--------------PROPRIETARY, PRIVILEGED AND CONFIDENTIAL ATTORNEY WORK PRODUCT--------------
A Statement of the Case:
Many substantial institutional nonprofit tax-exempt "public charities" such as operating charitable foundations and private educational institutions often create and develop independent revenue generating "enterprises" that may or may not be directly related to their "charitable public purpose".
This eventually brings forth the IRS, who then initiates a discussion as to whether or not the revenues generated by the "enterprise" are directly related to the sponsoring institution's tax-exempt purpose. If the Service determines that it is not (a determination that in the first instance is entirely within the
Service’s purview), the "income" from the enterprise is declared to be "Unrelated Business Income", or
"UBTI" upon which the appropriate income tax is due and payable (again, determined in the first instance by the Service, and at times with associated penalties and interest).
Institutional tax-exempt nonprofit organizations have for years tried to develop tax planning strategies to deal with this problem. Other than directly challenging the IRS, some of those strategies that have evolved over the years include:
1. Accept the IRS determination, pay the due UBTI tax bill, pay UBTI going forward, and go on about doing business.
2. Sell the enterprise.
3. Restructure the enterprise by selling a "controlling interest" to a private "enterprise partner".
4. Form a wholly owned for profit business corporation subsidiary, and "spin off" the enterprise.
There are other strategies, and there may be (other) very valid corporate advantages to “spinning off” enterprises (shielding the institution from potential liabilities associated with the enterprise, etc.).
However, all alternative strategies come with various degrees of either continuing the UBTI discussion with the Service or ceding control of the enterprise to a “related” or an unrelated third party which brings about a whole different set of problems, usually produced by introducing the concept and business objective of maximizing profits to what is essentially a nonprofit mission sensitive environment. No matter how carefully these steps are taken; no matter how clearly and specifically something like an operating agreement with a for profit third party is drawn; and, no matter how "mission sensitive" a for profit partner or a for profit subsidiary may try to be: either "the tax man cometh" with a continuing (and
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brooding) omnipresence, or unwanted (by the nonprofit) "mission drift" occurs with the third party and corporate difficulties ensue (many times in a conflicting corporate governance context).
In any event, a tax-exempt nonprofit institution, such as a private institution of higher learning that is embroiled in a UBTI "discussion" with the Service, or is having difficulty with a third party for profit
"enterprise partner", is faced with a number of governance and financial problems. Among them is how such matters might affect the Institution's ability to issue tax-exempt debt in the public markets and the resulting issues faced by bond and disclosure counsel.
The Focus of This Discussion:
This discussion is a response to The Statement of the Case posited by proposing a mission sensitive and tax friendly solution to the problems discussed above.
The Proposed Solution: A New Corporate Concept – Benefit Corporations
A benefit corporation is a relatively new, innovative form of business corporation which has been created to foster a material positive impact on society and the environment. Often referred to as having a "triple bottom line of … people, planet and profit”, benefit corporations give importance to generating societal benefits as well as profits.
Benefit corporations must comply with certain public standards of accountability and transparency while being bound to socially conscious commitments. The benefit corporation legal structure is designed to provide an entrepreneurial for-profit corporate legal structure that is an alternative to either a traditional for profit business corporation or a tax exempt nonprofit enterprise. (See Exhibit A “A Graphic View: C
Corps; B Corps and Nonprofits”). Moreover, the benefit corporation substantive corporate purpose structure is purposefully designed to foster private and venture capital investment in social enterprises
(sometimes referred to as “impact investment). The U. S. investment community has begun to realize that there is a substantial amount of private capital “sitting on the sidelines” and in some respects is searching for worthwhile “impact” or “social enterprise” investments (See Exhibit B “Benefit Corporations and
Enterprise Capital for Nonprofits”).
Principals and directors of a business/benefit corporation have a newly defined dual fiduciary duty and obligation to shareholders to ensure that the corporation both: provides shareholders with a financial return on investment; and, achieves an identifiable and quantifiable social enterprise objective. This is in contradistinction to the singular focus of maximization of profits that comprises the sole fiduciary duty of traditional business corporation directors; or, of properly maintaining, governing and operating a taxexempt nonprofit enterprise that comprises the fiduciary duty of traditional tax-exempt nonprofit corporation directors.
Benefit corporations operate subject to GAAP, earn a profit, pay income and property taxes and have shareholders like other (traditional) business corporations. However, in addition to achieving social
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enterprise objectives, benefit corporations also avoid the public disclosure, IRS compliance burdens, IRS compensation restrictions and other regulatory burdens imposed by the IRS and state law on tax-exempt public charities. Benefit corporations are IRS “C filers”, and pay applicable corporate state taxes, just as is the case with other for-profit business corporations. Benefit corporations have now been authorized by ten states including New York, California, Maryland, Virginia, Vermont, Hawaii, Louisiana, South Carolina and New Jersey. Another ten states, including North Carolina, are currently considering legislation.
Public compliance and certification standards for benefit corporations are established by state law and must be administered, monitored and publicly certified by an independent third party public certification agency, such a Underwriters’ Laboratory of Camas, WA and B Labs of Berwyn, Pa.. This certification process can be analogized to undergoing the rating agency processes of a Moody’s, Standard & Poor’s and Fitch’s. Each benefit corporation board of directors must have an independent member designated by the board as a “Benefit Director” who is corporately responsible for overseeing compliance with benefit statutory and certification requirements and compliance. Public enforcement responsibility for legal corporate compliance lies with each state’s Attorney General, just as is the case with traditional business corporations. Each benefit corporation must file a public annual report with each state’s Secretary of State in a form that looks much like an IRS Form 990 (Tax-Exempt Nonprofit Annual Tax Return).
The three most meaningful benefits of benefit corporations to be gained are 1) the aforementioned freeing of directors from the singular focus of maximization of profits and thus possible shareholder reprisal for pursuing “social” objectives; 2) the preservation of a social enterprise in a profit making environment as opposed to a nonprofit tax-exempt IRS controlled environment; and, 3) the preservation of the social enterprise mission upon sale of controlling interest or a succession in leadership.
Other advantages of benefit corporations having qualified for and receiving a UPL or B Lab certification, are many.
 Opens access to more than $1 trillion of currently uncommitted mission aligned investment capital over next decade (see Exhibit B);
 Directly appeals to nearly 68 million consumers preferring to purchase from socially and environmentally responsible companies of all types in all industries;
 Gives flexibility to officers and directors wanting to engage in socially and environmentally mission charged enterprise or projects ("the dual bottom line of profit plus");
 Avoids shareholder discontent with socially mission oriented enterprise activities, and in extreme situations, shareholder litigation.
 Enhances enterprise brand image, strengthening customer, consumer and contractor loyalty;
 Provides for the preservation of a corporate mission upon ownership succession;
 Sustains or improves competitive position in marketplace;
 Improves employee talent recruitment and employee retention;
 Mitigates 2 of the top risks in business today;
 The likelihood of “mission drift” away from enterprise business objectives;
 Costs associated with federal, IRS and state mandated regulations.
 Provides financial, intellectual and emotional rewards for "doing well by doing good".
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 Establishes consistent standards by which a company's performance can be judged and compared to others.
Applying The Proposal To Educational Institutions Of Higher Learning:
As discussed above, tax-exempt nonprofit institutions, such as institutions of higher learning, often develop mission related enterprises that may not (in the view of the IRS) be “directly related to” the institution’s “charitable public purpose” (See Exhibit C “Unrelated Business Taxable Income (UBTI)”). At the point the IRS makes it clear that such may be the case, the scramble begins to avoid UBTI in some fashion. If indeed a “third party solution” such as those outlined above is implemented, the problems, concerns and costs attendant thereto, also outlined above, generally ensue.
Enter The Benefit Corporation, an entirely new corporate concept, that has been called “the most original idea in corporate governance in twenty years” (see Exhibit D “Bill would let firms pursue public benefit”).
Three years ago (a nanosecond in the world of corporate governance) benefit corporations did not exist.
As noted above, today, twelve states and the District of Columbia have adopted legislation authorizing their existence and operation under state law. And ten other states are actively considering adopting legislation authorizing them.
The corporate bar, the impact investment community and financial experts are all just beginning to explore the possible uses and advantages of benefit corporations to different constituencies.
In our opinion, one of the most needful of constituencies likely to benefit from the judicious use of benefit corporations is the nation’s private colleges and university community. Our opinion is based upon long standing participation in and experience with that community; and, with a depth of experience with the operation of UBTI enterprises by all kinds of tax-exempt nonprofit enterprises.
Our long standing relationship with institutions of higher learning as a Trustee and Chairman of the Board
(UNC Wilmington): counsel to numerous supporting and mission related institutional tax-exempt nonprofits (including the NC State University Textile Foundation and Duke Student Publishing, Inc); and, bond and underwriters’ counsel in numerous tax-exempt financings undertaken by institutions of higher learning (including UNCW, Wake Forest University, Elon University and Methodist University) gives us a particularly advantageous view of the needs of institutions of higher learning.
In addition, we have varied, deep and broad experience with all types and descriptions of tax-exempt nonprofit institutions including numerous types of IRS Section 501(c) organizations: c1s and 2s
(government/public); c3s (all types of private foundations and public charities); c4s (social welfare); c6s
(trade associations); c7s (private social clubs); c10s (fraternal organizations); c12s (cooperatives, including electric distribution, agricultural and telephone); c13s (memorial cemeteries); and, c14s (state chartered credit unions). Mr. Carlton has been general counsel to one of North Carolina’s leading c6s (The NC
Bankers Association); the founding counsel of North Carolina’s leading 501(c)(3); 509(a)(1) community foundation (The NC Community Foundation); and, a member of the Board of Governors, an executive
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officer (Chair of the House of Delegates) and President of one of the nation’s largest 501c6 organizations-
--the American Bar Association. This experience and exposure gives us a breadth of experience and knowledge that we bring to bear on tax-exempt nonprofit related IRS matters in general and UBTI controversies and problems in particular.
The Application (Of the Remedy):
We unabashedly see the benefit corporation as a new and very effective alternative tax strategy for addressing the UBTI issues discussed above. Formation of a wholly owned benefit corporation subsidiary would provide a tax-exempt nonprofit institution that needs to house an enterprise entity outside its nonprofit corporate entity (for whatever corporate reason, but specifically for UBTI issues) with a very efficient, corporately manageable and mission sensitive alternative to other enterprise tax planning strategies.
Several advantages of a wholly owned benefit corporation mission sensitive enterprise subsidiary in this context include:
 Mission related activities of the subsidiary become a matter of a corporate organizational structure and not of an “agreement or contract” between two independent corporate entities.
 Any “Operating Agreement” between the for profit subsidiary and the parent tax-exempt nonprofit corporation becomes an exercise in “coordinating” between the subsidiary and the
“related” (for IRS purposes) nonprofit, instead of a “governance” or “legal/contract” exercise.
 Corporate governance of both the subsidiary and the parent is more clearly demarked and easily understood---by both parties -- and the IRS---and can be more easily coordinated without IRS interference (e. g. with overlapping boards of directors).
 The Taxman gets his due, no arguments there; and, the parent nonprofit gets its dividends, just like any other investment.
 The tax-exempt nonprofit reduces costs of time and expense associated with IRS oversight and compliance;
 The Board of the tax-exempt nonprofit sheds itself of management supervision and governance of a for-profit enterprise.
And there are many others, some not yet clearly developed or known.
Conclusion
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Thus, we would recommend to any private institution of higher learning that operates as a tax-exempt nonprofit that it seriously consider inclusion of a benefits corporation alternative in its overall corporate governance and tax planning and strategy.
We are available to assist.
Please contact:
Alfred P. Carlton, Jr.
Carlton Law PLLC
Telephone: (919) 600-6272
Email: ap@carltonlawpllc.com
GovernanceEducation.com
Telephone: (919) 600-6272
Email: info@governanceeducation.com
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