Thursday, January 24, 2013
For a number of years, I've espoused the view that we should expand the unrelated business income tax to a "commercial activity" tax - that is, a charity engaged in any commercial activity should pay taxes on any net revenues from that activity, whether or not the activity is "related" in some way to the organization's charitable purpose. See, e.g., John D. Colombo, Commercial Activity and Charitable Tax Exemption 44 WM. & MARY L. REV. 487 (2002). I've also opined that if we did this, we could grant tax exemption rather broadly to permit organizations with some legitimate charitable purpose the ability to get tax-deductible contributions for their charitable activities, while still fully taxing any commercial activity. I believe this would simplify current law and compliance. For example, museum gift shop revenues would be fully taxable, instead of having to parse whether specific sales were "related" or "unrelated" as is currently the case (e.g., an art museum gift shop can sell replicas of art, art books, "arty" postcards and the like without UBIT liability, but sales of science books or "I Love NY" coffee mugs are subject to the UBIT; see, e.g., Rev. Rul. 73-104). A charity that operates a pay garage would pay taxes on the garage revenues as a whole, without allocating between parking receipts that are "related" to charitable activities and those that are not. I readily admit there are still some interpretive issues (are museum admission charges "commercial" revenues?), but I think these issues would be fewer and easier to resolve than esoteric questions of "relatedness."
It appears that a recent decision by the Supreme Court of the Philippines interpreting its statutory law with respect to charities has more or less adopted my approach with respect to nonprofit hospitals (to be clear, they didn't do this because they read anything I wrote; still, this indicates my approach isn't completely crazy). In Commissioner of Internal Revenue vs. St. Luke's Medical Center, Inc., G.R. No. 195909, September 26, 2012 (full opinion here; an excellent summary is available here), the Philippine Supreme Court held that Philippine law distinguished between a fully exempt "charitable" hospital or educational institution (whose activities must be exclusively charitable) and a private nonprofit hospital or educational institution engaged in some charitable and some commercial activity. With respect to the latter, the organization is required to pay income tax on their commercial revenues (albeit at a reduced rate as provided in Philippine law), but not required to pay tax on revenues resulting from charitable activities. In the context of the private nonprofit hospital at issue, the court held that revenues from paying patients would be taxable (again, at the reduced rate provided for by Philippine law), because these revenues were part of a for-profit business.
The Court finds that St. Luke’s is a corporation that is not “operated exclusively” for charitable or social welfare purposes insofar as its revenues from paying patients are concerned. This ruling is based not only on a strict interpretation of a provision granting tax exemption, but also on the clear and plain text of Section 30(E) and (G). Section 30(E) and (G) of the NIRC requires that an institution be “operated exclusively” for charitable or social welfare purposes to be completely exempt from income tax. An institution under Section 30(E) or (G) does not lose its tax exemption if it earns income from its for-profit activities. Such income from for-profit activities, under the last paragraph of Section 30, is merely subject to income tax, previously at the ordinary corporate rate but now at the preferential 10% rate pursuant to Section 27(B).
In other words, revenues from commercial (e.g., for-profit) activity (in this case, paying patients) are taxable, but the organization remains tax-exempt on its actual charitable activities. There is no "relatedness" test here as under our UBIT; the only question is whether an activity is for-profit (commercial).
While this decision obviously is the result of the sui generis statutory law in the Philippines, if it works there, I don't see any reason why it couldn't work here . . . the description of St. Luke's operations in the opinion sounds like a pretty typical nonprofit hospital here in the U.S. (We'll have to talk, though, about this preferential rate stuff . . .).