UBIT Testimony by lonyoo


									Statement of the Pennsylvania Association of Nonprofit Organizations (PANO) Before the Philadelphia Department of Revenue Presented by David A. Ross, J.D. Public Policy Officer, Pennsylvania Association of Nonprofit Organizations Philadelphia, PA Friday, February 13, 2009 On behalf of the Pennsylvania Association of Nonprofit Organizations (“PANO”) and our member organizations, I respectfully submit the following comments in response to the proposed amendment to the City of Philadelphia Business Privilege Tax Regulations §101(D)(1) to extend the City’s Business Privilege Tax (“BPT”) to nonprofits’ unrelated business income. PANO is the statewide membership organization serving and advancing the charitable nonprofit sector through leadership, advocacy, education and services in order to improve the quality of life in Pennsylvania. PANO is a 501(c)(3) charitable nonprofit organization representing 800 member charitable, cultural and educational organizations. Pennsylvania is home to over 41,000 registered 501(c)(3) charitable nonprofit organizations. Philadelphia is home to nearly 2000. Philadelphia’s purely public charities and foundations operate on the front lines of our communities. Nonprofits are the primary provider of higher education, healthcare and basic scientific research. The sector is a major provider of social services for the disadvantaged, and regularly provides services that business and government either cannot or will not provide. It includes art and cultural organizations that preserve and enhance the history and diversity of our society. Charitable nonprofit organizations are considered “charitable” precisely because they provide uniquely for the public good. Pennsylvania’s Purely Public Charities Act, Act 55 of 1997 is the seminal statute that clearly defines the rules by which Pennsylvania 501(c)(3)’s can qualify for property tax and sales tax exemptions. Act 55 requires satisfaction of the following 5 criteria: a charity must 1) advance a charitable purpose; 2) serve a substantial and indefinite class of persons; 3) who are legitimate subject of charity; 4) relieve government of some of its burden; and 5) operate entirely free from private profit motive. For-profit businesses have no such duty. But Pennsylvania’s nonprofits are facing unprecedented challenges, from declining contributions, decreasing revenue, and losses of government and foundation funding. Resources are dwindling, while the community’s need for the services that nonprofits provide grows rapidly. Dr. Paul Light, a noted nonprofit sector scholar recently predicted that within the next 18-24 months more than 100,000 nonprofits throughout the country will fail due of the economic downturn. If this is correct, Pennsylvania should expect to lose about 4,000 mission-driven, community-based organizations. Two hundred of which would likely be from Philadelphia.

David A. Ross, J.D. PANO Public Policy Officer

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The city's definition of "unrelated business" is substantially different from the IRS definition of unrelated business taxable income. For both the charities and the City, the proposed amendment would be too difficult to administer for both the charities and the City. It may even cause charities to change their practices in order to avoid the tax altogether. Chapter 19-2600 of the Philadelphia Code §101(D)(1) defines “Business” as
“Carrying on or exercising for gain or profit within Philadelphia any trade, business, including financial business as hereinafter defined, profession, vocation or commercial activity or making sales to persons within the City of Philadelphia”

The proposed amendment to the regulation redefines the term “business” to include certain unrelated business activities that may now be treated as taxable events, including: “For the purpose of this tax, income generated by a nonprofit organization from rental of any residential or commercial real estate is deemed income derived from unrelated business activity”. The IRS defines “Unrelated Business” as:
“…a trade or business… regularly carried on… [that] is not substantially related to furthering the exempt purpose of the organization.”

The IRS further defines “substantially related” as follows:
“To determine if a business activity is substantially related requires examining the relationship between the activities that generate income and the accomplishment of the organization's exempt purpose. Trade or business is related to exempt purposes, in the statutory sense, only when the conduct of the business activities has causal relationship to achieving exempt purposes (other than through the production of income). The causal relationship must be substantial. The activities that generate the income must contribute importantly to accomplishing the organization's exempt purposes to be substantially related.”

By extending the City’s BPT to real estate rental income, the amended BPT would greatly exceed the scope of the Federal definition of UBIT. The City would deem income generated by a nonprofit organization from rental of any residential or commercial real estate as income derived from unrelated business activity. The IRS has struggled for years to reduce the uncertainty with regard to UBIT of numerous types of business activity payments to exempt organizations. Over time, the rules regarding revenue derived from real estate developed numerous exemptions. Much of this was achieved through decades of litigation, and had very specific underlying public policy purposes. For most charitable nonprofits, extending the BPT to Unrelated Business Income beyond the Federal definition of UBIT would greatly increase the administrative compliance burden. It would require changing bookkeeping and administrative policies and activities for local tax purposes while also retaining the policies that are in place for Federal taxes. A second set of books to track this separate criteria would be necessary. The cost would be significant, because
David A. Ross, J.D. PANO Public Policy Officer Page 2of 3 1/29/2010

both large and small nonprofits are not set-up to report this information separately. They don’t segregate the money in the first place. It all goes into a general fund. But nonprofits already have the necessary steps in place to follow the federal guidelines. It would be much simpler to tax unrelated business taxable income, as defined by the IRS that is earned in Philadelphia. Charities already have to calculate this and report it on the Federal IRS form 990 informational tax return. The 990’s are publicly available and can be used as a benchmark. The City could easily determine from public filings those charities that recognize this income rather than have to search out these entities and argue over definitions. For the City, using a definition that is different from that of Federal UBIT would be burdensome and costly to comply with as well. There would be no existing forms because UBIT was not previously taxed. There is nothing for the City to piggy-back on, not even auditors who are versed in the Federal UBIT laws. This is also an enforcement nightmare. If the City uses a definition that is different standard from that of Federal UBIT, such as including rental income, it will lack appropriate benchmarks. The Federal definition is already established and recognized, and easily administerable for both the Charity and the City. UBIT taxes income from business activities that are by definition unrelated to the mission of the organization. The proposed amendment could tax activities that are central to a charity’s mission, such as the rental income from a nonprofit economic development incubator or community center bringing services to low income people. In addition, unrelated business taxable income excludes certain items from the definition, such as rents from unmortgaged property as well as business activities conducted by volunteers or for the convenience of customers or patrons, such as the cafeteria in the museum. In summary, a City tax on nonprofits’ unrelated business activities would deplete charitable resources at a time when the city needs to support the institutions that improve the quality of life in its communities. The current proposed Amendment would prove costly to nonprofits and to the Philadelphia communities they serve. Nonprofits do not budget for unrelated activities separately from programming costs. All funds come from the same general funds. Some nonprofits would have to reduce programs and services in order to pay for this additional tax. PANO would not oppose the City extending BPT to nonprofits’ unrelated taxable income under the Federal UBIT laws, though we do not feel that it would be in the City’s best interest. While PANO would not oppose the City extending BPT to nonprofits’ unrelated taxable income, we would strongly oppose extending the City’s BPT beyond the Federal definition of UBIT. I would be happy to respond to your questions. David A. Ross, J.D., Public Policy Officer Pennsylvania Association of Nonprofit Organizations 777 East Park Drive, Suite 300 Harrisburg, PA 17111 p(717) 236-8584 x1009 | f(717) 236-8767 david@pano.org | www.pano.org
David A. Ross, J.D. PANO Public Policy Officer Page 3of 3 1/29/2010

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