Research Schools Seek Fix for Treatment of Investment Activities

COMMENTS ON PROPOSED 512(A)(6) “SILO” REGULATIONS

I. Introduction

We appreciate that the IRS and Treasury have recognized that investment activities of a tax-exempt organization that generate unrelated business taxable income ("UBTI") should be treated as a single group of activities for purposes of Section 512(a)(6) of the Code¹ (a "silo"), because exempt organizations engage in these activities with an intent to make an investment return to satisfy their fiduciary obligations "rather than with the intent to actively participate in any of the unrelated trade or business activities generating the UBTI."² However, the April 24, 2020 Notice of Proposed Rulemaking regarding Section 512(a)(6) (the "NPRM" or "Proposed Regulations") proposed a definition of "investment activities" that would still cause many bona fide investment activities, and in particular many investments in partnerships, to be excluded
from the investment activities silo.

The NPRM noted that the IRS and Treasury "will continue to consider whether the term 'investment activities' can be defined more generally in a manner that is administrable and consistent with the legislative intent of section 512(a)(6)." The NRPM also requested comments "regarding the specific factors that should be considered when determining whether an activity is an investment activity for purposes of section 512(a)(6)."

This letter provides comments in response to the IRS and Treasury's invitation. These comments are submitted on behalf of leading private and public research universities collectively serving over 320,000 students and employing over 35,000 faculty throughout the United States. Among other comments, we propose two alternative tests for identifying partnership interests that constitute bona fide investment activities eligible for qualifying partnership interest ("QPI") status (each, an "Alternative Test"). Each Alternative Test is intended to identify partnership interests in which the exempt organization does not significantly or materially participate. Further, each Alternative Test has been drafted in recognition of the fact that while the IRS and Treasury's stated intent is to include bona fide investments in the investment activities silo, any rules we propose must be administrable and consistent with legislative intent, and any interest in a partnership that is actually controlled by an exempt organization should not be treated as an investment activity.

II. Executive Summary

Our comments include the following proposals.

Proposed Professional Investment Manager and K-1 Reporting Test. An exempt organization may treat a partnership interest as a QPI if it is managed by a professional investment manager, as defined herein, and the exempt organization's Schedule K-1 indicates that the exempt organization does not significantly or materially participate in the partnership's business activities. 

Proposed Investment Activities Test. A partnership interest is eligible for treatment as a QPI if, with respect to the partnership interest, certain features of the governing documents of the partnership establish that an exempt organization does not actually participate in the partnership's activities.

Modifications to Control Test. Several modifications are proposed to the control test described in Section 1.512(a)-6(c)(4) of the Proposed Regulations, including an increase in the maximum percentage interest an organization may hold under the test and adjustments to the factors treated as giving rise to control of a partnership.

Proposed Look Through Rule. An exempt organization is permitted to look through any directly or indirectly held partnership interests for purposes of applying each test for QPI eligibility at the level of an indirectly held partnership interest that generates UBTI.

Modifications to Form 1065 Instructions. Several suggested modifications are described to the Instructions to the Form 1065 which would require partnerships to provide the information exempt organization partners need in order to comply with Section 512(a)(6).

III. Alternative for Identifying Partnership interests that Constitute "Investment Activities"

We propose that the final regulations include two Alternative Tests (briefly described in the Executive Summary, above) for identifying partnership interests that constitute "investment activities". We request that exempt organizations be permitted to treat as a QPI any partnership investment that satisfies one of these Alternative Tests, in addition to a partnership investment that satisfies the de minimis test outlined in Section 1.512(a)-6(c)(3) or the control test outlined in Section 1.512(a)-6(c)(4) of the Proposed Regulations (modified as described in Section IV below). Each Alternative Test is intended to stand on its own, such that a partnership interest satisfying a single Alternative Test would be eligible for treatment as a QPI (subject to satisfaction of the Actual Control Test, described below).

A. Principles Applicable to Alternative Tests

We believe each of these Alternative Tests is consistent with congressional intent in enacting Section 512(a)(6) and balances the interests of exempt organizations in having administrable standards with those of the government in ensuring enforceability by relying on objectively documented facts, thereby making the tests less susceptible to abuse. The following two principles shall apply with respect to each Alternative Test:

Actual Control over a Partnership. We agree with the IRS and Treasury's view, expressed in the NPRM, that if an exempt organization actually controls a partnership, its interest in that partnership should not be viewed as an investment activity. Accordingly, for each Alternative Test, we propose that a partnership interest would not be eligible to be treated as a QPI if the exempt organization controls the partnership based on all the facts and circumstances, as described in Section 1.512(a)-6(c)(4)(iii) of the Proposed Regulations, with the modifications discussed in Section IV.B, below (the "Actual Control Test").

Indirectly Held Partnership Interests. Additionally, as we believe that there is no principled reason for distinguishing between directly and indirectly held partnership interests in identifying an organization's investment activities, we propose an expansion of the look-through rule of the Proposed Regulations such that each Alternative Test, as well as the de minimis test and the control test of the Proposed Regulations, may be applied at the level of an indirectly held partnership interest generating UBTI. This proposal is described in more detail in Section V, below.

B. Professional Investment Manager and K-1 Reporting Test

Professional investment managers generally retain all rights to operate the investment partnerships they sponsor, and do not permit their investors to participate in the day-to-day operations of the investment partnerships. Furthermore, partnerships with exempt organization partners are in a position to determine whether an exempt organization partner significantly or materially participates in the business activities of the partnership.

Accordingly, we propose that an exempt organization may treat a partnership interest as a QPI if two requirements are met: (1) the partnership is managed by an otherwise unrelated professional investment manager; and (2) the exempt organization's Schedule K-1 reports that the organization's interest in the partnership meets certain criteria indicating the organization does not significantly or materially participate in the partnership's business activities.

Professional Investment Managers. In order to ensure that this standard is administrable, we propose that a partnership would be treated as managed by a professional investment manager if the manager is included in a listing of investment managers the Securities and Exchange Commission ("SEC") makes publicly available on its website.³ However, managers of certain types of investment assets, such as real estate or certain natural resources assets, are not subject to SEC registration requirements because they do not manage "securities". Accordingly, professional managers of these types of assets would not be listed on the SEC website. For these managers not subject to regulation by the SEC, we would propose that a professional investment manager is a person who either (i) is in the business of providing investment advice for compensation and manages at least $150 million in client assets or (ii) has filed a Form D notice with the SEC with respect to the partnership at issue indicating that interests in such partnership are offered under an exemption from SEC registration requirements. Information on assets under management is generally documented in the manager's offering documents (such as private placement memoranda or offering memoranda). Form D notices are publicly available on the SEC's EDGAR (Electronic Data Gathering, Analysis and Retrieval) system.

Schedule K-1 Reporting. Partnerships must generally file Form 1065 information returns with the IRS and issue Schedule K-1 information statements to each partner, reporting information about the partner's distributive share of partnership income and loss, together with certain other information about the partnership and its partners' interests. The instructions to Form 1065 currently require partnerships to report whether each partner that is an individual materially participates in the partnership within the meaning of Section 469 of the Code and the regulations thereunder.⁴ Partners are generally required to report on their own tax returns consistently with the information reported to them on Schedule K-1.⁵ Partnerships not required to file Form 1065, such as certain non-US partnerships, often issue to partners that are US persons equivalent Schedule K-1 statements which provide the information a Schedule K-1 would have provided.

We propose that an exempt organization be permitted to rely on a Schedule K-1 reporting that the organization does not materially participate in the partnership's conduct of any trade or business, applying Section 469 principles.⁶ If the Section 469 material participation standard is not adopted for purposes of this test, an alternative would be for the Schedule K-1 to report whether the exempt organization's partnership interest satisfies the Investment Activities Test described Section III.C., below. We request that reasonable reliance on a substitute or equivalent Schedule K-1 or written confirmation provided by a non-US partnership also be permitted to satisfy this standard. The proposed standard would be administrable because exempt organizations would only be permitted to treat a partnership interest as a QPI under this standard if the partnership reported to the investor that the standard was satisfied on the investor's Schedule K-1 (or a Schedule K-1 equivalent or written confirmation issued by a non-US partnership) for the relevant year.

Our proposal requires both (1) receipt of a K-1 reporting that either the material participation standard or the Investment Activities Test is met and (2) that the partnership is managed by a professional investment manager in the event that the inclusion of both of these factors may be desirable to the IRS and Treasury. Nevertheless, we believe that either requirement (1) or (2) would be enough on its own to appropriately identify a partnership interest in the nature of an investment activity. Therefore, we would prefer final regulations that treat each of (1) and (2) as a separate Alternative Test.

Proposed Professional Investment Manager and K-1 Reporting Test. Under this Alternative Test, a partnership interest is eligible for treatment as a QPI if two requirements are met: (1) the exempt organization receives a Schedule K-1 (or Schedule K-1 equivalent or other written confirmation provided by a non-US partnership) reporting that the organization's interest represents an activity which "involves the conduct of any trade or business, and in which the taxpayer does not materially participate," within the meaning of Section 469 of the Code and the regulations thereunder,⁷ and (2) as of the last day of the partnership's taxable year, the partnership is managed by a "Professional Investment Manager," as defined above.⁸

For these purposes, a partnership is "managed" by a Professional Investment Manager if a Professional Investment Manager is designated in the partnership's governing documents as the partnership's general partner, investment manager or managing member (or other similar role).

C. Investment Activities Test

The IRS and Treasury requested comments "regarding the specific factors that should be considered when determining whether an activity is an investment activity for purposes of section 512(a)(6)." The partnership interests in which exempt organizations typically invest have certain common features, each of which distinguishes such investments from partnership activities in which the exempt organization actually participates.

We request that partnership interests that share these common features be treated as QPIs. First, in order to be eligible for treatment as a QPI under this test, the exempt organization's interest in the partnership must be solely that of a limited partner in an entity formed as a limited partnership (a "Limited Partner") or a non-managing member of an entity formed as a limited liability company (a "Non-Managing Member).⁹

We recognize the IRS and Treasury's disinclination to rely solely on Limited Partner or Non-Managing Member status, given the possibility of variation in state law and the administrative burden that reliance on state law places on the IRS in terms of enforcement. Accordingly, Limited Partner or Non-Managing Member status is proposed as a necessary, but not sufficient, factor for treatment as a QPI. In addition, the exempt organization must have no right to enter into contracts on behalf of or in the name of the partnership and no right to be involved in the day-to-day management or operations of the partnership, and must not have formed the partnership or had the power to admit itself to the partnership, as these powers indicate significant involvement in the partnership. Finally, in order to exclude operational joint ventures between an exempt organization and a co-venturer, the exempt organization must not have contributed to the partnership any "property used for the exempt purposes of" the organization, using the standard set forth in Treasury Regulations Section 53.4940-1(f)(1).¹⁰ A test for QPI status based on these factors is simple to administer because the governing documents of investment partnerships, including partnership agreements and subscription agreements, typically make clear that limited partners do not have the powers described above.

Proposed Investment Activities Test. A partnership interest is eligible for treatment as a QPI if, with respect to the partnership interest, the exempt organization:

We propose that Factors 1-5 would be required to be established by the governing documents of the partnership or by the Schedule K-1 issued by the partnership¹¹; factor 6 could be established by the governing documents or the books and records of the partnership or the organization.

IV. Request for Modifications to the Control Test

The "control test" of the Proposed Regulations permits a partnership interest to be treated as a QPI if the exempt organization (i) holds no more than 20% of the capital interest in the partnership and (ii) does not have control over the partnership (we refer to this prong (ii) as the "Actual Control Test").¹²

A. 50% Threshold for Control Test

We understand the principle expressed by the IRS and Treasury that the maximum ownership percentage allowed under the control test is intended as "a proxy to identify partnership interests in which the exempt organization does not significantly participate in any partnership trade or business."¹³ Notwithstanding our belief that status as a Limited Partner or Non-Managing Member is more indicative of a lack of participation in the partnership's trade or business than a given partnership percentage, we understand the desire for a bright-line test based on ownership percentage as one aspect of the control test. Further, we believe the control test outlined in Section 1.512(a)-6(c)(4) of the Proposed Regulations should remain available to exempt organizations for determining QPIs. However, if a maximum ownership percentage is to be used as a proxy for lack of participation in the underlying trade or business, we do not agree that 20%, which the NPRM notes is consistent with Section 731(c)(3)(C)(i) and Treasury Regulations Section 1.731-2(e), is the right standard for interests in investment partnerships.¹⁴ We believe it would be more appropriate to use a 50% threshold, which is the standard set forth both in the UBTI rules under Section 512(b)(13) regarding payments from controlled entities,¹⁵ and in the rules governing exempt organizations' reporting of related organizations on Form 990, Schedule R, below which there clearly is an absence of control.¹⁶ The Section 512(b)(13) and Schedule R definitions support the conclusion that a Limited Partner interest below 50% signals a lack of control and, therefore, a lack of significant participation. To ensure that a large interest in an operational joint venture would not be included as a QPI due to this modification, we propose that the increased 50 percent threshold would not apply if the exempt organization contributed to the partnership any "property used for the exempt purposes of" the exempt organization, using the standard set forth in Treasury Regulations Section 53.4940-1(f)(1).

Proposed 50% Threshold for Control Test. A partnership is eligible for treatment as a QPI if the exempt organization holds an interest in a partnership that meets the requirements of the control test described in Section 1.512(a)-6(c)(4) of the Proposed Regulations,¹⁷ substituting "50 percent" for "20 percent" in Section 1.512(a)-6(c)(4)(i). Notwithstanding the foregoing, the increased 50 percent threshold would not apply if the exempt organization contributed to the partnership any "property used for the exempt purposes of" the exempt organization, using the standard set forth in Treasury Regulations Section 53.4940-1(f)(1).

B. Modifications to Actual Control Test

Whether an organization has control over a partnership for purposes of the Actual Control Test is generally determined based on all the facts and circumstances, which we agree is appropriate. However, the Proposed Regulations treat certain factors as establishing control per se under the Actual Control Test.¹⁸ The IRS and Treasury recognized that this may not be an appropriate approach in all circumstances and that, although the per se factors "indicate control in some situations, other facts and circumstances may tip the scale the other way." Accordingly, the IRS and Treasury requested comments regarding whether all the per se factors should be weighted equally or whether there are certain circumstances in which a right or power would never indicate control of a partnership.

We believe that in certain situations, application of the per se factors of the Proposed Regulations could preclude bona fide investment activities from being treated as investment activities for purposes of Section 512(a)(6), and therefore propose certain modifications to the factors to prevent this result.

1. Per se control factor in Prop. Reg. 1.512(a)-6(c)(4)(iii)(A): "The organization, by itself, may require the partnership to perform, or may prevent the partnership from performing, any act that significantly affects the operations of the partnership."

Certain rights and powers are very common in the context of investment partnerships and are provided to limited partners by fund sponsors to enable limited partners to protect and preserve the value of their investment, and not for the purpose of granting the limited partners rights to control or actively participate in the day-to-day operations of the partnership. These rights and powers are entirely consistent with, and reflective of, legitimate investment activities. However, it is unclear to us whether certain of these rights and powers may be viewed under the Proposed Regulations as creating the ability to require the partnership to perform (or prevent the partnership from performing) an act that significantly affects the operations of the partnership, for example, where unanimous consent of all investors is required and a single investor therefore has a veto right in respect of a particular decision. We therefore propose that the regulations include a list of rights, powers and restrictions common in investment partnerships that will not be treated as establishing that an organization has control over a partnership, whether under the general facts and circumstances test or under any per se control factor.

Proposed modification to per se control factor in Prop. Reg. 1.512(a)-6(c)(4)(iii)(A). An exempt organization will not be treated as controlling a partnership, whether under the general facts and circumstances test or under any per se control factor, as a result of any of the following rights, powers or restrictions:

2. Per se control factors in Prop. Reg. 1.512(a)-6(c)(4)(iii)(B) and (C): "Any of the organization's officers, directors, trustees, or employees have rights to participate in the management of the partnership at any time," and "Any of the organization's officers, directors, trustees, or employees have rights to conduct the partnership's business at any time."

For the reasons discussed below, we request that the two per se factors in Prop. Reg. 1.512(a)-6(c)(4)(iii)(B) and (C) (quoted above) be removed in favor of a facts and circumstances analysis. These two per se factors would treat an exempt organization as controlling a partnership based solely on the fact that an officer, director, trustee or employee of the organization is also affiliated with the sponsor of an investment partnership, even if the organization in fact has no special rights or ability to control the partnership, and the officer, director, trustee or employee is not acting on behalf of the exempt organization. As many exempt organizations include prominent business professionals on their boards of directors or trustees (including alumni of the organization in the case of many universities), this rule may prevent organizations from treating bona fide investments as investment activities for purposes of Section 512(a)(6). The IRS and Treasury specifically noted this possibility, but nevertheless stated that "[n]o exception is provided for certain professionals that may serve on the boards of both the exempt organization and partnerships in which the exempt organization is a partner."

We believe that these per se control factors are overly restrictive. The presence of investment professionals on governing boards of tax-exempt organizations is entirely appropriate, even essential, as they bring financial expertise to institutional governance. There is no reason why the presence on an exempt organization's governance board of an individual who is associated with a particular investment management firm should automatically cause the organization's investment in a fund managed by that firm to be ineligible for treatment as a QPI under the Actual Control Test. Such a per se rule could lead exempt organizations to forego qualified and dedicated directors or trustees rather than accept additional tax reporting complexity or liability.

The same is true with respect to officers or employees of the exempt organization that are affiliated with investment funds in which the organization invests, but are not responsible for or actively involved in the organization's decision to invest in those funds. For example, universities frequently invite prominent business professionals, including investment fund professionals, to participate in the organization's activities as lecturers, adjunct faculty, professors of practice, and the like. And the officers of many tax-exempt organizations serve on a volunteer basis. These individuals may be affiliated with professional investment management firms independent of their service as an officer of an exempt organization. Thus, an employee's or officer's involvement in his or her individual capacity — and not on behalf of the exempt organization — with the management firm of an investment partnership does not indicate that the exempt organization has any ability to exercise control over the partnership. A per se rule automatically treating an organization as controlling the partnership in these circumstances could, again, lead exempt organizations not to hire qualified instructors or benefit from the volunteer services of qualified officers.

Proposed elimination of per se control factors. An organization will not be treated as controlling a partnership solely because one or more of its officers, directors, trustees, or employees who is not actively involved in or responsible for the exempt organization's decision to invest in the partnership has rights to participate in the management of the partnership at any time or to conduct the partnership's business at any time. Instead, involvement by such officers, directors, trustees, or employees in the management of the partnership or the conduct of the partnership's business will be taken into account as one fact in the general facts and circumstances analysis.

V. Request for Modifications to Look-Through Rule

We appreciate the recognition by the IRS and Treasury that, under certain circumstances, the nature of a partnership interest as an investment activity should be determined at the level of an indirectly held partnership. The IRS and Treasury have acknowledged that providing this "appropriate relief" reduces the administrative burden on exempt organizations, which frequently hold partnership interests indirectly through other partnerships for a variety of bona fide investment reasons.¹⁹ However, the Proposed Regulations allow organizations to "look through" directly held partnership interests only for the purpose of applying the de minimis test for QPI status. As a result, an organization that holds a greater than 2% but not greater than 20%²⁰ indirect interest in an underlying partnership, cannot treat the indirectly held partnership interest as a QPI, even if the organization could have treated such interest as a QPI if it held the interest directly. We do not believe that there is a principled reason for this distinction between directly and indirectly held partnership interests.

Accordingly, we request that organizations be able to look through to any indirectly held partnership interests for purposes of applying each test for QPI eligibility, whether under one of the Alternative Tests described above or the de minimis and control tests outlined in the Proposed Regulations.²¹ Figure 1 illustrates this proposal, showing an exempt organization that holds 70% of a directly held partnership, but only 7% of the interests in two indirectly held UBTI-generating partnerships. Under the Proposed Regulations, the exempt organization would not be permitted to treat its 7% indirect interests as investment activities.

Figure 1.

Result: Exempt Organization A indirectly holds a 7% interest in each of the UBTI-Generating LLCs.

Our proposed look-through approach would apply regardless of the exempt organization's ownership interest in, or level of control over, an upper-tier partnership. A significant interest in, or control over, a directly held partnership does not indicate that the exempt organization materially or significantly participates in the underlying partnership or that the underlying partnership investment is not a bona fide investment activity. We therefore believe it is appropriate to consider only the partner's indirect interest in the partnership actually engaging in the UBTI-generating activities for purposes of QPI eligibility. This preserves the distinction described in Notice 2018-67 and the Proposed Regulations between a business activity in which the exempt organization actually participates, which should be categorized by NAICS 2-digit codes, and a business activity engaged in by an entity in which the exempt organization is a mere investor (based on its lack of actual control or significant participation in the entity that actually engages in the UBTI-generating business activity).

Proposed Look Through Rule. An exempt organization is permitted to look through any directly or indirectly held partnership interests for purposes of applying each test for QPI eligibility at the level of an indirectly held partnership interest that generates UBTI.²²

VI. Request for Modifications to Form 1065 Instructions

Section 6031(d) of the Code requires any partnership that regularly carries on a trade or business to provide to each tax-exempt partner the information it needs to compute its distributive share of partnership income or loss from such trade or business in accordance with Section 512(a)(1). Notwithstanding this statutory requirement, exempt organizations often must engage in onerous and costly negotiations with the managers of investment partnerships in which they invest over how and at what level of detail the required information will be reported. The scope of the information exempt organizations will need to group the UBTI generated as a result of their partnership investments will only exacerbate the importance of — and the costs associated with — such negotiations. Moreover, in many cases there may not be an opportunity, as a practical matter, for exempt organizations to negotiate for the detailed information they need.

We therefore request that the instructions to Form 1065 be revised to instruct partnerships to report the following:

We further request that the instructions to Form 1065 be revised to instruct partnerships to report the following, solely with respect to partnership interests that do not qualify for treatment as QPIs under the final regulations:

The instructions requested above would only apply in situations in which the relevant partnership realized UBTI gain or loss during the taxable year and has tax-exempt partners or has been informed that tax-exempt partners hold interests in such partnership indirectly through other partnerships. The requested reporting would only apply to such partners' Schedules K-1. Where an underlying partnership has been asked to provide information to indirect tax-exempt owners, the partnership would report the relevant information to its direct partner(s), which in turn would report such information to its partner(s) on Schedule K-1. The requested information can be added to the footnote reporting the UBTI and we do not believe these requests would require a change in the form itself.

Additionally, regardless of whether Treasury and the IRS adopt the proposed modifications to the Form 1065 instructions outlined in this Section VI, we propose that the final regulations specifically provide that, if the information outlined above is not provided on a tax-exempt partner's Schedule K-1, the partner may use any reasonable method to make the determinations necessary to report its UBTI consistent with the final regulations. The need for authorization to use any reasonable method to make such determinations is most acute in the first several years during which Section 512(a)(6) is in effect as a transition matter, as sponsors and exempt organizations need time to implement compliance practices and policies and update their reporting practices.

Proposed Form 1065 Instructions. We request that the instructions to Form 1065 be revised to instruct partnerships that realized UBTI gain or loss during the taxable year and had tax-exempt partners or have been informed that tax-exempt partners hold interests in such partnership indirectly through other partnerships to report the following on the relevant partner's Schedule K-1:

Solely if the partnership interest is not a QPI pursuant to the final regulations:

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 Appendix

This Appendix provides additional background information to accompany our comments on Section 512(a)(6) of the Code and the Notice of Proposed Rulemaking thereunder²⁴ (the "NPRM" or the "Proposed Regulations"). The Appendix responds to a portion of the NPRM that addressed the relationship between Section 512(c) of the Code and the "material participation" standard under Section 469 of the Code, and explains why we believe that the material participation standard is appropriate for identifying investment activities of an exempt organization.

The NPRM noted that comments on Notice 2018-67 recommended using the definition of "material participation" in Section 469 as a method to identify an exempt organization's "investment activities," but explicitly rejected that approach. In so doing, the NPRM pointed to Section 512(c) and explained that "Section 512(c) applies regardless of whether the exempt organization is an active or passive participant in the unrelated trade or business of the partnership or whether it is a general or limited partner. . . . Thus, the Treasury Department and the IRS do not believe that use of the criteria for finding 'material participation' under section 469 is appropriate in applying section 512(a)(6)."²⁵

We believe Treasury and the IRS's focus on Section 512(c) in determining whether application of the Section 469 material participation standard is appropriate for identifying an organization's investment activities is misplaced. Section 512(c) provides that "[i]f a trade or business regularly carried on by a partnership of which an organization is a member is an unrelated trade or business with respect to such organization, such organization in computing its unrelated business taxable income shall, subject to the exceptions, additions, and limitations contained in subsection (b), include its share (whether or not distributed) of the gross income of the partnership from such unrelated trade or business and its share of the partnership deductions directly connected with such gross income." Section 512(c) thus simply provides that an organization includes any income generated by an unrelated trade or business carried on through a partnership in calculating its UBTI. We do not question the appropriateness of this rule and agree that income generated by an unrelated trade or business carried on through a partnership must be treated as UBTI, including for purposes of Section 512(a)(6).

However, the inquiry under Section 512(a)(6) does not end there. The question remains whether UBTI generated through a partnership should be viewed as part of an organization's investment activities or instead as part of its non-investment activities that must be categorized by NAICS 2-digit codes. Section 512(c) does not speak to this issue. Indeed, Treasury and the IRS have recognized that — notwithstanding the existence of Section 512(c) — UBTI generated through partnerships engaging in unrelated trades or businesses can constitute part of an organization's investment activities so long as the partnership interest qualifies for treatment as a QPI. The QPI tests of the Proposed Regulations effectively use ownership and control as proxies for identifying UBTI-generating activities conducted through partnerships in which the exempt organization does not materially participate and which therefore should be treated as part of its investment activities. We believe using the material participation standard of Section 469 — which directly addresses whether a partner materially participated in the income-producing activities of a partnership — would be one of several more appropriate standards for this determination. Use of the material participation standard for identifying which of an organization's partnership interests constitute investment activities is not inconsistent with Section 512(c) — just like use of the de minimis and control tests of the Proposed Regulations for this purpose is not inconsistent with Section 512(c).²⁶