Determination 1025079: IRS denied exemption to an online bartering marketplace

Plain-English summary

The IRS denied an organization's application for recognition under IRC § 501(c)(3). The organization proposed an online marketplace where registered users could exchange goods and services, with the organization tracking transaction values and offering an online payment option. The IRS concluded that the activity was a commercial bartering service rather than an exclusively charitable or educational program, and that the applicant had not established that it served a charitable class. The IRS also found a private-benefit problem because the organization's officers owned the website-related intellectual property and operated the website through a partnership. The release includes the final determination and the proposed adverse determination letter.

Ruling snapshot

• Question: Did the applicant satisfy the organizational and operational tests for exemption under IRC § 501(c)(3)?
• Outcome: Denied
• Key authorities: IRC §§ 170, 501(a), 501(c)(3), 513(a), 6104(c), 6110, and 7428; Treas. Reg. §§ 1.501(a)-1(a)(2), 1.501(a)-1(a)(3), 1.501(c)(3)-1(a)(1), 1.501(c)(3)-1(b), 1.501(c)(3)-1(c)(1), 1.501(c)(3)-1(d)(1)(ii), 1.501(c)(3)-1(d)(1)(iii), and 1.501(c)(3)-1(e)(1); Rev. Rul. 76-442 and Rev. Proc. 2009-9

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

Release Number: 201025079 Contact Person:
Release Date: 6/25/10
Date: March 30, 2010 Identification Number:

UIL Code: 501.03-00
Contact Number:

Employer Identification Number:
Form Required To Be Filed:

Tax Years:

Dear

This is our final determination that you do not qualify for exemption from Federal income tax
under Internal Revenue Code section 501(a) as an organization described in Code section

501(c)(3).
We made this determination for the following reason(s):

You failed to establish that you are organized and operated for purposes described in section
501(c)(3) of the Code. You did not file a substantially complete application, are not organized
for an exempt purpose, do not operate exclusively for an exempt purpose and do not engage
primarily in activities that accomplish an exempt purpose.

You have also failed to establish that you do not serve a private interest rather than a public
interest within the meaning of section 1.501(c)(3)-1(d)(1)(ii) of the Income Tax Regulations. You
are operated to serve a private benefit rather than public interests. Accordingly, you are not an
organization exempt from tax under section 501(c)(3) of the Code.

Because you do not qualify for exemption as an organization described in Code section
501(c)(3), donors may not deduct contributions to you under Code section 170. You must file
Federal income tax returns on the form and for the years listed above within 30 days of this
letter, unless you request an extension of time to file. File the returns in accordance with their
instructions, and do not send them to this office. Failure to file the returns timely may result in a

penalty.

If you decide to contest this determination under the declaratory judgment provisions of Code
section 7428, you must initiate a suit in the United States Tax Court, the United States Court of
Federal Claims, or the District Court of the United States for the District of Columbia before the
91st day after the date that we mailed this letter to you. Contact the clerk of the appropriate
court for rules for initiating suits for declaratory judgment. Filing a declaratory judgment suit
under Code section 7428 does not stay the requirement to file returns and pay taxes.

We will make this letter and our proposed adverse determination letter available for public
inspection under Code section 6110, after deleting certain identifying information. Please read
the enclosed Notice 437, Notice of Intention to Disclose, and review the two attached letters that
show our proposed deletions. If you disagree with our proposed deletions, you should follow
the instructions in Notice 437. If you agree with our deletions, you do not need to take any

further action.

In accordance with Code section 6104(c), we will notify the appropriate State officials of our
determination by sending them a copy of this final letter and the proposed adverse letter. You
should contact your State officials if you have any questions about how this determination may
affect your State responsibilities and requirements.

If you have any questions about this letter, please contact the person whose name and
telephone number are shown in the heading of this letter. If you have any questions about your
Federal income tax status and responsibilities, please contact IRS Customer Service at
1-800-829-1040 or the IRS Customer Service number for businesses, 1-800-829-4933. The
IRS Customer Service number for people with hearing impairments is 1-800-829-4059.

Sincerely,

Robert Choi
Director, Exempt Organizations
Rulings & Agreements

Enclosure

Notice 437
Redacted Proposed Adverse Determination Letter

Redacted Final Adverse Determination Letter

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Date: January 21, 2009 Contact Person:
Identification Number:
Contact Number:
FAX Number:

Employer Identification Number:

Legend:

President
B

N

Website
State

New State
Date

Date2

Dear

We have considered your application for recognition of exemption from Federal income tax
under section 501(a) of the Internal Revenue Code (Code). Based on the information provided,
we have concluded that you do not qualify for exemption under section 501(c)(3) of the Code.
The basis for our conclusion is set forth below.

Facts:

You initially incorporated on Date in State. Soon after, you filed a Form 1023, Application for
Recognition of Exemption under Section 501(c)(3) of the Code. On Date2, you informed us that
you had never commenced business in State, had moved to New State, and had reincorporated
in New State, and submitted a revised application. Later, you advised us that you had dissolved
the corporation in State and filed a third, revised application. None of your applications included
articles of incorporation with a state stamp or other evidence showing that you filed them with
and obtained approval from the appropriate state authority on a specific date, as requested by
the form. You also did not provide an acceptable substitute for certification such as a copy of
your articles of incorporation accompanied by a declaration, signed by an officer authorized to
sign for you, that the copy is a complete and correct copy of your articles of incorporation. Also,
the third, revised application that you filed reported zero amounts on the statement of receipts
and expenditures and the balance sheet.
Your articles of incorporation state that you are organized exclusively for charitable and
educational purposes, including:

• The making of distributions to organizations that qualify as exempt
  organizations under section 501(c)(3) of the Internal Revenue Code of 1954,

• To underwrite delivery of charitable services to the poor, disabled or
  disadvantaged in the operation of a free Internet human needs and resources
  matching service operated by N when economic, educational, and/or social
  need can be demonstrated,

• Provide free shipping of items from donors to the poor, disabled or
  disadvantaged recipients, and

• Carry on lawful business activities allowed by nonprofit corporations in State,
  subject to the limitations of section 501(c)(3) of the Internal Revenue Code.

Since you stated that you primarily operate your website to deliver charitable services to the
poor, disabled or disadvantaged, we asked what steps you take and what criteria you use to
establish whether a recipient meets those requirements. You replied that the donor makes that
evaluation, that you do not monitor the activities that take place on your website and users must
make their own arrangements for completing their transactions. You added that you also do not
plan to make grants, loans or distributions to other organizations.

You will promote your website by conducting the following activities:

• Organizing a speakers bureau for making presentations to civic groups, social
  service organizations, churches, schools, and government agencies,

• Recruiting volunteers around the U.S. and on your website,

• Issuing press releases,

• Garnering feature coverage in all free media such as print, radio, and TV,

• Buying online advertising,

• Writing stories and blogs,

• Participating in forums, social networks, and other networks aligned with your
  purpose,

• Contacting numerous community and individual opinion leaders,

• Producing audiovisual products to promote your service on internet video sites, and

• Reaching out to non-profit and corporate underwriters to piggyback on existing
  publicity or to underwrite your own initiatives.

You compare your website favorably with other well-known online commercial marketplaces.
Like them, your website provides registered members with an online searchable database of
available goods and services. Although your website is open to the public, you require users to
register before they participate. After registration, a member may post an ad to offer or search
the database to find goods or services. Your website assists the exchange of offer and
acceptance emails between members and you created a medium of currency unique to your
website to measure the value of each transaction. Finally, your system tracks and posts the
value of pending and completed transactions for each member so that other members can
assess the risk of entering into a transaction with that member.
You will generate revenue by soliciting public support such as gifts of real and intellectual
property, but will not charge fees for the transactions that take place on your website. Your
fundraising efforts will include:

• Providing an online payment service with a “click to donate” option on your website
  so that participants may make cash contributions,

Conducting email fundraising and newsletter campaigns,

Sustaining the ability to accept any type of contribution,

Soliciting contributions by mail, and

Accepting funds raised by other non-profit organizations.

Your President owns the copyright for your website. Your President and B, your vice president,
are two of your three compensated officers who are also board members. Your President and B
own the rights to the database, artwork, films, text and all other technical and artistic property
used on the website. Your President and B are also the two partners of N, a partnership that
operates the website for you. You contracted to lease the website and related intellectual
property from N for one dollar a year.

Law:

Section 501(c)(3) of the Code provides for the exemption from federal income tax of
organizations organized and operated exclusively for charitable, educational and other
purposes, provided that no part of the net earnings inure to the benefit of any private
shareholder or individual.

Section 513(a) of the Code states, in part, that the term “unrelated trade or business” means, in
the case of any organization subject to the tax imposed by section 511, any trade or business
the conduct of which is not substantially related (aside from the needs of such organization for
income or funds or the use it makes of the profits derived) to the exercise or performance by
such organization of its charitable, educational, or other purpose or function constituting the
basis for its exemption under section 501.

Section 1.501(a)-1(a)(2) of the Income Tax Regulations (regulations) states that an organization
is not exempt from tax merely because it is not organized and operated for profit. In order to
establish its exemption, it is necessary that every such organization claiming exemption file an
application form with the Internal Revenue Service.

Section 1.501(a)-1(a)(3) of the regulations states that an organization claiming exemption under
section 501(a) and described in any paragraph of section 501(c) (other than section 501(c)(1))
shall file the form of application prescribed by the Commissioner and shall include thereon such
information as required by such form and the instructions issued thereto.

Section 1.501(c)(3)-1(a)(1) of the regulations provides that, in order to be exempt as an
organization described in section 501(c)(3), an organization must be both organized and
operated exclusively for one or more of the purposes specified in such section. If an
organization fails to meet either the organizational test or the operational test, it is not exempt.
Section 1.501(c)(3)-1(b) of the regulations states that an organization is organized exclusively
for one or more exempt purposes only if its articles of organization limit the purposes of such
organization to one or more exempt purposes, and do not expressly empower the organization
to engage, otherwise than as an insubstantial part of its activities, in activities which in
themselves are not in furtherance of one or more exempt purposes.

Section 1.501(c)(3)-1(c)(1) of the regulations provides that an organization will be regarded as
“operated exclusively” for one or more exempt purposes only if it engages primarily in activities
that accomplish one or more of such exempt purposes specified in section 501(c)(3). An
organization will not be so regarded if more than an insubstantial part of its activities is not in
furtherance of an exempt purpose.

Section 1.501(c)(3)-1(d)(1)(ii) of the regulations assigns the burden of proof to an applicant
organization to show that it serves a public rather than a private interest and specifically that it is
not organized or operated for the benefit of private interests, such as designated individuals, the
creator or his family, shareholders of the organization, or persons controlled, directly or
indirectly, by such private interests.

Section 1.501(c)(3)-1(d)(1)(iii), Example (3) of the proposed regulations describes O, an
educational organization the purpose of which is to train individuals in a program developed by
P, O’s president. All of the rights to the program are owned by Company K, a for-profit
corporation owned by P. Prior to the existence of O, the teaching of the program was
conducted by Company K. O licenses, from Company K, the right to use a reference to the
program in O’s name and the right to teach the program, in exchange for specified royalty
payments. Under the license agreement, Company K provides O with the services of trainers
and with course materials on the program. O may develop and copyright new course materials
on the program but all such materials must be assigned to Company K without consideration if
the license agreement is terminated. Company K sets the tuition for the seminars and lectures
on the program conducted by O. O has agreed not to become involved in any activity
resembling the program or its implementation for 2 years after the termination of O’s license
agreement.

O’s sole activity is conducting seminars and lectures on the program. This arrangement causes
O to be operated for the benefit of P and Company K in violation of the restriction on private
benefit in section 1.501(c)(3)-1(d)(1)(ii), regardless of whether the royalty payments from O to
Company K for the right to teach the program are reasonable. Based on these facts and
circumstances, O is not operated exclusively for exempt purposes and, therefore, is not
described in section 501(c)(3).

Section 1.501(c)(3)-1(e)(1) of the regulations states that an organization may meet the
requirements of section 501(c)(3) of the Code although it operates a trade or business as a
substantial part of its activities, if the operation of such trade or business is in furtherance of the
organization's exempt purpose and if the organization is not organized or operated for the
primary purpose of carrying on an unrelated trade or business, as defined in section 513.

Rev. Rul. 76-442, 1976-2 C.B. 148, denied exempt status to an organization that provided free
legal services for personal and estate tax planning for individuals who wished to make gifts to
charity as part of their tax planning. The Service found that the organization was not operated
exclusively for charitable purposes because its primary purpose was to provide commercial tax
services to individuals who were not a charitable class. The benefits to the public were tenuous.

Rev. Proc. 2009-9, 2009-2 I.R.B., section 3.03 states that an organization seeking recognition of
exemption under section 501(c)(3) must submit a completed Form 1023.

Rev. Proc. 2009-9, 2009-2 I.R.B., section 3.08(3) states that a substantially completed
application, including a letter application, is one that includes a statement of receipts and
expenditures and a balance sheet for the current year and the three preceding years (or the
years the organization was in existence, if less than four years). If the organization has not yet
commenced operations, or has not completed one accounting period, a substantially completed
application generally includes a proposed budget for two full accounting periods and a current
statement of assets and liabilities.

Rev. Proc. 2009-9, 2009-2 I.R.B., section 3.08(6) states that a substantially completed
application, including a letter application, is one that, if the organizing or enabling document is in
the form of articles of incorporation, includes evidence that it was filed with and approved by an
appropriate state official (e.g., stamped “Filed” and dated by the Secretary of State).
Alternatively, a copy of the articles of incorporation may be submitted if accompanied by a
written declaration signed by an authorized individual that the copy is a complete and accurate
copy of the original copy that was filed with and approved by the state. If a copy is submitted,
the written declaration must include the date the articles were filed with the state.

In Better Business Bureau of Washington D.C., Inc. v. U.S., 326 U.S. 279, 66 S. Ct. 112, 90 L.
Ed. 67, 1945 C.B. 375 (1945), the Supreme Court held that the presence of even a single non-
exempt purpose, if substantial in nature, will destroy the exemption regardless of the number or
importance of truly exempt purposes.

In B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 (1978), the court found that a corporation
formed to provide consulting services was not exempt under section 501(c)(3) because its
activities constituted the conduct of a trade or business that is ordinarily carried on by for-profit
commercial businesses. Its primary purpose was not charitable, educational, nor scientific, but
commercial. The court found that the corporation failed to demonstrate that its services were
not in competition with commercial businesses.

In Living Faith, Inc. v. Commissioner, 950 F.2d 365 (7" Cir. 1991) affg 70 T.C. 352 (1978), the
court held that a vegetarian restaurant and health foods store that adhered to the principles of
the Seventh Day Adventist Church was not operated exclusively for exempt religious purposes,
but rather for a substantial commercial purpose. The court examined the method of operations
to infer the purposes. Although the organization catered to the dietary restrictions of the Church,
its primary activities were managing a restaurant and health food store, which operated in
competition with commercial entities, charging competitive prices set by formulas common in
the retail food business, and using commercial promotional methods.

In Church by Mail v. Commissioner, 765 F.2d 1387 (9th Cir. 1985), aff'g TCM 1984-349 (1984),
the Tax Court found it unnecessary to consider the reasonableness of payments made by the
applicant to a business owned by its officers. The 9th Circuit Court of Appeals, in affirming the
Tax Court's decision, stated:

The critical inquiry is not whether particular contractual payments to a related for-
profit organization are reasonable or excessive, but instead whether the entire
enterprise is carried on in such a manner that the for-profit organization benefits
substantially from the operation of the Church.

In Arlie Foundation v. Commissioner, 283 F. Supp. 2d 58 (D.D.C., 2003), the District Court
found that the organization was formed principally to organize, host, conduct and sponsor
educational and other charitable functions on its facilities. The organization paid significant
advertising and promotional expenses and derived substantial income from events held at its
conference center. The court determined that the organization’s activities competed with a
number of commercial, as well as non-commercial entities, which strongly evidenced a
commercial nature and purpose.

Among the major factors courts have considered in assessing commerciality are
competition with for profit commercial entities; extent and degree of below cost
services provided; pricing policies; and reasonableness of financial reserves.
Additional factors include, inter alia, whether the organization uses commercial
promotional methods (e.g. advertising) and the extent to which the organization
receives charitable donations.

Thus, the court looked at the business methods of the organization as a method of inferring
whether its purpose was to serve the public or whether there was a substantial non-exempt
purpose of operating a business for profit.

Analysis:

Based on the information you provided in your application and supporting documentation, we
conclude that you are not an exempt organization described in section 501(c)(3) of the Code.
First, in order to be exempt as an organization described in section 501(c)(3), an applicant must
file a substantially completed application that includes the information required by the form and
instructions. You did not provide the certified organizing documents, a substitute certification, or
the financial information required by section 501(a)-1(a)(3) of the regulations, Form 1023
Instructions, and Rev. Proc. 2009-9, 2009-2 I.R.B. Second, an exempt organization must be
both organized and operated exclusively for exempt purposes. If an organization fails to meet
either the organizational test or the operational test described in section 1.501(c)(3)-1(a)(1) of
the regulations, it is not exempt. The information you provided shows that you are not
organized or operated for an exempt purpose described in section 501(c)(3) of the Code.

To establish exemption from tax under section 501(c)(3), an organization must first pass the
organizational test set out in section 1.501(c)(3)-1(b) of the regulations. Under this test, an
applicant’s articles of organization must limit the organization’s purposes to one or more exempt
purposes specified in section 501(c)(3). In addition, the articles may not authorize the
organization to engage in substantial activities that are not in furtherance of an exempt purpose.
Your articles of incorporation state, in part, that you are organized to “underwrite delivery of
charitable services to the poor, disabled or disadvantaged in the operation of a free Internet
human needs and resources matching service”. Since operating an online bartering service is
not an exempt purpose described in section 501(c)(3), your articles of incorporation do not limit
your purposes to one or more exempt purposes described in section 501(c)(3) and authorize
you to engage in substantial activities that do not further an exempt purpose. The information
you provided does not meet the requirements of the organizational test in section 1.501(c)(3)-
1(b).

Second, the information provided by the organization must demonstrate conclusively that it
meets the operational test described in section 1.501(c)(3)-1(c) of the regulations. The
operational test first requires an organization to prove that it operates exclusively for one or
more exempt purposes within the meaning of section 501(c)(3) of the Code. An organization
will be regarded as “operated exclusively” only if it engages primarily in activities which
accomplish one or more of the exempt purposes described in section 501(c)(3). The presence
of a single nonexempt purpose, if substantial in nature, will destroy the exemption regardless of
the number and importance of truly exempt purposes. See Better Business Bureau of
Washington, D.C. v. U.S., supra. Your purpose and principal activity is the operation of an
internet matching service for the general public. An organization that operates primarily to
conduct a trade or business that is unrelated to an exempt purpose described in section
501(c)(3) will not pass the operational test.

However, organizations that operate a trade or business as a substantial part of their activities
may meet the requirements of section 501(c)(3) of the Code if the activity is related to and
furthers an exempt purpose. Section 1.501(c)(3)-1(e)(1) of the regulations. Several courts have
considered nonprofit organizations that conduct businesses to determine whether the business
was conducted for an exempt purpose or for a commercial, non-exempt purpose. See B.S.W.
Group, Inc. v. Commissioner, Living Faith, Inc. v. Commissioner, and Arlie Found. v. IRS, supra.
These courts considered such factors as the particular manner and commercial hue of the
activities an organization conducts and the existence and amount of annual or accumulated
profits to determine the existence of a nonexempt commercial purpose. The exchange of goods
and services is the essence of commercial activity.

You have failed to establish that your activities accomplish any of the charitable purposes
described in section 501(c)(3) of the Code, which includes the relief of the poor and distressed
or of the underprivileged and the advancement of education in the definition of the term
“charitable”. Like other online commercial websites, you do not monitor users’ activities and
they must make their own arrangements with regard to their transactions. Further, you have
failed to provide confirmation that you provide relief to any charitable class, since your
members, not you, determine whether a recipient is poor, distressed or underprivileged. You
are like the organization described in Rev. Rul. 76-442, supra., because you are not operated
exclusively for a charitable purpose and your primary purpose is to operate an online
commercial bartering marketplace for individuals who are not a charitable class.

Competition is strong evidence of a commercial nature and purpose. You compared your
bartering website favorably to several other commercial retail websites. To compete
successfully, you maintain a website open to the public; plan significant advertising, marketing
and promotion activities; place a value on the transactions; and offer an online payment service
option. The information you provided shows that you primarily operate a bartering website for a
commercial, non-exempt purpose.
The operational test also assigns the burden of proof to an applicant to show that it serves a
public rather than a private interest and specifically that it is not organized or operated for the
benefit of private interests, such as designated individuals, the creator or his family,
shareholders of the organization, or persons controlled, directly or indirectly by such private
interests. See section 1.501(c)(3)-1(d)(1)(ii) of the regulations. Control is an important factor in
determining whether an organization operates for the benefit of private interests. Your
President, and B, your vice president, are the partners of N, who operates your primary activity,
the website. Your President and B also own all rights to the database and the artwork, films,
text and other technical and artistic property that you publish and promote on your website. Like
the organization described in Church by Mail v. Commissioner, supra., you are operating to
create a market for N’s services and your President and B’s intellectual property. Like the
organization described in section 1.501(c)(3)-1(d)(1)(iii), Example (3) of the regulations, your
operations provide a benefit for your creator, a for-profit entity owned by your creator, and your
registered members, in more than an incidental way. You have failed this part of the operational
test because you are organized and operated for the benefit of your President, B, and N in
violation of the restriction on private benefit, regardless of whether lease payments for the right
to use the website are reasonable.

Conclusion:

Based on the information you provided, we conclude that you are not entitled to recognition of
exempt status under section 501(c)(3) of the Internal Revenue Code because you did not file a
substantially completed application, are not organized for an exempt purpose, do not operate
exclusively for an exempt purpose and do not engage primarily in activities that accomplish an
exempt purpose. Your principal activity is the operation of a commercial bartering website that
does not achieve charitable or educational purposes. Even if you were able to establish that
you were formed and operated for charitable or educational purposes, you would not qualify for
exemption because you are operated for a substantial non-exempt purpose. You are operated
for the purpose of serving a private benefit rather than public interests. Accordingly, you are
not an organization exempt from tax under section 501(c)(3) of the Code.

You have the right to file a protest if you believe this determination is incorrect. To protest, you
must submit a statement of your views and fully explain your reasoning. You must submit the
statement, signed by one of your officers, within 30 days from the date of this letter. We will
consider your statement and decide if the information affects our determination.

Your protest statement should be accompanied by the following declaration:

Under penalties of perjury, I declare that I have examined this protest statement, including
accompanying documents, and, to the best of my knowledge and belief, the statement
contains all the relevant facts, and such facts are true, correct, and complete.

You also have a right to request a conference to discuss your protest. This request should be
made when you file your protest statement. An attorney, certified public accountant, or an
individual enrolled to practice before the Internal Revenue Service may represent you. If you
want representation during the conference procedures, you must file a proper power of attorney,
Form 2848, Power of Attorney and Declaration of Representative, if you have not already done
so. For more information about representation, see Publication 947, Practice before the IRS
and Power of Attorney. All forms and publications mentioned in this letter can be found at
www.irs.qov, Forms and Publications.

If you do not file a protest within 30 days, you will not be able to file a suit for declaratory
judgment in court because the Internal Revenue Service (IRS) will consider the failure to protest
as a failure to exhaust available administrative remedies. Code section 7428(b)(2) provides, in
part, that a declaratory judgment or decree shall not be issued in any proceeding unless the Tax
Court, the United States Court of Federal Claims, or the District Court of the United States for
the District of Columbia determines that the organization involved has exhausted all of the
administrative remedies available to it within the IRS.

If you do not intend to protest this determination, you do not need to take any further action. If
we do not hear from you within 30 days, we will issue a final adverse determination letter. That
letter will provide information about filing tax returns and other matters.

Please send your protest statement, Form 2848 and any supporting documents to this address:

Internal Revenue Service
TE/GE SE:T:EO:RA:T:2

1111 Constitution Ave, N.W.
Washington, DC 20224

You may also fax your statement using the fax number shown in the heading of this letter. If
you fax your statement, please call the person identified in the heading of this letter to confirm
that he or she received your fax.

If you have any questions, please contact the person whose name and telephone number are
shown in the heading of this letter.

Sincerely,

Robert Choi
Director, Exempt Organizations
Rulings & Agreements