, services, or facilities in connection with an exempt organization’s activity.  An exclusive provider arrangement generally results in a substantial return benefit to the payor. Thus, only the portion of the payment that exceeds the fair market value of the exclusive provider arrangement and any other benefit(s) received is a qualified sponsorship payment that does not constitute receipt of income from an unrelated trade or business.

IRC Section and Treas. Regulation

  • IRC Section 511 — Imposition of tax on unrelated business income. 
  • IRC Section 513(i) — Treatment of certain sponsorship payments.
  • Treas. Reg. Section 1.513-4 — Certain sponsorship not unrelated trade or business. 
  • Treas. Reg. Section 1.513-4 (c)(2)(vi)(B) — Exclusive Provider. 
  • Treas. Reg. Section 1.513-4(d) — Allocation of payment. 
  • Treas. Reg. Section 1.513-4(f), Example 6 — Example of exclusive provider arrangement. 

Analysis:

IRC Section 513(i)(1) provides that the term “unrelated trade or business” does not include an exempt organization’s solicitation and receipt of a “qualified sponsorship payment.” The term “qualified sponsorship payment” means any payment made by a person engaged in a trade or business with respect to which the person will not receive, or expect to receive, a “substantial return benefit.” Treas. Reg. Section 1.513-4(c)(1).  A substantial return benefit is any benefit other than: (1) the use or acknowledgment of the name or logo (or product lines) of the person’s trade or business in connection with the organization’s activities; or (2) a benefit that is disregarded under Treas. Reg. Section 1.513-4(c)(2)(ii). See Treas. Reg. Section 1.513-4(c)(2)(i). A benefit is disregarded if the aggregate fair market value of all the benefits provided to the payor in the organization’s taxable year is not more than 2% of the amount of the payment. See Treas. Reg. Section 1.513-4(c)(2)(ii).

An exclusive provider arrangement occurs when an organization, in exchange for a payment, agrees to limit the sale, distribution, availability, or use of any competitor’s products, services, or facilities during a special event or in the course of its regular exempt activity. Treas. Reg. Section 1.513-4(c)(2)(iii) provides that an “exclusive provider arrangement” is a benefit provided to the payor, which would constitute a substantial return benefit if it is not disregarded under Treas. Reg. Section 1.513-4(c)(2)(ii). Thus, exclusive provider arrangements generally result in a substantial return benefit to the payor. Treas. Reg. Sections 1.513-4(c)(2)(iii)(B), (c)(2)(vi)(B).

An example of an exclusive provider arrangement would be when Brand A pays $10,000 to sponsor an organization’s event and the organization agrees to restrict all of its soft drink sales to only Brand A. The fair market value of the exclusive provider arrangement is determined to be $1,000. The fair market value of the exclusive provider arrangement exceeds 2% of the payment (2% of $10,000 is $200), and is not a disregarded benefit under Treas. Reg. Section 1.513-4(c)(2)(ii). Therefore, only the portion of the sponsor’s payment that exceeds the fair market value of the exclusive provider arrangement ($9,000) is a qualified sponsorship payment, assuming that no other substantial benefit is provided to Brand A (the $9,000 would be reduced by the fair market value of any other substantial benefit provided). If the exempt organization does not establish that the payment exceeds the fair market value of the exclusive provider arrangement and any other substantial return benefit, then no portion of the payment constitutes a qualified sponsorship payment. 

A payment that does not meet the criteria as a qualified sponsorship payment is not automatically subject to UBIT. Rather, the unrelated business income tax treatment of such unqualified payment is determined under the existing principles and rules found in IRC Sections 512, 513, and 514. Treas. Reg. Section 1.513-4(d)(1)(i).    

Issue Indicators / Audit Tips:    

Review contracts for sponsorship payments to determine if:

  • An exclusive provider arrangement exists.
  • Any other benefits were received.
  • Benefits are disregarded under Treas. Reg. Section 1.513-4(c)(2)(ii).
  • The sponsor received a substantial return benefit. 
  • The exempt organization has established the fair market value of the substantial return benefit.
  • The payment received exceeds the fair market value of the substantial return benefit

An exclusive provider arrangement exists if:

  • The arrangement with the sponsor limits the exempt organization's rights for the sale, distribution, availability, or use of any competing products, services, or facilities in connection with conducting the activity. 

If the arrangement with a sponsor indicates that there may be an exclusive provider arrangement issue, it may also be appropriate to review:

  • Meeting minutes of the organization's board of directors or trustees during which relevant discussions and votes occurred.
  • Correspondence or other written statements between the organization, the corporate sponsor, or other parties relating to the sponsorship contract/ arrangement. 
  • Films, videotapes or photographs of the events over the years to determine the extent the corporate sponsor's name is mentioned or depicted and the products and services available at the events.
  • In making a determination whether a substantial return benefit has been provided to the sponsor all the facts and circumstances of the relationship between the sponsor and exempt organization must be considered.