Tax Exempt Bonds and Research
The University, as a non-profit educational institution, qualifies for issuance of tax-exempt bonds that have the benefit of offering to purchasers the advantage of tax-exempt interest. However, in order to retain tax-exempt status of the bonds, the University must use the funds, and facilities financed by the funds, in accordance with IRS regulations. One important condition is that any bond financed facility may not be used for more than a minimal “private business use”. Bonds issued to the University are typically part of a larger bond issue for other state purposes, and measurements of the limits on private use (10% of the total issue over the life of the bond) are complicated. But, generally, due to the complexities of calculating the de minimis use of bond financed facilities which are part of a much larger bond issuance, it is prudent to exercise care that we do not permit “private use” of our facilities that have active tax-exempt bond financing.
Under the Internal Revenue Code, “private business use” is defined as “use (directly or indirectly) in a trade or business carried on by any person other than a governmental unit.” I.R.C. 141(b)(6). Private business use may be found even in situations where the private entity does not occupy the tax-exempt space, but enjoys special legal entitlements of use, or special economic benefits, as may be the case in the licensing terms in a sponsored research agreement. Research sponsored by a commercial entity is considered “private business” for IRS purposes unless it falls within one of two safe harbors described in Rev. Proc. 2007-47. (26 CFR 1.141-3: Definition of Private Business Use)
The first “safe harbor” relates to the timing of and the price paid for a license to use the intellectual property resulting from corporate or privately sponsored research. Research will not be considered private business if (1) any license or other use of resulting technology by the private sponsor is permitted only on the same terms as the university would permit that use by a non-sponsoring party (competitive price) and (2) the price paid for use of the resulting technology must be determined at the time that the resulting technology is available for use. (i.e. the royalty rate or other consideration for the license cannot be included in the research agreement). As unfair as this may seem to industry sponsors, who understandably believe that they should get a “better deal” to use the results of research they have funded, the university can only grant the sponsor license rights in the research agreement that it would be willing to grant to a non-sponsor. Our bond counsels have advised, however, that the option to an exclusive license does not remove a research agreement from the “safe harbor” protection of Rev.Proc. 2007-47.
The second “safe harbor” relates to the non-exclusive royalty free license obtained by the federal government when an invention arises from federally funded research. Bayh-Dole Act. 35 USC 202(c)(4). Since the IRS considers the federal government to be “private” for purposes of tax-exempt bond financed facilities, it was the intent of the drafters of Rev. Proc. 2007-47 to ensure that the non-exclusive license granted under Bayh-Dole not trigger the “private use” disqualification for tax-exempt treatment. Rev. Proc. 2007-47 provides that an industry sponsor may receive a non exclusive royalty free license on the same basis as the federal government. Under Rev. Proc. 2007-47, industry or federally sponsored research will not be considered “private business” if (1) the research is “governmentally” performed basic research (2) the university determines the research to be performed and the manner in which it is to be performed (3) title to any patent or other product incidentally resulting from the basic research lies exclusively with the university and (4) the sponsor or sponsors are entitled to no more than a nonexclusive royalty free license to use the product of any of that research.
The IRS Office of the General Counsel has advised that the royalty-free nonexclusive that may be granted to a private industry sponsor is exactly the same as that granted to the federal government under Bayh-Dole. That license is a royalty free license to use the technology or have it made for the use of the sponsor/licensee. It does not include the granting of a commercial license.
Since bonds issued to a University are typically part of a larger bond issuance for other governmental purposes, such as public schools or other facilities that do not have any private use, University private use may be minimized by other funded facilities with no private use. To be certain that we are within the 10% limit on private use, however, we must be able to track the facility to the specific bond issuance and to know how much private use, beyond our own, attaches to all the facilities funded by the bond issuance. In those cases where we are uncertain as to whether any specific “private use” would cause the total “private use” for the bond issuance to exceed the 10% limit, it is very important that the University take care to operate within the “safe harbor” conditions described above. The consequence of failing to adhere to these conditions, or to fall within the de minimis exception, is that the IRS can revoke the tax exempt status of the bond issue, causing the entire debt on the state bond issue to be due immediately.
For additional information on private activity in the University’s tax exempt bond buildings contact: Lori Johnson, Director, Strategic Debt Management, 919-513-0748 or the Office of General Counsel, 919-515-3071.