LTR 7936006, May 23, 1979
[Code Sec. 512]

Unrelated business taxable income; Taxable v. not taxable; Modifications; Testing of pharmaceutical products.—CCH.

ISSUE

Whether the income received by a medical college from the testing of pharmaceutical products is subject to unrelated business income tax.

FACTS

The medical college was organized for the purposes of promoting the providing instruction in medical science. The college is currently recognized as exempt from Federal income tax under section 501(c)(3).

The college, pursuant to written agreements with five pharmaceutical manufacturers, undertook certain studies. The purpose of the studies was to explore the effects of various pharmaceutical products as they related to the diagnosis or the development of new methods of treatment of human diseases and conditions.

In all five studies, the particular medical college researchers involved had responsibility for the design and management of the research, including data collection and analysis. The studies were conducted using the facilities and personnel, including professors, technicians and students, or the college. The college was reimbursed for its expenses, including personnel costs, incurred in carrying out the tests.

The data generated by the studies and the conclusions reached by the researchers have been published and have been utilized in the instruction of graduate students.

LAW

Section 511 imposes a tax on the unrelated business taxable income of organizations exempt under section 501(c)(3).

Section 512 defines “unrelated business taxable income” as the gross income derived by any organization from any unrelated trade or business (as defined in section 513) regularly carried on by it.

Section 512(b)(8) excludes from the computation of unrelated business taxable income, in the case of a college, university, or hospital, all income derived from research performed for any person, and all deductions directly connected with such income.

Section 1.512(b)-1(f)(4) of the Income Tax Regulations provides that the term “research” does not include activities of the type ordinarily carried 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 or buildings.

Revenue Ruling 54-73, 1954-1 C.B. 160, also provides that the term “research” as used in the unrelated business income modifications does not include activities of a type ordinarily carried on as an incident to commercial or industrial operations.

Revenue Ruling 68-373, 1968-2 C.B. 206, states that a nonprofit organization primarily engaged in testing drugs for commercial pharmaceutical companies, as required by the Food and Drug Administration before marketing can begin, does not qualify for exemption under section 501(c)(3).

Revenue Ruling 76-296, 1976-2 C.B. 142, states that commercially sponsored research otherwise qualifying as scientific research under section 501(c)(3), the results of which, including all relevant information, are timely published in such form as to be available to the interested public, constitutes scientific research carried on in the public interest. Research, the publication of which is withheld or delayed significantly beyond the time reasonably necessary to establish ownership rights, however, is not in the public interest and constitutes the conduct of unrelated trade or business within the meaning of section 513.

Revenue Ruling 78-426, 1978-50 I.R.B. 5, states that an organization whose activities include the inspection, testing, and safety certification of cargo shipping containers and research, development, and reporting of information in the field of containerization is not operated exclusively for the purpose of testing for public safety or for scientific purposes. The revenue ruling also states that, in addition, the safety and efficiency of shipping containers are closely allied to successful commercial operations, since manufacturers and shippers must protect themselves against losses due to spoilage, leakage, delays in transit, and employee injuries. Thus, the organization's testing and research activities are of a type ordinarily carried on as an incident to commercial or industrial operations.

RATIONALE

On the basis of the information submitted, it is clear that the primary responsibility for the research lay with the college researcher undertaking the studies. The studies themselves involved the search for new or improved methods of treating human afflictions. The results obtained were made available to the general public through publication in scholarly journals and through presentations at conferences unlike the situations described in Revenue Ruling 76-296. The results were also used in the instruction of students at the college. In addition, a number of graduate students assisted in the conduct of the research. The activities funded by the manufacturers are thus within the purposes for which the college was formed. The research is central to the basic purposes of promoting and teaching medical science.

Even if the research was not so related to the exempt purposes of the college, the income derived from the research would fall within section 512-(b)(8). That section excludes from the calculation of unrelated business taxable income all income received by a college from the performance of research. Section 1.512(b)-1(f)(4) of the regulations, however, excludes activities ordinarily carried on as an incident to commercial or industrial operations from the definition of “research.” The key issue this becomes whether the activities of the college constituted research or whether they more closely resembled ordinary testing or inspection of materials or products.

The phrase “activities of a type ordinarily carried on as an incident to commercial or industrial operations” also appears in section 1.501(c)(3)-1(d)(5) of the regulations concerning qualification for exemption under section 501(c)(3). In that context, the phrase has been illustrated in Revenue Ruling 68-373 and Revenue Ruling 78-426.

Unlike the situation described in those revenue rulings, the studies undertaken by the college are concerned with new applications of products or drugs in order to improve the ability to treat various diseases and conditions. The studies are not, therefore, mere quality control programs or ordinary testing for certification purposes, as a final procedural step before marketing, but rather are research within the meaning of section 512(b)(8).

CONCLUSION