Travel and Tour Activities of Tax Exempt Organizations

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-121268-97]

RIN 1545-AW10

Travel and Tour Activities of Tax Exempt Organizations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations clarifying when

the travel and tour activities of tax exempt organizations are

substantially related to the purposes for which exemption was granted.

These proposed regulations are intended to augment the guidance that

currently exists with respect to travel tours and the unrelated

business income tax.

DATES: Written comments and requests for a public hearing must be

received by July 22, 1998.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-121268-97), room

5226, Internal Revenue Service, POB 7604, Ben Franklin Station,

Washington, DC 20044. Submissions may be hand delivered between the

hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-121268-97), Courier's

Desk, Internal Revenue Service, 1111 Constitution Avenue NW.,

Washington, DC. Alternatively, taxpayers may submit comments

electronically via the internet by selecting the ``Tax Regs'' option on

the IRS Home Page, or by submitting comments directly to the IRS

internet site at http://www.irs.ustreas.gov/prod/tax__regs/

comments.html.

FOR FURTHER INFORMATION CONTACT: Robin Ehrenberg, (202) 622-6080 (not a

toll-free number).

SUPPLEMENTARY INFORMATION:

Background

An organization generally exempt from tax under section 501(a) of

the Internal Revenue Code (``Code'') must pay tax on its unrelated

business taxable income, as defined in section 512. Section 512(a)(1)

defines unrelated business taxable income (''UBTI'') as the gross

income derived by any organization from any unrelated trade or business

(as defined in section 513) regularly carried on by the organization,

less the deductions which are directly connected with the conduct of

the trade or business. Gross income from an unrelated trade or business

and any deductions directly connected to that trade or business are

both computed in accordance with the general income tax rules of

chapter 1 of the Internal Revenue Code, subject to the modifications

provided in section 512(b).

Section 513(a) generally defines an unrelated trade or business as

any trade or business the conduct of which is not substantially related

(aside from the need of an organization for income or funds or the use

it makes of the profits derived) to the exercise or performance by the

organization of its charitable, educational, or other purpose or

function constituting the basis for its exemption under section 501.

A ``trade or business'' is defined in Section 1.513-1(b) of the

Income Tax Regulations as having the same meaning it has for purposes

of section 162, and ``generally includes any activity carried on for

the production of income from the sale of goods or performance of

services.'' The key test of whether an activity constitutes a trade or

business is whether the activity was conducted with a profit motive.

See U.S. v. American Bar Endowment, 477 U.S. 105 (1986); Professional

Insurance Agents of Michigan v. Commissioner 726 F.2d 1097 (6th Cir.

1983); National Water Well Association v. Commissioner, 92 T.C. 75

(1989). The regulations further provide that an activity conducted for

the production of income does not lose its character as a business

``merely because [it is] carried on within a larger aggregate of

similar activities or within a larger complex of other endeavors which

may, or may not, be related to the exempt purposes of the

organization.'' This ``fragmentation rule,'' as it is commonly known,

may result in different treatment of related activities under the

unrelated business income tax.

Section 1.513-1(d)(2) of the Income Tax Regulations provides that a

trade or business is ``substantially related'' to exempt purposes only

where the conduct of the business activities has a substantial causal

relationship to the achievement of the exempt purposes (other than

through the production of income) of the organization conducting the

trade or business. Thus, a trade or business is substantially related

for purposes of section 513 only if the conduct of the trade or

business contributes importantly to the accomplishment of the

organization's exempt purposes.

In recent years, taxpayers and Congress have asked the IRS to

publish guidance addressing questions relating to the unrelated

business income tax treatment of income generated from travel tours

conducted by tax exempt organizations. Although the IRS has issued a

number of revenue rulings addressing situations in which tax exempt

organizations sponsor travel tours, most of these rulings have analyzed

whether an organization that offers travel tours as its primary

activity can qualify as a charitable or educational organization

described in section 501(c)(3) of the Code.

Rev. Rul. 67-327, 1967-2 C.B. 187, holds that an organization whose

purpose is to arrange group tours for students and faculty of a

university in order to allow them to travel abroad does not qualify for

exemption because the organization operates essentially as

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a commercial travel agency. The ruling concludes that the

organization's activities are not ``educational'' as that term is

defined in Treas. Reg. Sec. 1.501(c)(3)-1(d)(3)(i)(a), because they do

not provide instruction or training of individuals for the purpose of

improving or developing their capabilities.

In contrast, in Rev. Rul. 69-400, 1969-2 C.B. 114, an organization

that selects students and faculty members interested in a certain

foreign history and culture and enrolls them at foreign universities

and arranges for on-site tours conducted by local scholars that

complement classroom studies, is held to be exempt. Rev. Rul. 69-400

distinguishes Rev. Rul. 67-327 on the basis that the organization in

the later ruling is arranging for instruction not just travel.

Rev. Rul. 70-534, 1970-2 C.B. 113, describes an organization that

conducts travel study tours as its primary activity. Tours are geared

toward students, but others can take the tours as long as they

participate in the mandatory study programs. Organized study, taught by

certified teachers, is conducted five to six hours a day, and a library

of materials related to the courses being taught is available. Exams

are given, each student is graded and a state board of education allows

credit for a student's participation in the study tour program. The

revenue ruling concludes that the organization furthers educational

purposes because it performs training and instruction for the purpose

of allowing individuals to improve and develop their capabilities, and

is, therefore, described in section 501(c)(3).

Rev. Rul. 77-366, 1977-2 C.B. 192, concerns an organization that

arranges and conducts ocean cruises for ministers, church members and

their families for the purpose of providing continuing education in an

atmosphere supporting spiritual renewal. The organization's activities

include lectures, discussions, workshops and some shore activities that

further charitable purposes. However, because of the extensive

resources the organization devotes to social and recreational programs,

the scheduling of those programs relative to the schedule for the

exempt purpose programs, and other facts and circumstances, the

organization was held to be also serving a substantial nonexempt

purpose and, therefore, not to qualify for exemption as an organization

described in section 501(c)(3).

The Tax Court applied a similar analysis to an organization

operating a mountain lodge when it held that the organization failed to

qualify as a religious organization described in section 501(c)(3).

Although religious activities were offered to guests in addition to a

wide range of recreational activities, guests were not required to

participate in the religious activities, and the record failed to show

that the recreational activities were insubstantial. See The Schoger

Foundation v. Commissioner, 76 T.C. 380 (1981).

In contrast, Rev. Rul. 77-430, 1977-2 C.B. 194, holds that an

organization conducting weekend retreats is furthering its stated

purpose of advancing religion. Individuals come to participate in a

program of seminars, lectures, prayer sessions and meditation led by

ministers and priests that are scheduled on an hourly basis throughout

the day. Recreational activities are not scheduled, but are available

to participants during their limited free time. Under these facts and

circumstances, the ruling holds that the facilities are being used to

advance religion and that recreational activities are incidental to the

accomplishment of this purpose.

The revenue rulings all focus on the degree of educational or

religious content participants are expected to receive in each travel

program in determining whether the activity serves an exempt purpose.

The same approach was taken in the one ruling that has specifically

addressed the application of the unrelated business income tax to

income generated by travel tours. Rev. Rul. 78-43, 1978-1 C.B. 164,

describes the travel tour activity of a university alumni association.

The association's program of approximately ten tours per year is open

to all current members and their immediate families and is planned with

various travel agencies. Each travel agency pays a per person fee to

the association. The tours do not include any formal educational

program and do not differ substantially from commercially operated

tours. Rev. Rul. 78-43 concludes that there is no causal relationship

between arranging the travel tours described in the ruling and the

achievement of an exempt purpose. Accordingly, the ruling holds that

the sale of tours to members is an unrelated trade or business within

the meaning of section 513.

These proposed regulations are intended to augment the guidance

that currently exists with respect to travel tours and the unrelated

business income tax. The proposed regulations also provide additional

guidance regarding the fragmentation rule and the distinctions that may

be necessary among different tours or activities that are part of a

single organization's travel program.

The IRS and Treasury are soliciting comments on these proposed

regulations. In particular, because the IRS relies heavily on review of

records to determine whether an organization's trade or business

activities further an exempt purpose, comments are requested on whether

the IRS should specify the types of records organizations should keep

to establish the activity's purpose.

Explanation of Provisions

The proposed regulations add a new Sec. 1.513-7 providing that the

determination of whether travel tour activities of tax exempt

organizations are substantially related to an organization's exempt

purposes is a question of facts and circumstances. The proposed

regulations set forth a series of examples to illustrate how various

facts and circumstances would be analyzed.

Proposed Effective Date

These regulations are proposed to be effective for taxable years

beginning after the date final regulations are published in the Federal

Register. For prior taxable years, the IRS will continue to apply

principles of existing law.

Special Analyses

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in EO 12866. Therefore,

a regulatory assessment is not required. It also has been determined

that section 553(b) of the Administrative Procedure Act (5 U.S.C.

chapter 5) does not apply to these regulations, and because the

regulation does not impose a collection of information on small

entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not

apply. Pursuant to section 7805(f) of the Internal Revenue Code, this

notice of proposed rulemaking will be submitted to the Chief Counsel

for Advocacy of the Small Business Administration for comment on its

impact on small business.

Comments and Requests for a Public Hearing

Before these proposed regulations are adopted as final regulations,

consideration will be given to any written comments (a signed original

and eight (8) copies) that are submitted timely to the IRS. All

comments will be available for public inspection and copying. A public

hearing may be scheduled if requested in writing by a person that

timely submits written comments. If a public hearing is

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scheduled, notice of the date, time, and place for the hearing will be

published in the Federal Register.

Drafting Information

The principal author of these regulations is Robin Ehrenberg,

Office of Associate Chief Counsel (Employee Benefits and Exempt

Organizations). However, other personnel from the IRS and Treasury

Department participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in

part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.513-7 is added to read as follows:

Sec. 1.513-7 Travel and tour activities of tax exempt organizations.

(a) Travel tour activities that constitute a trade or business, as

defined in Sec. 1.513-1(b), and that are not substantially related to

the purposes for which exemption has been granted to the organization

constitute an unrelated trade or business with respect to that

organization. Whether travel tour activities conducted by an

organization are substantially related to the organization's exempt

purpose is determined by looking at all relevant facts and

circumstances. Section 513(c) and Sec. 1.513-1(b) also apply to travel

tour activity. Application of the rules of section 513(c) and

Sec. 1.513-1(b) may result in different treatment for individual tours

within an organization's travel tour program.

(b) Examples. The provisions of this section are illustrated by the

following examples:

Example 1. O, a university alumni association, is exempt from

federal income tax under section 501(a) as an educational

organization described in section 501(c)(3). As part of its

activities, O operates a travel tour program. The program is open to

all current members of O and their guests. O works with travel

agencies to schedule approximately 10 tours annually to various

destinations around the world. Members of O pay $X to the organizing

travel agency to participate in a tour. The travel agency pays O a

per person fee for each participant. Although the literature

advertising the tours encourages O's members to continue their

lifelong learning by joining the tours, and a faculty member of O's

related university is invited to join the tour as a guest of the

alumni association, none of the tours includes any scheduled

instruction or curriculum related to the destinations being visited.

By arranging to make travel tours available to its members, O is not

contributing importantly to the accomplishment of its educational

purpose. Rather, O's program is designed to generate revenues for O

by regularly offering its members travel services. Accordingly, O's

tour program is an unrelated trade or business within the meaning of

section 513(a) of the Code.

Example 2. N is an organization formed for the purpose of

educating individuals about the geography and culture of the United

States. It is exempt from federal income tax under section 501(a) as

an educational and cultural organization described in section

501(c)(3). N engages in a number of activities to accomplish its

purposes, including offering courses and publishing periodicals and

books. As one of its activities, N conducts study tours to national

parks and other locations within the United States. The study tours

are conducted by teachers and other education professionals. The

tours are open to all who agree to participate in the required study

program. The study program consists of community college level

courses related to the location being visited by the tour. While the

students are on the tour, five or six hours per day are devoted to

organized study, preparation of reports, lectures, instruction and

recitation by the students. Each tour group brings along a library

of material related to the subject being studied on the tour.

Examinations are given at the end of each tour and N's state board

of education awards academic credit for tour participation. Because

the tours offered by N include a substantial amount of required

study, lectures, report preparation, examinations and qualify for

academic credit, the tours clearly further N's educational purpose.

Accordingly, N's tour program is not an unrelated trade or business

within the meaning of section 513(a) of the Code.

Example 3. R is a section 501(c)(4) social welfare organization

devoted to advocacy on a particular issue. On a regular basis

throughout the year, R organizes a travel tour for its members to

Washington, D.C. The tours are priced to produce a profit for R.

While in Washington, the members follow a schedule according to

which they spend substantially all of their time over several days

attending meetings with legislators and government officials and

receiving briefings on policy developments related to the issue that

is R's focus. Bringing members to Washington to participate in

advocacy on behalf of the organization and learn about developments

relating to the organization s principal focus is substantially

related to R's social welfare purpose. Therefore, R's operation of

the travel tours does not constitute an unrelated trade or business.

Example 4. S is a membership organization formed to foster

cultural unity and to educate X Americans about X, their country of

origin. It is exempt from federal income tax under section 501(a)

and is described in section 501(c)(3) as an educational and cultural

organization. Membership in S is open to all Americans interested in

the X heritage. As part of its activities, S sponsors a program of

travel tours to X. All of S's tours are priced to produce a profit

for S. The tours are divided into two categories. Category A tours

are trips to X that are designed to immerse participants in the X

history, culture and language. The itinerary is designed to have

participants spend substantially all of their time while in X

receiving instruction on the X language, history and cultural

heritage. Destinations are selected because of their historical or

cultural significance or because of instructional resources they

offer. Category B tours are also trips to X, but rather than

offering scheduled instruction, participants are given the option of

taking guided tours of various X locations included in their

itinerary. Other than the optional guided tours, Category B tours

offer no instruction or curriculum. Even if participants take all of

the tours offered, they have a substantial amount of time free to

pursue their own interests once in X. Destinations of principally

recreational interest, rather than historical or cultural interest,

are regularly included on Category B tour itineraries. Based on the

facts and circumstances, sponsoring Category A tours is an activity

substantially related to S's exempt purposes, and does not

constitute an unrelated trade or business with respect to S.

However, sponsoring Category B tours does not contribute importantly

to S's accomplishment of its exempt purposes and is designed to

generate a profit for S. Therefore, sponsoring the Category B tours

constitutes an unrelated trade or business with respect to S.

Michael P. Dolan,

Deputy Commissioner of Internal Revenue.

[FR Doc. 98-10747 Filed 4-20-98; 2:48 pm]

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