Online Marketplace/Charity Ruled Commercial, Nonexempt

• Published date: 01 March 2015
• Date: 01 March 2015
• DOI: http://doi.org/10.1002/npc.30047

Bruce R. Hopkins’ NONPROFIT COUNSEL

March 20156THE LAW OF TAX-EXEMPT ORGANIZATIONS MONTHLY

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

Not surprisingly, the IRS first held that this organiza-

tion does not meet the definition of a club within the

meaning of IRC § 501(c)(7). There is no mingling or

fellowship as a material part of its activities. There are

no meetings, gatherings, recreational events, or similar

activities. There is no facility to facilitate member meet-

ings. (Recall the ruling denying recognition of exemption

to an online sorority, summarized in the October 2014

issue.) Nonmembers are allowed to participate. The

entity was said to lack a “true membership.”

Also, the IRS noted that the organization’s “mem-

bers” do not exercise any control over the organization

and do not have a voice in management of the entity.

Management control is vested solely in the board. Mem-

bers’ rights are confined to the making of online posts

in the forum. [15.1(b)]

Note: Rather unusually, the IRS passed on opportunities

here to apply the private inurement or private benefit

doctrines, or to complain about the size of the govern-

ing board. ◆

ONLINE MARKETPLACE/

CHARITY RULED

COMMERCIAL, NONEXEMPT

A nonprofit organization, not employing the most

felicitous of language, advised the IRS that it will function

as an “automated fundraising online marketplace.” The

vendors are to be manufacturers, distributors, and other

large corporations that will give all of the net profits of

sales to charity. The purchasers will choose at checkout the

charity to receive the “profits” involved in each transaction.

The organization stated that it will operate as an

“online charity.” The model is that an “individual’s every-

day shopping also becomes a way of giving.” Charities are

to be able to have their supporters, and family and friends,

share this “special place,” where they can shop and simul-

taneously support charities of their choice. Donors will have

the option of donating directly to the entity.

The IRS did not accept any of this. First, the IRS said

that promotion of the development of public access to

and use of an e-commerce site is not an enumerated

charitable purpose under the tax regulations (Priv. Ltr.

Rul. 201503016). That is indisputably true. It is also

wholly irrelevant. (The issue should be whether a set of

activities are charitable, not whether it is expressly refer-

enced in the regulations.)

The IRS also ruled that, under the operational test,

the operation of an “internet retail shopping site” is not

a charitable activity but rather a commercial business.

Moreover, it was said to be an unrelated activity. There-

fore, the IRS ruled that this organization does not qualify

for tax exemption. [4.10] ◆

EXEMPT UNIVERSITY’S

FOR-PROFIT SUBSIDIARY’S

OPERATIONS HELD NOT

ATTRIBUTABLE FOR TAX LAW

PURPOSES

An educational institution launched a program to

improve educational opportunities for working adults.

This is an online educational program that allows stu-

dents to enroll in educational courses, utilizing a self-

paced and self-directed model. At the time this program

was implemented, no other universities offered degree

programs based on this competency-based learning

structure. Now, other colleges and universities have

become interested in offering comparable programs.

This institution has formed a for-profit wholly owned

subsidiary to develop software to run and track the pro-

gram. This software will be contributed to the subsidiary,

with the university retaining a royalty-free license for use

in its operations. The subsidiary will charge a fair market

value for the licensing of the software to other institutions.

The university will appoint all of the subsidiary’s

directors, a majority of which will not be parties related

to the university. The president of the subsidiary will not

be related to the university. The subsidiary will maintain

separate facilities, addresses, telephone numbers, tel-

ephone listings, bank accounts, and financial records. In

the event the subsidiary leases office space or receives

administrative services from the university, it will pay fair

market value.

All compensation the subsidiary pays to its directors,

officers, employees, and agents for services rendered

will be reasonable. The university represented to the IRS

that this use of a subsidiary will allow it to “attract and

retain key employees with an equity-based compensa-

tion system.” This compensation system was said to be

in conformity with those offered by comparable entities.

The IRS ruled that the university’s ownership of the

for-profit subsidiary will not adversely affect its tax-

exempt status—that is, the activities of the subsidiary

will not be attributed to the university for federal tax

purposes (Priv. Ltr. Rul. 201503018). The IRS stressed

that the subsidiary is a “separate legal entity,” with its

own “activities and management.” The subsidiary was

said to have a “real and substantial business purpose,”

so that its existence will not be disregarded for federal

tax purposes. The subsidiary, the IRS added, will not be

a “mere instrumentality” of the university.

The IRS also ruled that dividends the university

receives from the subsidiary will not be taxable as

unrelated business income. First, dividends are excluded

from taxation under the general modification rules (IRC