In the fall of 1965, the University of Florida football coach enlisted a professor to develop a high-energy drink to replace the nutrients his players were perspiring away on the humid practice field.(1) The University now receives $4.5 million per year in royalty proceeds from the Quaker Oats Corporation as a result of this professor's invention: Gatorade.(2) The potential for profit may be even greater for Professor Milton Torres and Florida International University ("F.I.U."). Torres and F.I.U. hold the patent for polyisocyanurate, or "Pantherskin," a polymer coating that can increase the service life of aircraft skin while also making it more fire-resistant.(3) In the wake of the Valujet crash and the bombing of TWA Flight 800, the FAA is investigating the possibility of using Pantherskin in American fuselages.(4) For F.I.U., Pantherskin may become "the proverbial pot of gold at the end of the school's research rainbow."(5)
Not every invention need be of blockbuster proportions for a university to see income from licensing royalties. Louisiana State University, for example, has collected $65,000 from the sale of laboratory-developed fish bait.(6) While such a sum is not significant to a university budget, no school in the country would object to the infusion of an additional $65,000.
These examples demonstrate the phenomenon of university technology transfer, through which a university makes an invention or discovery available to the for-profit sector for commercial development.(7) The of the prevalent forms of technology transfer is patent licensing, in which a university licenses a patent or other valuable right to a corporation. In exchange for the grant of the license or right, the university receives fixed or contingent royalty(8) payments annually or on some other negotiated basis.(9) This marriage benefits both partners: the university develops a new revenue stream and the corporation gains access to heretofore untapped technologies that may be prohibitively expensive to develop in its own laboratories.
Not all voices inside or outside the academy, however, express the same enthusiasm regarding technology transfer and the increasingly close relationship between universities and corporations. Former Harvard University President Derek Bok, in his final annual report to the school's Board of Overseers, warned that "[f]lashing yellow lights should appear, however, whenever the institution seeks to make a profit on basic academic functions ... such as ... research ... in order to finance its other activities."(10) Bok's remarks directly addressed the issue of research and royalty income, as he noted that greater university efforts to transform discoveries into products and services may lead to the sacrificing of "essential values."(11) The Deputy Director of the National Institutes of Health, Daryl Chamblee, in testimony before the Senate, "acknowledged that the heightened involvement of industry in academic research has prompted concern that tech transfer might stifle the free exchange of knowledge in the academic community, promote secrecy and distort research priorities to conform with commercial aims."(12) The fear is that in time universities will resemble nothing more than commercial research centers. As one writer has argued, "MIT looks more like a corporation engaged in the relatively profitable business of producing ideas that it licenses to the highest bidders."(13)
Holding aside philosophical debates regarding the "mission" of the university, why should increased emphasis on technology transfer and patent licensing be of legal concern? The difficulty arises when one considers that universities are able to operate technology-transfer ventures with a considerable public subsidy -- namely, their long-standing exemption from the federal income tax(14) as well as state and local property taxes.(15) First, academic researchers use laboratory facilities situated on tax-exempt property to develop inventions that will subsequently aid corporations in creating new (and profitable) products.(16) Second, the income derived from these discoveries, including licensing and royalty income, is exempt from federal income taxation.(17) In each of the aforementioned examples of university technology transfer -- Gatorade, Pantherskin and the L.S.U. fish bait -- the universities involved paid (or would pay) no taxes on the revenue received. The same royalty payments, however, would be taxable if the recipient were a commercial enterprise.(18)
The income tax exemption granted by [sections] 501 (c) (3) of the Federal Income Tax Code is vital to the continuing survival of the university.(19) Currently, the value of the federal exemption and other tax breaks amounts to nearly $4 billion a year.(20) As the university and its faculty become increasingly oriented toward promoting technology transfer and developing intellectual property with potential commercial value, the tax exemption for licensing and royalty income derived from such activity may be called into question. It is well settled that an otherwise-exempt organization that engages in an "unrelated trade or business" must pay income tax on its "unrelated" income.(21) The question, therefore, is whether changes in the manner in which technolog-transfer research is conducted and emphasized are so at odds with the letter and spirit of the tax exemption that subsequent revenues should be subject to federal income taxation under the unrelated business income tax ("UBIT"). In other words: Has the increased focus on technology transfer moved the university so far from the educational and scientific missions on which the exemption was premised that the gains from patent licensing should be taxable?
This Comment will examine income generated from technology-transfer activity and determine that in certain circumstances -- and contrary to the current state of the law -- such revenue should be taxable as unrelated business income. Part I will examine the scope of the university-industry technology-transfer relationship as it exists today and identify the reasons for the explosive growth in these arrangements over the past fifteen years. Part II will analyze the applicable sections of the Tax Code and corresponding regulations to determine how the Internal Revenue Service ("IRS" or "the Service") has treated the [sections] 501 (c) (3) tax-exempt status of universities and unrelated business income, concentrating on income derived from research endeavors.
Part III will examine the manner in which the modern academic research environment has been affected by the promise of technology-transfer income. It will look at restrictions on publication and the public dissemination of research results, the granting of exclusive licenses, effects on teaching, conflicts of interest and the potential compromise of academic freedom. In considering each of these issues, the Comment will consider whether income from the research enterprise should be subjected to UBIT due to the failure to conform to the public interest rationale behind the university tax exemption. The Comment will conclude in Part IV that a conflict exists between the unfettered pursuit of technology-transfer revenues and the letter and spirit of higher education's tax exemption. It proposes creating two types of technology-transfer arrangements to give universities the choice, depending on the facts and circumstances of each individual case, whether to execute a taxable or a nontaxable agreement. As part of this proposal, the Comment will analyze the steps universities need to take to ensure that their income-generating technology-transfer activities conform with the Code's explicit and implied tax-exemption requirements.
The University-Industry Partnership Today
Until recently, research universities" considered the commercialization of campus discoveries and inventions outside their mission as teaching institutions.(23) While it is doubtful that commercial research has become so prominent as to be the primary focus of university labs, statistics demonstrate that technology transfer and patent licensing have become significant endeavors.(24) The Association of University Technology Managers ("AUTM") reported that in 1994 royalty revenues for nonprofit universities exceeded $265 million, compared with $1 million in 1980.(25) The income generated by certain individual universities presents a more compelling picture. M.I.T. received $4.56 million in royalty income in 1994,(26) and, as University President Charles Vest explained in recent Senate testimony, that income is especially attractive because, unlike traditional grant income, its subsequent use is unrestricted.(27) Stanford University has garnered $23.5 million from its Cohen-Boyer patent for recombinant DNA,(28) and Michigan State University has received $60 million from just one patent.(29 Considering these numbers in conjunction with the current applicable corporate tax rate ranging from 15% to 35%(30) reveals why the Service might take an interest in reexamining the treatment of technology-transfer income.(31) Furthermore, overall revenues from royalties are expected to grow at a rate of 25% a year,(32) making taxability considerations all the more important for both the schools and the Service.
Evidence of the significance of technology-transfer activity for major research universities goes beyond the dollars involved. The potential income has also had a notable effect on the manner in which universities conduct their research enterprises. Of sixty-five schools surveyed, 75% had revised their patent policies since 1980(33) -- 20% from 1990 to 1993(34) -- and most of these changes were driven "by a desire to promote technology transfer, or ... to increase royalty income.'"(35) Many universities have either established or expanded technology-transfer offices to handle patent and licensing matters on a full-time basis. The...