[Congressional Record Volume 142, Number 143 (Monday, October 21, 1996)]
[Senate]
[Pages S12470-S12471]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]




                      UNFAIR NONPROFIT COMPETITION

 Mr. SHELBY. Mr. President, language included in the Senate 
report of the Subcommittee on Treasury, Postal Service and General 
Government appropriations, and included by reference in the fiscal year 
1997 Omnibus Appropriations bill, directs the Department of the 
Treasury to review the problem of unfair nonprofit competition with 
small firms. The language also directs the Treasury to take ``steps, if 
necessary, to develop regulations clarifying the substantially related 
test as it applies to tax-exempt travel and tour activities.'' I want 
to speak briefly to the need for such regulatory clarification.
  Mr. President, the travel and tour industry in this Nation is 
comprised predominately of the smallest entrepreneurial firms--tour 
operators and promoters, travel agents, hotel and motel owners, bus 
owners and operators. Small businesses that organize tours, small 
businesses that conduct tours, and small marketers that sell tours 
combined comprise one of the largest sectors of our economy. Although 
not often thought of as such, these entrepreneurs are vital exporters. 
By providing a large flow of service to foreign visitors they 
constitute one of the most successful exporting blocs in the United 
States. They export America and an understanding of America, from the 
national parks to our many other great attractions.
  Mr. President, I raise these points not only to recognize the immense 
size and contribution of this industry, but to help us appreciate how 
important it is to ensure that our policies support and nurture a 
vibrant, competitive travel and tour industry. To an increasing extent 
these small businesses have been besieged by a source of unfair 
competition from nonprofit organizations, who now comprise more than 10 
percent of our GDP. Some of the Nation's wealthiest tax-exempt 
organizations have discovered that travel and tour activities, albeit 
primarily a commercial venture, are an easy way to supplement income.
  Now, Mr. President, small businesses support nonprofits in financing 
many of their endeavors. Small businesses recognize the important work 
of many nonprofits. They are partners with nonprofits. Indeed, while 
their contributions are not often publicized in the Conference Board, 
the U.S. Small Business Administration has determined that small firms 
are the largest contributors to nonprofits on an employee-by-employee 
basis. Small firms also do not fear competition from tax-exempt 
organizations, any more than they do from large firms, foreign firms, 
or any other entity. They embrace competition as a necessary part of 
their daily routine.
  But what small businesses do resent, however, is competition where 
one party has been given an unfair advantage. And the competitive 
playing field between small firms and nonprofits has not been level for 
some time. Today, nonprofits make extensive use of privileged franking 
on mail, and they often cross-subsidize their travel activities using 
capital acquired for other purposes. And last but not least, when they 
directly compete against small firms they frequently enjoy the largest 
benefit taxpayers can bestow upon them--complete absolution from the 
income tax.
  Mr. President, my concerns and the concerns expressed by this 
Congress are not new. Congress has tried to address this concern of 
unfair competition in the past. Indeed, more than 45 years ago, the 
Congress passed what is known as the unrelated business income tax, 
which taxes income that is not substantially related to the tax-
exempt's mission. And, in 1986, the Supreme Court in U.S. v. American 
Bar Endowment, 477 U.S. 105, reiterated that ``[t]he undisputed purpose 
of the unrelated business income tax was to prevent tax-exempt 
organizations from competing with businesses whose earnings were 
taxed.''
  However, growth in the number of nonprofits, an increased emphasis on 
commercial as opposed to donative sources of revenue, and most 
importantly, a paucity of guidance over what is meant by substantially 
related have combined to make that standard virtually meaningless.
  The Congress is not alone in its concern over the failure of the law 
to prevent unfair competition. Even the IRS itself believes the 
substantially related standard, without adequate definition, is 
virtually unenforceable. And equally important, the U.S. Small Business 
Administration believes that guidance is necessary. I offer for 
inclusion in the Record a recent letter sent by the SBA chief counsel 
to the Department of the Treasury urging a regulation.
  For many small tour operators, the discernible distinction between 
their activities and that of the nonprofit is not in the markets they 
serve or in the services they market, but rather in the inexplicable 
and unjustifiable distinction that, on the income predicted, one pays 
taxes and the other does not. And to make matters worse, a rationale 
for this cross-subsidization does not exist. As businesses point out, 
rather than enabling nonprofits to serve the needy for which an 
exemption is warranted, the exemption enables nonprofit travel and tour 
promoters to tap and maintain access to the high-end, most lucrative 
part of the market--the segment with the greatest disposable income, 
the greatest number of professionals, and the highest component of 
educated customers. When this competition occurs, there is a distinct 
and quantifiable competitive advantage nonprofits enjoy from total 
relief from the income tax.
  Mr. President, for these reasons, the Senate report which accompanied 
the appropriations bill for the Treasury, Postal Service and General 
Government Appropriations Subcommittee, directed the IRS to review this 
situation. Action on this issue is requested by Congress. It is being 
requested by the U.S. Small Business Administration. It is sought by 
the IRS field agents. And last but not least, it is urged by the 
millions of small businesses that suffer from unfair competition.
  The letter follows:

                           U.S. Small Business Administration,

                                    Washington, DC, June 27, 1996.
     Re unrelated business income tax travel and tour-related 
       services--need for clarification.

     Hon. Donald C. Lubick,
     Acting Assistant Secretary for Tax Policy, U.S. Department of 
         the Treasury, Washington, DC.
       Dear Assistant Secretary Lubick: This office has heard from 
     numerous small business groups for more than a decade about 
     the problems that taxpaying small businesses have when they 
     are in competition with tax exempt organizations. As you 
     know, resolving this issue was a recommendation of the White 
     House Conference on Small Business and, we believe, the 
     intent of the unrelated business income tax (UBIT) was to 
     maintain an equitable business environment when tax-exempt 
     organizations produced income from activities that are beyond 
     the activities on which their exemption status is based. Most 
     recently, a concern has been expressed within the travel and 
     tourism industry (an industry made up predominantly of small 
     businesses) that the line has become so imprecise that their 
     industry is being damaged. They fear that the area will be 
     regulated or is being regulated in a manner which prevents 
     their participation in the regulation drafting process. We 
     share their concern.
       I am writing to urge the Treasury Department to incorporate 
     a rule-making into the 1997 IRS Business Plan that would 
     clarify the ``substantially related'' test for purposes of 
     determining unrelated business income arising from the travel 
     and tour activities of tax-exempt entities. A regulation 
     would provide guidance where there is little existing 
     guidance and would address an important, persistent and 
     growing concern of small businesses over an issue of 
     fundamental fairness. It would raise additional revenue 
     through greater compliance in an area of known non-
     compliance, and standardize inconsistent application of the 
     law by clarifying a hazy area of the law.
       As you know, whether or not income from a commercial travel 
     and tour activity by a university, a museum or other 
     nonprofit is taxable depends upon whether or not the activity 
     is ``substantially related'' to the organization's exempt 
     function.

[[Page S12471]]

       Unfortunately, the inherently subjective nature of the 
     ``substantially related'' test, difficulties in its 
     administration, and extremely limited guidance have 
     contributed to a perception of fundamental unfairness by the 
     small business community, particularly in the travel 
     industry. This helps to explain why the issue rose to such 
     prominence in the 1995 White House Conference on Small 
     Business (and, for that matter, in the 1986 White House 
     Conference on Small Business). Rather than enabling 
     nonprofits to serve traditional educational tour markets for 
     which exemption is appropriate, small businesses complain 
     that this exemption has emboldened tax-exempts to maintain 
     and expand into those market segments with the highest 
     disposable income, the largest number of professionals, the 
     most educated customers, and the least need for tax 
     exemption.
       Under current guidance, Technical Advise Memoranda or 
     Private Letter Rulings, the Service has a fairly well 
     established set of criteria under which it has found such 
     activity to be exempt. However, the industry tells us that 
     the subjective nature of the criteria gives a little reliable 
     guidance for determining when commercial tours and travel 
     will be taxable. It is in the resulting gray area that most 
     of the commercial activity is currently undertaken. Despite 
     substantial increases in tax-exempt travel and tour activity 
     and greater commercial character of that activity, the tax 
     treatment of such activity remains largely undefined, fueling 
     the perception of unfairness and increasing overlap in the 
     travel and tour activities conducted by both sectors.
       Guidance in the form of a regulation, with examples, would 
     better define the contours of the ``substantially related'' 
     test and fill these gaps. Promulgation of a proposed 
     regulation will ensure that the issue is framed in terms of 
     the central focus of the debate--the application of the UBIT 
     to what are essentially commercial travel and tour 
     activities. A rulemaking will attract the greatest level of 
     factual input from both the for-profits and nonprofits. 
     Moreover, a rulemaking may even save Federal resources by 
     eliminating the need for extensive audits with limited 
     guidance and negative and inconsistent court rulings that may 
     result from inadequate guidance. Indeed, it is our 
     understanding that guidance has also been requested by the 
     nonprofit community in order to alleviate increased audit 
     activity.
       We understand that the Treasury, in its proposed 1997 
     business plan will be focusing on several issues affecting 
     nonprofits. We would welcome your including the regulatory 
     guidance under the ``substantially related'' test--already 
     identified to be of central concern to small businesses--as 
     one of the priorities under that plan.
       The Office of Advocacy, and specifically Russ Orban of my 
     staff, would welcome the opportunity to work with you, and 
     would be pleased to discuss how such a regulation might be 
     fashioned.
           Sincerely yours,
                                                   Jere W. Glover,
                                           Chief Counsel. 
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