What could a nonprofit public charity of modest means have in common with National Geographic Society and 21st Century Fox? Plenty, if the nonprofit teams up financially with a business for charitable ventures, such as to promote media projects, medical services, and a host of other activities leveraging multiple resources.
Last September, venerable nonprofit National Geographic Society (NGS or Society) teamed up with 21st Century Fox (Fox) to form a powerful new for-profit media company called National Geographic Partners (NG Partners). In exchange for $725 million from Fox, National Geographic transferred its media-related assets, including its television channels and magazine to the new jointly-held for-profit company in which Fox and NGS have 73%/27% financial stakes respectively. To be sure, the “wow factor” and scope of this collaboration, or joint venture, between NGS and Fox is unusual. But the underlying rationale for joint ventures is not novel. Joint ventures are a relatively common way nonprofits develop new avenues of financing, and new opportunities for collaboration. In these ways, the NGS/Fox deal is fairly typical. However, this deal does raise several important questions nonprofits thinking about joint ventures with for-profit entities should consider.
1. Is a nonprofit joint venture with a for-profit organization legally valid?
Yes, nonprofit joint ventures with for-profits can be legally viable, provided these agreements are properly structured. The IRS has long-recognized the validity of nonprofit joint ventures with individuals and for-profit entities, so long as the joint venture agreements adhere to key principles under Section 501(c)(3) of the Internal Revenue Code and related regulations.1 Where parties are willing to carefully develop their agreements to meet these requirements, a joint venture may open doors for the parties to share strengths.
2. How is the NGS/Fox deal typical, given its size?
The massive National Geographic Society/Fox joint venture provides a good illustration of strength sharing common to joint-ventures: The $725 million payment from Fox increases National Geographic’s endowment to nearly $1 billion. NGS also receives a revenue stream that is taxable at the subsidiary level but tax free as a dividend when received by the charity. Fox gains access to millions of new customers including National Geographic’s 6.2 million magazine subscribers, 100 million Facebook followers, 120 million Twitter followers, and 30 million Instagram followers.2
Other collaborations often yield outcomes that are similar in nature to the NGS/Fox deal, if not in size. Nonprofits often contribute vision, charitable goals, volunteers and access to donor lists and related resources. For-profit businesses often contribute financing, business connections, real property, staffing and other resources. The parties should plan carefully to ensure these types of “win-win scenarios” comply with the rules governing joint-venture agreements.
3. What limitations apply to the activities resulting from a nonprofit/for-profit joint venture?
As illustrated by the NGS/Fox deal, nonprofits may consider a broad spectrum of rationale for joint-ventures: to expand the scope of the nonprofit’s charitable services, to spread costs, to limit liability, to improve access to new markets, or to develop new financial resources. However, these practical considerations must be assessed, and limited when necessary, in light of the nonprofit’s tax-exempt purposes. Under federal law, the joint venture must actually carry out the nonprofit’s charitable purpose, and the nonprofit must maintain a sufficient level of control over the jointly-held entity to ensure such furtherance of the nonprofit’s charitable purpose.3
The National Geographic Society, for example, as an organization described under section 501(c)(3) of the Internal Revenue Code, is organized and operated exclusively (primarily) for tax-exempt purposes. The Society’s joint venture with Fox had to be structured to allow NGS to maximally pursue its tax-exempt purposes. In particular, NGS leadership noted that the collaboration with Fox offloaded the resource-intensive media programs to the joint-venture and freed the Society to refocus its attention on the Society’s original tax-exempt goals: “exploring our planet, protecting wildlife and habitats, and helping assure that students in K-12 are geographically literate.”4
Nonprofits with similarly diverse operations might also consider a joint-venture in order to “get back to basics,” to refocus and reorient on the original reasons for which the nonprofit was formed. But whether the purpose of the joint-venture is to refocus, or has some other practical consideration in mind, ultimately the collaboration must be in furtherance of the nonprofit’s exempt purposes.
4. How can a nonprofit considering a joint venture with a for-profit entity protect its tax-exempt status?
A few important legal principles apply here. Care must be taken to ensure that the nonprofit receives adequate value in the transaction, has enough control over the new venture, and guards against impermissible private benefit. In its evaluations of joint ventures involving nonprofits and for-profits, the IRS employs a facts and circumstances test to determine their legitimacy. In particular, the Service looks at the facts and circumstances related to the transaction to determine:
a. Whether the nonprofit has sufficient control to ensure that the joint venture will further the exempt purposes of the nonprofit; and
b. Whether the joint venture is structured to safeguard against inurement to the for-profit partners and otherwise impermissible private benefit.
The importance of both principles is illustrated in Plumstead Theatre Soc., Inc. v. C. I. R. Plumstead Theatre Society (“Plumstead”) was a nonprofit corporation organized and operated to promote and foster the performing arts.5 Plumstead co-produced a play entitled ‘First Monday in October.’ In order to meet its share of the costs in putting on the play, Plumstead sold a portion of its rights in the production to outside investors through a limited partnership.6 The limited partners were two individuals and a for-profit corporation, which provided capital in exchange for an interest in the profits of First Monday in October.7 The IRS sought to revoke Plumstead’s tax exempt status, alleging that Plumstead’s profit-sharing joint venture agreement constituted private benefit in violation of federal regulations governing 501(c)(3) organizations.8 The Federal Court of Appeals rejected the IRS’ characterization. In particular, the court noted that the private investors were limited partners of the joint venture only, not shareholders in or officers or directors of the nonprofit, and the partnership agreement expressly reserved full management control to the nonprofit.9 Because the nonprofit so retained control, the arrangement was permissible.
In the NGS/Fox deal, even though the Society holds only 27% of the assets in the jointly held NG Partners, voting control of the new company is split 50/50. Furthermore, the Society’s president currently serves as the initial chair of the board of directors. These facts are extremely significant, from a nonprofit tax perspective. Nonprofits considering joint ventures with for-profit organizations should take steps to carefully structure their control mechanisms and charitable safeguards in the legal documents governing the collaboration to ensure it is sufficient to protect the charity’s exempt status. This can be a difficult negotiation point, particularly with for-profit business investors who are bringing significant capital to the project. It is often the biggest challenge in structuring the joint venture. A limited liability company (LLC) often provides needed flexibility for this level of creative structuring, such as that described in the NGS/Fox agreement.
5. Are there other tax-related considerations for a nonprofit that participates in a joint venture with a for-profit organization?
Yes, when a nonprofit organization regularly carries on trade or business that is not related to its exempt purposes, it may owe “unrelated business income tax” (known as UBIT). Many tax-exempt entities pay some measure of UBIT each year. The key is to structure the joint venture in a way that minimizes this tax exposure and/or prevents the unrelated business from becoming the primary activity of the charity (below). In the Fox/NGS joint venture, the joint venture was structured into a separate, taxable entity in which the nonprofit NGS holds a 27% stake. This created a revenue stream from NG Partners (the taxable subsidiary) that is excluded from the UBIT as a passive dividend when received by the NGS.
When a joint venture does trigger a substantial level of unrelated business income for the charity, the charity may want to consider moving these activities into a separate taxable entity to prevent the organization from jeopardizing its tax-exempt status under Section 501(c)(3). Under the “commerciality” tax doctrine, the IRS may determine that a nonprofit with too much unrelated business activity no longer operates primarily for exempt purposes and revoke the organization’s exemption.10 Relocating unrelated business activities conducted by the joint venture into a separate taxable entity can often resolve this issue. However, additional tax considerations will also apply.
