Normative Speculations About The Unrelated Business Income Tax

From Mixing Business with Charity

Last week’s post wondering why any of the King’s former colonies should tax unrelated business income prompted a correction and some new information that actually bolster’s the suggestion that UBIT is neither a fundamental nor normative feature of charitable tax exemption.  As it turns out, Australia has never adopted an unrelated business income tax.  It thought to do so only recently, but rejected the notion as too complex for what little revenue it generates.  Kenya, on the other hand, only recently adopted an UBIT that comes into effect next year.  Kenya is another former colony by the way.  Here, in the Law’s Section 4, is the deceptively simple articulation:

Provided that any such income which consists of gains or profits from a business shall not be exempt from tax unless such gains or profits are applied solely to such charitable purposes and either—

(i) such business is carried on in the course of the actual execution of such purposes;

(ii) the work in connection with such business is mainly carried on by beneficiaries under such purposes; or

(iii) such gains or profits consist of rents (including premiums or any similar consideration in the nature of rent) received from the leasing or letting of land and any chattels leased or let therewith.

There is nothing else on the subject in Kenya’s concisely and clearly stated Tax Regulations.  But I agree with Myles McGregor-Lowndes who sent greetings from Downunder. He told me that Australia thought about UBIT for awhile but determined the whole damn thing would add intolerable complexity for what little good it would do.  McGregor-Lowndes tells the fascinating story of UBIT’s Australian rise and fall here.  

It’s almost intuitive what Rose-Akerman said many years ago.  It can’t often be the case that tax exemption gives nonprofits an unfair business advantage in their business activities.  Certainly not on a macro-economic basis.  The argument was that if left unchecked, exempting unrelated business profits would lead to nonprofits capturing entire industries, not just single pasta factories.  That always perplexed me because fiduciaries’ don’t have sufficient private profit motive for that kind of economic empire building.    

So if UBIT is no threat to the macro-economics and contains all sorts of ridiculous implementing tools like the unrelated debt financing rules, why would anybody bother?  By the way, Kenya’s new charitable tax exemption law is a far better restatement of our laws here in the United States.  For example, the discussion of private benefit in Section 8 is a huge improvement over our own murky laws on the topic.  This is no simple cut and paste.  It appears the drafters had the benefit of hindsight and close study of other countries’ laws, filling in gaps our laws maintain. So why include a tax on unrelated business income? That could not have been by accident in Kenya’s law. 

Here is my speculation, after having excluded in my mind any other good reason.  A UBIT is useful for requiring the wealthiest fee-generating exempt organizations to pay a little more than their charitable public benefit. The tax extracts an occasional but direct financial rebate to the public whose subsidy and paid patronage helped accumulate the organization’s wealth.  That’s why even state colleges and universities are included under U.S. law.  And, of course, why the tax cannot apply to donations even if we thought total donations exceeded need. People stop giving when they think enough is enough so donations are never over-subsidized.  So the government’s imposition of an unrelated business tax constitutes an involuntary rebate justified by an entirely ad hoc determination that a particular organization doesn’t need as much subsidy as it was initially granted.  The big wealthy organizations ought to contribute more on that fact alone, never mind unfair competition or destination of income.  They can afford it and the people ought to have some of it as unwitting investors in the business.  

Just a theory so far.  It probably works better to explain taxing pressures on charitable property tax exemption but it seems to explain the ad hoc nature of the UBIT.  

darryll k. jones