I agree with Erin and would consider what you have defined as AY research buyout as allowable time to be charged the sponsored award.
I don't think sponsors think in terms of academic institutions (or departments) providing time for faculty to conduct research that is covered [aid for by departmental funding sources. From their limited viewpoint, they view researchers as either teaching or conducting sponsored research. At a lot of smaller institutions and in departments that are not research intensive, that viewpoint is probably accurate more often than not.
My interpretation of what they are trying to say is that you cannot cost share the time spent on their award (it must be charged to the award) and you cannot pay the researcher more than they otherwise would have been paid
(i.e. they don't want you giving the researcher overload pay for the time they will spend working on this award).
David