I have previously discussed Rev Proc 2007-47 and its forerunner Rev Proc 97-14. These “revenue procedures” set out an explanation by the Internal Revenue Service of how the research use of facilities financed with tax-free bonds could result in a determination of the IRS of “private use” that might threaten the tax-free standing of a bond issue. Clearly, if a company were to set up to do research (such as under a lease agreement) in such a facility financed with tax-free bonds, that would be a private business use. But then, putting a cafeteria operated by a private company in the same facility also may well be a private use. And, just to put a point on it, as far as the IRS is concerned, the federal government is a non-qualified user, too, so its research “uses” of tax-free supported facilities is also, apparently, a “private use.”
The question then arises, if a company (or the feds) cannot send their personnel to use a facility financed with tax-free bonds without threatening the tax-free standing of the bonds, what happens if a company supports research done by, say, university personnel? The point of this series of articles is not so much to deal with the complexities of US tax law as it is to point out how those complexities have been exploited by university administrations to undermine freedom to innovate by faculty and students. It is something more than an irony that construction of new university research facilities, under the banner of discovery, innovation, economic development, and collaboration with industry, is often financed in a manner that thwarts these very activities.
Contract Research
In contract research, a commissioning party hires a second party to do the research and deliver the results. The second party, the independent contractor, does the work, makes its profit from the cost of the research, and delivers back all plans, data, designs, inventions, results, software, reports, notes, and ideas that have been developed in the course of the research. The contractor might keep equipment and supplies purchased under the research contract, and will retain a knowledge of whatever was learned in doing the research, and especially any thoughts about how to go about working on research problems of a similar nature. In contract research, the commissioning party generally supplies the objectives, often key technology, often also the research protocol, and defines the deliverables.
Cast this way, contract research is not much different from doing the research with one’s own personnel–the differences are not having to hire for the work, kit out a lab, and build expertise in the area of study. It would be easy to see how such work would also be viewed as a “private use.” If it were not, then it would be an easy work-around of the objectives of tax-free bonds to simply have a university hire the company’s research talent, do the research, deliver the results, and then hop back to the company. Rules are only rules for the unclever. If one tries to write rules for the clever, then clever folks act as if the rules are too complicated and cleverly behave uncleverly–doh!–until “caught”–if ever.
Clinical Trials
In university settings, clinical trials in which the company sponsor provides the protocol could well be construed as contract research. There is little to expect by way of outcomes other than data collection and analysis, with perhaps some inventive thoughts sprinkled in as the data is examined for possibly beneficial side effects or new areas to study. Alternatively, one might argue that clinical trials are not research at all, any more than assaying ore for its gold content is research. Sure, there’s this bit of “discovery” when one decides whether the ore contains gold or pyrite, but that’s not much more research than determining whether a size 34 waist will still work when in a fitting room at Nordstrom.
One might go further and ask whether a clinical trial is purely for the benefit of the company holding rights to the compound or procedure under review, or whether such activity also serves a broad public interest. What is odd, however, is why such a question comes up in the context of federal tax law. Why should the question of a clinical trial at a university sponsored by a company be primarily a matter of technical issues in how tax laws are drafted–something that has next to nothing to do with the conduct of research, clinical trial or otherwise. If the construction of new research facilities is a matter of public interest, then so long as research is conducted in those facilities, why should it matter whether the immediate beneficiaries of that research include companies sponsoring work? Even the fact of sponsorship could be construed as a public good. But no, that is not how regulatory brains keep in the IRS refrigerator.
Tax-Free Bonds for Higher Education
The situation with bond-financed construction of university facilities is complicated. Complication appears to be a feature, perhaps even desired. Once things are “complicated,” clever folks can hide most anything in the details. Regulations then serve to prevent the arrangement of from being challenged. We will dig in anyway.
Consider, for instance, a recent $200M bond issue on behalf of Princeton University. The bond is actually issued by the New Jersey educational facilities authority. This Authority is a special instrument of state government established to address a legislatively declared “serious public emergency” in educational resources (my emphasis at the end):
18A:72A-1. Preamble, purpose of chapter
It is hereby declared that a serious public emergency exists affecting and threatening the welfare, comfort, health, safety and prosperity of the people of the state and resulting from the fact that financial resources are lacking with which to construct required dormitory and other educational facilities at public and private institutions of higher education; that it is essential that this and future generations of youth be given the fullest opportunity to learn and to develop their intellectual and mental capacities; that it is essential that institutions for higher education within the state be provided with appropriate additional means to assist such youth in achieving the required levels of learning and development of their intellectual and mental capacities; that it is essential that all resources of the state be employed in order to meet the tremendous demand for higher educational opportunities; that all institutions of higher education in the state, both public and private, are an integral part of the total educational effort in the state for providing higher educational opportunities, and that it is the purpose of this chapter to provide a measure of assistance and an alternative method to enable institutions of higher education in the state to provide the facilities which are sorely needed to accomplish the purposes of this chapter, all to the public benefit and good, to the extent and manner provided herein.
Notice how the purpose defined for financing focuses on students and education. No mention directly of research. The financing, however, is established “all to the public benefit and good.” Consider how such phrasing must be read. Does this statement of objectives define all uses of financing authorized under the statute to be for the public benefit–that is, as an instruction to anyone considering how funds are spent? Or does this statement require all uses of financing to be for the public benefit, however any other authority might construe such benefit?
Is any construction undertaken by, say, Princeton and financed with tax-free bonds presumptively of “educational facilities” so that “youth” be given “the fullest opportunity to learn”? One can see how the argument that research (of any form) is a function of “higher education” is not merely a position taken for the sake of discussion. In terms of regulations, research has to be a contribution to student learning. Not in actual fact, necessarily, but by definition–otherwise, the use of the bond issues by the university are outside the scope of the Authority’s powers under state law. From university bond counsel’s perspective, there is no discussion to have. Things have to be the way the documents portray them. University activities must conform to the paperwork, not the other way around.
The Authority thus issues tax-free securities and enters into repayment agreements with the institutions that benefit from the use of the moneys raised by the Authority. Princeton, though a private institution, benefits from the state’s bond issuing authority. For its 2014 bond, Princeton describes a “Facility Z”:
Consider what this must mean. If the authority to issue bonds to support educational goals, then presumably students should be able to use the facilities supported by the bond financing to advance their education. “Higher education” must mean “education of students at the university level” except where, in fact, it does not mean that at all. Thus, research of any sort must be part of the education of students, not because students actually learn anything at all from such research but because research is defined to be part of “higher education” just as janitorial services are part of higher education, but do not contribute materially to “learning.”
Students and IP
Take it one step further. Students, in using educational facilities, learn. That is, they come into possession of knowledge, skills, and experience that have the potential to benefit themselves personally. This learning is a fundamental public purpose, yet it results in private gain. Is such learning a “private use” of tax-free bond financed facilities? One would think not, or else there would be no point in using tax-free bonds for the purpose.
Consider further that students may do more than simply learn: they may author and invent in such facilities and thus own copyrights and patents that attach to their works of authorship and inventions. It would make no sense to claim that students may learn in tax-free bond supported facilities, but not own anything that might result from their learning. It would also be simply grasping for state officials to make a claim for owning such copyrights and patents on the basis that if they allowed students to keep their copyrights and patents, their learning would be a “private use” and could jeopardize the tax standing of the bond issue. It would also be grasping for officials to try to define “learning” to exclude authoring or inventing, somehow construing learning to be devoid of creative activity and consist entirely of filling up blank slates with information. That would be nonsensical. We conclude that “higher education” involves providing facilities in which students learn, and benefit privately from their learning, and own the creative results of the activities involved in their learning, such as works of authorship, inventions, and “data” that students gather or produce.
Any claim by the IRS that higher education student learning cannot involve private benefit would as well be nonsensical. Or worse, it would be an inappropriate intrusion of the power of government to attempt to force universities to adopt policies requiring administrative ownership of knowledge. But even if the IRS is not willing to pursue this line of reasoning, it appears that university officials are happy to do so, because the threat of IRS action, rather than being resolved, provides a rationale for administrators to take what they otherwise would have to request. The dag, as it were, wagging the dog.