Coffee Shop Ruled Related Business, Gift Shop Held Functionally Related Business

• Date: 01 May 2017
• DOI: http://doi.org/10.1002/npc.30316
• Published date: 01 May 2017

Bruce R. Hopkins’ NONPROFIT COUNSEL

May 20174THE LAW OF TAX-EXEMPT ORGANIZATIONS MONTHLY

Bruce R. Hopkins’ Nonprofit Counsel DOI:10.1002/npc

certification of the intended use of the vehicle and the

intended duration of the use.

As the court concluded, Congress “imposed very

strict requirements” as to charitable gift substantiations

in connection with used vehicles and “[w]e are not at

liberty to override this legislative command.” [21.3,

21.4] ◆

COFFEE SHOP RULED RELATED

BUSINESS, GIFT SHOP HELD

FUNCTIONALLY RELATED

BUSINESS

The IRS ruled that a coffee shop to be operated as part

of a cultural center will be a related business and that

a gift shop to be operated therein will be a functionally

related business, without ruling as to whether the latter

is a related business (Priv. Ltr. Rul. 201710005).

Facts

Entity A, a private operating foundation, is operated

to establish and manage programs that provide educa-

tional services and resources to the public in a city. It is

planning construction and operation of a community

cultural center that will display traveling educational

exhibits, and house a museum containing historical

artifacts owned by a historical society (a public char-

ity). The center will offer multipurpose spaces that will

accommodate music, theater, and artistic performances

and exhibits. It will include an archive, library, and atrium

with a memorial area for reflection and contemplation.

The center will be open to the public, without charge.

As part of the center, A will construct and maintain

a gift shop and a coffee shop for use by the center’s

employees and visitors. The gift shop will sell items

affiliated with the center’s exhibits, artifacts, and per-

formances. A’s board will evaluate potential product

suppliers for the gift shop, review the quality of their

products, and ensure that purchase costs and any

supplier-imposed restrictions are reasonable.

The coffee shop will sell food and drink obtained

from separate and unrelated suppliers or from a national

chain of coffee shops. In either instance, A will ensure

good product quality and that the contract terms are

reasonable. Patronage of the coffee shop by the public

will not be solicited. As the IRS stated the matter, this

shop is not designed to be a “public eating establish-

ment” but rather a “convenient eating place” for the

center’s visitors and employees.

Entity A has 11 directors. Two of them are married

to each other. Entity B is a private nonoperating founda-

tion, with three directors, including this married couple.

B will be making substantial grants to A.

Analysis

The IRS ruled that A’s operation of the coffee shop will

not be an unrelated business. Rather, sale of items at this

shop “will help attract visitors” to the center. Having this

shop onsite “will relieve the need for visitors to seek food

and drink outside the Center, thus allowing them to spend

more time” viewing the center’s exhibits and historical

artifacts, and utilize the center’s atrium, library, and the like.

Having an onsite coffee shop was also seen by the IRS as

enabling the center’s staff to remain in it throughout the

day and thus contribute to the center’s “efficient opera-

tion.” Consequently, maintenance of the coffee shop was

held by the IRS to be a “service” that will contribute impor-

tantly to achievement of A’s exempt educational purposes.

Without explanation, the IRS did not rule on whether

the gift shop or any items to be sold in that shop would

result in unrelated business income. Nonetheless, the

agency held that the gift shop as proposed “is an activity

carried on as part of the overall activities as they relate

to the Center’s exempt educational purpose” and that

as long as it is “actually operating as a functional part of

the Center’s larger aggregate of other activities which are

related to the Center’s exempt educational purpose,” the

gift shop will be a functionally related business.

Also, the IRS ruled that A’s expenditures for construc-

tion and operation of the shops will constitute qualifying

distributions and not taxable expenditures, and that the

shops will not be excess business holdings. For good

measure, the agency also held that A’s legal, accounting,

and other expenses related to this ruling request will be

qualifying distributions and not taxable expenditures,

assuming A can demonstrate a good-faith belief that the

expenses were reasonable and that payment of them was

consistent with ordinary business care and prudence.

The IRS further ruled that the transfers from Entity B

to Entity A will not entail self-dealing. [12.4(a), 12.4(c),

24.4] ◆

BENEFITS PLAN FAILED TO

QUALIFY AS SOCIAL WELFARE

ORGANIZATION BUT RULED

“EXEMPT” AS QUASI-

GOVERNMENTAL ENTITY

The IRS ruled that an employee benefits plan could

not qualify for tax exemption as a social welfare organi-

zation because of private inurement concerns but that it

is “exempt” as a quasi-governmental unit (Priv. Ltr. Rul.

201710034).

Facts

A nonprofit organization primarily benefits its partici-

pants and their employees by providing employee health