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March 15, 1990
I. REFERENCES
A. Business and Finance Bulletin A-47, University Direct Costing
Procedures
B. Business and Finance Bulletin A-56, Academic Support Unit Costing
and Billing Guidelines
C. Business and Finance Bulletin BUS-72, Establishment and Review of
Auxiliary Enterprises
D. Internal Revenue Code Sections 501, 511, 512, 513 and 514
E. Office of Management and Budget Circular A-21, Principles for
Determining Costs Applicable to Grants, Contracts, and Other
Agreements with Educational Institutions
II. INTRODUCTION
This Bulletin sets forth the procedures for determining the income and
expenses of unrelated business activities conducted by the University of
California. Income and expenses charged to an unrelated business
activity in conformance with these procedures will provide the basis for
the annual preparation of the University's Exempt Organization Business
Income Tax Return (Form 990-T) filed with the Internal Revenue Service.
The activities included in the tax return typically involve the sale of
goods or services to the general public or outside organizations or the
sale of consumer advertising in University publications.
Any organization exempt under Section 501(c) of the Internal Revenue
Code (Code) must file Form 990-T if it has gross income from an
unrelated trade or business of $1000 or more. Since FY 1980-81, the
University has filed a consolidated Form 990-T reporting on the
unrelated business activities operated by the campuses. The University,
however, is not subject to the State franchise or corporation income tax.
Because of its status as an instrumentality of the State of California,
the University is not required to file annual tax or information
returns with the Franchise Tax Board.
In general, a commercial-type activity operated by the University will
be subject to Federal income tax if it is (1) a trade or business, (2)
regularly carried on, and (3) not substantially related to the
University's exempt purposes (aside from the need of the University to
raise funds or the use it makes of the profits). However, even if an
activity meets all three criteria it may be exempt from taxation if it
satisfies one of several exceptions contained in the Code. For example,
activities performed by volunteers or for the convenience of University
students, faculty, staff, or patients are typically exempt. In most
cases, income derived from royalties, research, or rents from real
property is also exempt from the unrelated business income tax.
III. SCOPE OF BULLETIN
The procedures contained in this Bulletin are not applicable to the
Department of Energy Laboratories or to campus entities which are
separately incorporated or exempt under Section 501 (c) of the Code.
Examples of such entities include ASUC-operated enterprises,
foundations, alumni associations, and faculty clubs. Those entities are
responsible for filing their own annual information and income tax
returns with the IRS and the Franchise Tax Board.
IV. REPORTING DETERMINATIONS
The tax status of each new activity with a potential for generating
unrelated business income will be determined by the Corporate Accounting
Office (CAO), Office of the President, based on the Nonfinancial
Questionnaire completed annually by the campus. Completion of the
Questionnaire may also be required for an established activity if the
activity has changed its mode or scope of operations. Changes in the
Code, Income Tax Regulations, court decisions, or other circumstances
may also require that the Questionnaire be prepared for an activity. The
income and direct expenses of the activities determined to be taxable
will be reported to the CAO on the Financial Worksheet prepared for each
activity. The Financial Worksheets and Instructions establish the
mechanism for distributing the income and expenses of a department
between its exempt and unrelated functions.
V. INCOME
A. UNRELATED BUSINESS INCOME
The term unrelated business income means gross income derived from any
unrelated trade or business activity regularly carried on by the
University. All income (or revenue) from an unrelated business
activity shall be recorded in the revenue account(s) assigned to the
activity. If a unique revenue account is not assigned to the
activity, detailed records should be maintained that segregate the
department's unrelated and related income. User data or special
sampling studies may also be used to estimate income attributable to
the unrelated business activity.
B. PUBLICATION ACTIVITIES
1. Advertising Income
Under the Code, income received by the University from the sale of
commercial advertising in a campus newspaper, journal, or other
periodical is gross income from an unrelated trade or business
involving the exploitation of an exempt activity, i.e., the
publication and distribution of the readership content of the
periodical. Accordingly, the allocation of depreciation and
other indirect costs to advertising activities is subject to
more stringent rules than for nonadvertising unrelated business
activities (see Section VI. D.).
2. Circulation Income
Circulation income refers to all income (other than advertising
income) received by the University from the production,
distribution, or circulation of a periodical. Circulation
income also includes amounts realized from reprints of articles
and the sale of back issues. Circulation income is generally
not taxable, provided that the editorial content of the
publication relates to the accomplishment of the
University's exempt purposes.
C. MIXED LEASES
Rents from real property are not subject to the unrelated business
income tax. In addition, the Code provides that rents from personal
property leased with real property are excluded where the rents
attributable to the personal property are incidental, i.e., 10% or
less of the total rents received under the lease, as determined when
the personal property is first placed in service. The general
exclusion does not apply if the real or personal property rentals
are based on net income or profits or if substantial services are
provided for the convenience of the occupant.
In a mixed lease where the rent attributable to personal property is
more than 50% of the total rent, none of the rent (including the rent
from real property) is excludable from tax. If the rent attributable
to personal property is 11% to 50% of the total rents, then only the
personal property rent is taxable.
VI. DIRECT COST
A. NATURE AND EXTENT
Costs (or expenses) directly connected with the conduct of an
unrelated business activity shall be charged to the activity. To
qualify as a deduction in computing unrelated business taxable
income, an item must otherwise be an allowable deduction for income
tax purposes and also must be directly connected with the carrying
on of the unrelated business activity. Under the Code, to be
directly connected with the conduct of an unrelated business, the
item must have a proximate and primary relationship to the carrying
on of that business.
Under Business and Finance Bulletin A-47, University Direct Costing
Procedures, examples of direct costs include salaries and wages
(when the effort devoted and the benefit derived are directly
identifiable with a specific activity); associated employee
benefits costs; supplies and other general expenditures (such as
travel, storehouse purchases, and garage and telephone charges);
equipment purchases; and, for self-sustaining operations,
equipment, depreciation, operations and maintenance of plant, and
campus general administrative support recharges.
The cost of interest paid to third parties associated with assets
used in support of an unrelated business activity shall be charged
to the activity as a direct cost. Such assets include buildings
acquired or constructed, major reconstruction or remodeling of
existing buildings, and the acquisition or fabrication of capital
equipment. (However, any interest paid or incurred during the
production period of the asset must be capitalized.) The interest
paid must pertain to a debt of the University and must result from
a debtor creditor relationship based on an enforceable obligation
to pay a fixed or determinable sum of money.
B. EXPENSES ATTRIBUTABLE SOLELY TO UNRELATED BUSINESS ACTIVITIES
Expenses attributable solely to the conduct of an unrelated business
activity must be charged in full to the activity. For example, the
cost of supplies used entirely in the conduct of an unrelated
business activity are directly connected with the activity and
should be charged in full to the activity.
C. EXPENSES ATTRIBUTABLE TO THE DUAL USE OF PERSONNEL OR FACILITIES
When personnel or facilities are used to conduct both exempt
activities and unrelated business activities, salaries, expenses,
and similar items attributable to such personnel and facilities
must be allocated between the two uses on a reasonable basis.
Depreciation and operation and maintenance costs associated with
the use of a facility are allocated either by the corporate
Indirect Cost System (ICS) or by comparable campus-based costing
systems (see Section VII). The distribution method which most
accurately reflects the actual costs associated with
conducting the unrelated business activity should be used to assign
expenses to the activity. The method selected may vary with the
nature of the cost item. However, the method adopted must be
consistently applied.
1. Dual Use of Personnel
The salaries, benefits, and related expenses of personnel used
both for exempt and unrelated business activities should be
allocated based on the percent of time or effort devoted to
each activity. The time or effort attributable to the
unrelated activity may be documented by time records or by an
annual statement of estimated effort signed by the employee.
2. Use of Facilities by the General Public
Direct costs associated with the use of a campus facility, such
as an athletic or parking facility, by the general public for a
nonexempt purpose, should be determined based on the percent of
time the facility is actually used for exempt and nonexempt
activities. For example, if a facility is not available for
use by the public at certain times because of campus events or
activities, the costs attributable to these exempt functions
should not be included in the allocation of costs to the
unrelated activity. The remaining costs associated with the
period(s) of time when the facility is available for use by both
University members and the general public may be allocated based
on the relative amount of sales revenue attributable to each
user group. However, if the fee paid by the general public is
larger because of a surcharge, the surcharge must be deducted
from the unrelated revenue (and total revenue) before
calculating the percentage of unrelated use to total use.
D. EXPENSES ATTRIBUTABLE TO PUBLICATION ACTIVITIES
The Code contains special rules for the allocation of direct expenses
attributable to the sale and publication of commercial advertising
in a campus periodical. First, the total costs of the periodical
must be established. Periodical costs consist of direct
advertising costs and readership (or circulation) costs. Costs
associated with teaching, research, or other exempt activities of
the department may not be allocated to the periodical. Any costs
pertaining both to the periodical and other exempt functions must be
allocated on a reasonable and consistent basis.
After the total periodical costs have been identified, the costs
benefiting advertising and readership activities must be determined.
1. Advertising Costs
Direct advertising costs consist of the following categories of
expenses:
a) Costs attributable solely to the selling and publishing of
advertising, such as salaries, commissions, transportation,
travel, promotion, research, telephone, postage, artwork,
and copy preparation may be charged in full to advertising.
b) Salaries, benefits, and related expenses of personnel
performing both advertising and circulation activities
should be allocated based on the percent of time or effort
devoted to each activity as provided in Section VI.C.1.
c) Mechanical and distribution costs and other shared expenses
benefiting both advertising and circulation activities may
be allocated on the basis of advertising lineage (or page
space) to total periodical lineage (or page space) if the
departmental records are insufficient to permit a more
precise allocation of such costs. Examples of mechanical
and distribution costs include composition, press work,
binding, paper, mailing, and bulk postage. Such expenses
charged to advertising must not include any costs
attributable to producing or distributing the periodical's
readership content.
2. Readership Costs
Readership costs include those expenses directly connected with
the production and distribution of the readership content of
the periodical (to the extent not allocated to advertising
under the procedures above).
E. EXPENSES ATTRIBUTABLE TO MIXED LEASES
Expenses attributable to a mixed lease are allocable to the taxable
portion of the rental income, if any, depending on the percentage of
personal property rents to the total rents received under the
agreement. If the rents attributable to personal property are
greater than 50% of the total rents received, then all direct
costs; associated with the real and personal property rentals
should be charged to the activity. If the rents; attributable to
personal property are 11% to 50% of the total rents received, then
only those costs directly connected with the personal property may
be charged to the activity.
VII. INDIRECT COSTS
In addition to direct costs, indirect costs will also be charged to an
unrelated business activity in accordance with Office of Management and
Budget Circular A-21, Principles for Determining Costs Applicable to
Grants, Contracts, and Other Agreements With Educational Institutions.
The principles are designed to ensure that the Federal government bear
its fair share of total accepted costs, determined in accordance with
generally accepted accounting principles, except where restricted by
law.
Indirect costs are first allocated to the department conducting the
unrelated business activity by the ICS or comparable campus-based
systems. Indirect costs assigned to the department by the ICS are
then allocated to the unrelated business activity using the procedures
set forth in Circular A-21.
A. INDIRECT COST ALLOCATIONS-NONADVERTISING ACTIVITIES
Allocations of indirect costs to nonadvertising activities will be
made from the following five cost pools (allocations from
additional cost pools, such as the student administration and
library cost pools, may be made, if appropriate, in conformance
with Circular A-21):
1. Building Use Allowance
The building use allowance is calculated by applying the 2% use
allowance rate to the non-Federal acquisition cost of the
building. The building use allowance for each building is then
distributed to departments within the building based on the
assignable square feet (ASF) occupied by the department. The
departmental share of the building use allowance is allocated to
the unrelated business activity based on the salaries and
wages of the personnel charged to the activity.
2. Equipment Use Allowance and Depreciation
Equipment use allowance and depreciation costs are calculated
for each department's equipment inventory. Only one method of
cost recovery is used for each class of assets established in
the University's CALCODE system. Under the use allowance
method, the allowance is calculated at an annual rate of 6
2/3% of the non-Federal acquisition cost of the equipment.
The depreciation method used is straight-line, less salvage
value and any use allowance previously taken on the item. The
period of useful life applicable to the asset is based on the
CALCODE Equipment Class Table. The sum of the departmental
equipment use allowance and depreciation costs is then
allocated to the unrelated business activity based on the
salaries and wages of the personnel charged to the activity.
3. Operations and Maintenance
The cost of operations and maintenance (OM) is allocated to
buildings based on various methods depending on the nature of
the cost item. For example, grounds maintenance costs are
allocated based on the linear feet associated with the outside
perimeter of the building; janitorial costs are allocated
based on the number of janitors permanently assigned to each
building; and utilities costs are allocated based on the
building's consumption of gas and electricity. The OM costs
are then aggregated by building and allocated to the
departments within the building based on the ASF assigned to
the department. The departmental share of the total building
OM costs is allocated to the unrelated business activity based
on the salaries and wages of the personnel charged to the
activity.
4. General Administration
The costs of general administration (GA) incurred for each
campus (e.g., Chancellor's Office, Accounting Office, etc.)
are allocated to departments based on the modified total
direct costs (MTDC) of each department. Under Circular A-21,
MTDC consists of salaries and wages, fringe benefits,
materials and supplies, services, travel, and subgrants and
subcontracts up to $25,000 each. The departmental share of GA
costs is then allocated to the unrelated business activity
based on the MTDC of the activity.
5. Departmental Administration
The costs of departmental administration (DA) consist of the
department's own administrative costs, plus its share of the
Dean's Office costs. The Dean's costs are allocated to
departments under the Dean's responsibility based on the MTDC
of each department. The department's allocation of the Dean's
costs is then aggregated with the department's own
administrative costs and distributed to the unrelated business
activity based on the MTDC of the activity.
B. INDIRECT COST ALLOCATIONS-ADVERTISING ACTIVITIES
The Code provides that indirect costs associated with a periodical
must first be allocated to the exempt function of the periodical.
Accordingly, allocations from the cost pools described in Section
VII. A. will be made initially to circulation or readership
activities. The share of the periodical's indirect costs
attributable to advertising may be claimed only as an expense
under the following conditions:
1. The advertising activity is profitable, i.e., gross advertising
income of the periodical exceeds direct advertising costs; and
2. The circulation activity is not profitable, i.e., the total
direct and indirect costs attributable to producing and
distributing the readership content of the periodical exceed
circulation income.
Thus, if the advertising activity is profitable, the excess, if any,
of readership expenses over circulation income may be distributed
to the unrelated activity. However, the allocation of the excess
readership expenses may not result in an advertising loss, i.e.,
the advertising income can be reduced to zero but not less. Under
these rules, therefore, advertising income will be taxed only if
the periodical produces an overall profit.
VIII. FUNDING TAX LIABILITY
Unrelated business taxable income reported by the University would be
subject to the normal corporate income tax rates. Unrelated business
taxable income is defined in the Code as the aggregate of gross income
from all of an organization's unrelated businesses, regularly carried
on, less the aggregate of deductions allowed with respect to all such
unrelated businesses. Any tax liability incurred by the University
would be assessed against the campuses with unrelated business
taxable income. The determination of each campus' unrelated business
taxable income would be net of any carry forward or carry back losses
available to the campus.
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