Commentary on ECFA Standard 7.9

 An understanding of the following terms is essential to understanding Standard 7.9:

1. Officer, director, or other principal.  Certain individuals may be in a position to significantly influence the distribution of products for which they or close relatives (related by blood or marriage) would personally benefit, either by receiving a royalty from these products or, in the case of self-produced products, by making a profit. While these individuals are often officers, directors, or other principals (referred to as "insiders" in this document), the definition of insiders includes anyone in a position to influence the marketing of products.
2. Self-produced products.  Self-produced products are defined as products that are self-published (e.g., books) or self-produced (e.g., CD-roms) by an officer, director, or other principal of the member organization (or by an entity in which an officer, director, or other principal has a significant financial interest) and subsequently distributed by the member organization. 
   
       Example: An officer, director, or other principal of a member organization self-produces a product at a cost of $10.  The product is sold to a member organization for $15. The officer, director, or other principal of the organization receives a profit of $5 ($15 sale price minus $10 cost).
   
   This Standard does not cover self-produced products for which the rights to the product have been transferred to the ministry. For example, the ministry’s CEO has written a book and self-published it. If he sells the books to the ministry from his inventory, this Standard applies. However, if the ministry owns the publishing rights to the book, this Standard does not apply since the ministry receives the royalties.
3. Sale.  The use of the word "sale" in this commentary refers to an exchange of property for an agreed upon sum of money or other valuable consideration. This definition includes quid pro quo transactions that are commonly defined as part sale and part gift. 
   
   The exchange of a product for a contribution is also included in the definition.
   
       Example: A charity offers to provide a product and suggests a donation amount for the product.
4. Specific promotion of products.  When a member organization specifically promotes a product for sale, for which an officer, director, or other principal of the organization is eligible to receive royalties, the ministry has specifically promoted the product. To qualify as a "specifically promoted" product, it must be the organization’s only product or one of few products the organization promotes.  
   
       Examples: A product catalog, a website, a bookstore, or a book table that primarily offers insider products would qualify as "specifically promoting" these products. A speaker might distribute a certain product to attendees and ask them to purchase it (or receive it as a gift for a suggested price). This too is a type of "specific promotion." 
       Example: An organization is not "specifically promoting" a product when it offers the product amidst a significantly larger offering of products, including those of non-insiders.
5. Royalties.  Producers of products sometimes receive royalty advances. Standard 7.9 also applies to products that relate to a royalty advance. 
   
   If an insider eligible to receive a royalty is subject to a royalty advance instead of a periodic royalty payment, the Standard applies. 
   
       Example: An author receives a royalty advance of $25,000 and does not begin to receive quarterly royalty checks until the number of books sold times the royalty rate exceeds the $25,000 advance. This Standard applies to the books sold to help achieve the $25,000 royalty level and to those sold after that point. In other words, the officer, director, or other principal must not receive either the advance nor the royalties.

Permissible royalty payments.  The following royalty payments are permitted under the Standard:

1. Any sale of products by member organizations for which an insider, including anyone in a position to influence product marketing, does not receive royalties (or profit from self-publishing). 
2. Non-sale distribution of products by a member organization for fund-raising or promotional purposes and for which someone other than an insider receives a royalty. 
   
       Example: A member organization offers a product at no charge as a part of a name acquisition/donor acquisition program (the author receives royalties from the publisher based on the publisher’s product sale to the member organization). Under this Standard, an insider would not be eligible to receive royalties related to this product distribution. However, royalties paid to someone other than an officer, director, or other principal of the organization would be permitted.
   
       Example: A member organization offers a product authored by an insider, in exchange for a gift of $40. Under this Standard, the insider would not be eligible to receive royalties related to this product distribution. However, royalties paid to someone other than an insider would be acceptable.
3. Royalties paid by a publisher to an insider on sales of products by outlets (e.g., Christian bookstores other than the ministry’s bookstores) are permitted under the Standard.
4. A self-produced product that is sold by a ministry to a Christian bookstore for resale to the public is acceptable for royalties under this Standard, whether the product is owned by the ministry or by the insider that produced the product.

Impermissible royalty payments.  The following royalty payments are not permitted under the Standard:

1. Any non-sale distribution of products for fund-raising or promotional purposes for which an insider receives a royalty.
   
       Example: If a ministry distributes a product (for which an insider is eligible to receive royalties) to everyone at a convention or to everyone on the ministry’s mailing list, the Standard does not permit the payment of royalties on the product. 
2. Any sale of products that has been specifically promoted by a member organization and for which an insider receives a royalty.

Tax and legal considerations.  General copyright law provides that the employer is considered the author of a "work made for hire" and "owns all of the rights comprised in the copyright," unless the employer and employee "have expressly agreed otherwise in a written instrument signed by them." A "work made for hire" is "a work prepared by an employee within the scope of his or her employment." Such rights may pertain to books, articles, sermons, music, and other materials.

Accordingly, organizations should affirm corporate ownership of all such rights in personnel policies and manuals, and should retain signed acknowledgment by employees of this provision.

However, if an individual rather than the organization owns the rights, care should be taken to:

1. Assure that work on the product containing the rights is performed outside the time and duties of employment with the organization, and that compensation is appropriately reduced if the work infringes upon the employee’s time and duties.
2. Assure that the organization is reimbursed for any organizational resources used in the production of work owned by individuals (e.g., equipment, secretarial help, proofreading, recording, etc.) at fair value. This is true even if the organization supports the “ministry” of the works as good or worthwhile. Alternatively, if a Board agrees to absorb support cost as in the best interest of the organization, then the fair value of the work must be added to the employee’s taxable income.

In cases where intellectual property rights are owned by the employer and subsequently assigned to an individual, or where duties are concurrent (such as a pastor’s sermons), care should be taken to:

1. Consult legal counsel knowledgeable in the specialized area of intellectual property rights.
2. Establish written agreements approved by the Board and signed by the organization and individual.
3. Consider the fair value of the rights as an element of compensation when establishing reasonable compensation limits and when reporting compensation for tax purposes.

Tax-exempt organizations must take care not to enter into any arrangement with their officers, directors, or other related parties that would constitute "private inurement" or an "excess benefit transaction" under federal tax law. Entering into such an arrangement can subject the parties involved to personal penalties and can expose the organization’s tax-exempt status to risk. 

    Example: An excess benefit transaction or private inurement may occur if an exempt organization transfers something of value to one of its officers without receiving something of at least equal value in exchange. 

Due to its complexity, the area of intellectual property ownership in the context of exempt organizations has a heightened risk. Organizations addressing these issues would be well advised to consult competent tax and legal counsel.