IRS determination 1126039: IRS denies exemption to health supplement research organization

Plain-English summary

The IRS denied exemption under IRC § 501(c)(3) to an organization that planned to research health maintenance and sell customized vitamin supplements. The organization also planned seminars and health education, but the IRS found that its main activities were the commercial marketing and sale of products and a book created by its founder. Because the founder retained rights in those products and the book, the IRS found that the organization served private interests and was not operated exclusively for charitable purposes. The final determination required the organization to file Form 1120 returns for the listed years.

Ruling snapshot

• Question: Whether the organization operated exclusively for charitable purposes under IRC § 501(c)(3), or instead operated commercially and for the private benefit of its founder.
• Outcome: Denied.
• Key authorities: IRC §§ 501(c)(3), 170, 6104, 6110, and 7428; Treas. Reg. § 1.501(c)(3)-1(c)(2); Rev. Rul. 72-369.

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Number: 201126039 Contact Person:
Release Date: 7/1/2011

Identification Number:
Date: April 8, 2011

Contact Number:

Employer Identification Number:

Form Required To Be Filed:
1120
Tax Years:
UIL: 501.03-21 All Years

Dear

This is our final determination that you do not qualify for exemption from Federal income tax as
an organization described in Internal Revenue Code section 501(c)(3). Recently, we sent you a
letter in response to your application that proposed an adverse determination. The letter
explained the facts, law and rationale, and gave you 30 days to file a protest. Since we did not
receive a protest within the requisite 30 days, the proposed adverse determination is now final.

Since 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. |

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.

Letter 4038(CG) (11-2005)
Catalog Number 47632S

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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,

Lois Lerner
Director, Exempt Organizations

Enclosure
Notice 437
Redacted Proposed Adverse Determination Letter
Redacted Final Adverse Determination Letter

Letter 4038(CG) (11-2005)
Catalog Number 47632S

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

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION

Date: October 15, 2010 Contact Person:
Identification Number:
Contact Number:
FAX Number:
Employer Identification Number:

LEGEND: UIL: 501.03-21

B-Date

C-State

D-Applicant

E- Supplement Name

F- Founder

G- Website

H- Book title
J- Board Member

Dear

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

Issues:

Are you operating exclusively for charitable purposes within the meaning of Section
501(c)(3)? No, for the reasons described below.

Letter 4036 (CG) (11-2005)
Catalog Number 47630W

Facts:

You were incorporated on B in the state of C. Your board consists of two individuals;
your founder, F, and J. F is an Internal Medicine resident, and has a Doctor of
Philosophy in the field of health and biochemistry. He also has a Master of Arts in
sociology and is a medical scientist. J is your vice President and secretary. Before
your incorporation, F developed a theory concerning healthy longevity. This theory
involves the triangle of health consciousness, rest sleep hygiene, and the use of E
vitamin supplements. F dedicated years of his life to this research, which involved
promoting health, preventing and fighting disease, and ensuring healthy longevity. He
also developed scientific principles resulting in the development of E vitamin
supplements.

The first article of your Articles of Incorporation describes your purpose as follows:

D is organized to continue research and development of health maintenance and
E based on the published work of F and to provide health education to people in
developing countries and to educational institutions in the USA and to provide
subsidy for people to benefit from such E.

E are vitamin supplements that consist of unique combinations of various known
biochemical and nutritional supplements such as Beta Carotene, Glucosamine and
Riboflavin. They come in capsules, pills or tablets. You purport that these vitamin
supplements have documented evidence that they are beneficial to one’s health and are
essential for healthy living.

As a result of his research, F wrote a manuscript titled H. It explains his theories in
detail concerning healthy longevity and the role that the consistent use of E vitamin
supplements has in promoting healthy longevity. You indicated your primary activity is
to conduct seminars educating people about E, and to educate people on the topics of
health consciousness and the relativity of healthy longevity. H is intended to set the
stage for the content of your seminars. These seminars will promote the use of E by
explaining the role they have in healthy longevity. Both you and F will share the
copyrights of H.

You have set up a dedicated website, G, where you market and sell these vitamin
supplements to the general public. In order to purchase E, interested individuals
complete a form found on your web site detailing their medical history and pay a $55.00
consultation fee. You evaluate each individual based on the information on the form to
determine what unique regimen of these products is ideal for their health. After the
evaluation, you customize a personal regimen of E vitamin supplements specifically
targeting the individual's health. Thus, regimens and pricing will vary greatly from
person to person according to each person’s individual health and the unique

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combination of E vitamin supplements recommended for his/her condition. Interested
individuals will then receive a cost analysis in advance and decide from there if they will
purchase E. After an individual receives the first regimen, he/she may decide to stop
receiving E and pay nothing. The actual amount an individual pays for his personalized
regimen of E is based on manufacturing costs, processing fees and the shipping costs.
In addition, a potential customer may request free samples and pay only shipping
costs. Like, H the rights to E will be shared by you and your founder, F.

Some of the claims you make on your website about E is that they can help individuals
recover from chronic diseases, they may prevent medical crisis that require
hospitalization, they are the best approach to preventing any diseases for which an
individual may have a family history or risk factors such as cancer or heart disease, and
they may prevent the recurrence of disease. You also claim that E can boost immune
mechanisms and help individuals acquire resistance to diseases, including infectious
diseases, such as malaria.

The following phrases are found on your website:

“We guarantee that the first regimen of E will boost your health and life. If not, stop and
pay no consultation fees”. and “Need to Know More. Evaluation of Your Condition at No
Cost”

To emphasize E’s effectiveness, your website has a page devoted to testimonials of
very satisfied individuals who have used E.

To date you have only tested E on volunteers and state that E has not been for sale to
the public. You indicated that you purchase the components of E from vendors in the
United States. However, you were unable to provide any contracts. You and your
founder will also share the trademark rights to E until you can afford to enter into an
agreement.

You listed other future activities such as the support of research and the development of
E, and the promotion of health consciousness and E as tools for reducing the costs of
health and medical insurance for everyone.

Fees charged for E vitamin supplements will fund your operations. Expenses consist of
advertising and costs of procuring and distributing E.

Tax Law:

Section 501(c)(3) of the Internal Revenue Code provides for the exemption from federal
income tax of organizations organized and operated exclusively for charitable purposes.

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Section 1.501(c)(3)-1(c)(2) of Internal Revenue Regulations states that an organization
whose net earnings inure to the benefit of private shareholders or individuals or which is
operated for the benefit of private interests is not operated exclusively for exempt
purposes.

In Rev. Rul. 72-369, 1972-2 C.B. 245, an organization was formed to provide
managerial and consulting services for section 501(c)(3) organizations to improve the
administration of their charitable programs. The organization enters into agreements
with unrelated section 501(c)(3 ) organizations to furnish managerial and consulting
services on a cost basis. This revenue ruling stated that::

An organization is not exempt merely because its operations are not conducted for
the purpose of producing a profit. To satisfy the ‘operational test,’ the organization's
resources must be devoted to purposes that qualify as exclusively charitable within
the meaning of section 501(c)(3) of the Code and the applicable regulations.
Providing managerial and consulting services on a regular basis for a fee is a trade
or business ordinarily carried on for profit. The fact that the services in this case are
provided at cost and solely for exempt organizations is not sufficient to characterize
this activity as charitable within the meaning of section 501(c)(3) of the Code.
Furnishing the services at cost lacks the donative element necessary to establish
this activity as charitable.

In Old Dominion Box Co. v. United States, 477 F2d 344 (4"" Cir. 1973) cert. Denied 413
U./S. 910 (1973) the court held that operating for the benefit of private parties
constitutes a substantial non-exempt purpose.

Harding Hospital, Inc. v. United States, 505 F2d 1068 (1974), holds that an organization
seeking a ruling as to recognition of its tax exempt status has the burden of proving that
it satisfies the requirements of the particular exemption statute. Whether an
organization has satisfied the operational test is a question of fact.

In B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 (1978), the Tax Court held that an
organization did not qualify for exemption under section 501(c)(3) of the Code because
it was primarily engaged in an activity that was characteristic of a trade or business and
ordinarily carried on by for-profit commercial businesses. The Tax Court stated: “We
must agree with the Commissioner that petitioner's activity constitutes the conduct of a
consulting business of the sort which is ordinarily carried on by commercial ventures
organized for profit.”

In Living Faith Inc. v Comm'r, 60 T.C.M., 710, 713(1990), aff'd 950 F.2d 365 (& Cir.
1991) the court wrote that the activities were conducted as a business and the
organization was in direct competition with other restaurants and health food stores;
thus it did not qualify for exemption under Section 501(c)(3). The appellate court stated

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the factors that the court relied on to find commerciality and thus offered the best
contemporary explanation of the commerciality doctrine. These factors include:

1) The organization sold goods and services to the public.

2) The organization was in direct competition with for profit businesses (Food
stores and restaurants).

3) The prices set by the organization were based on pricing formulas common in
retail food businesses.

4) The organization utilized promotional materials and “Commercial catch
phrases” to enhance sales.

5) The organization advertised its services and food.

6) The organization did not receive any charitable contributions.

Application of Law:

You are not described in section 501(c)(3) of the Code because a substantial portion of
your activities consists of selling health supplements for a fee in a commercial manner.
You are not organized and operated exclusively for charitable purposes.

As described in section 1.501(c)(3)-1(c)(2) of the Regulations, you are not operated
exclusively for exempt purposes because your net earnings inure to the benefit of private
shareholders or individuals . This is evidenced by the fact that your activities consist of
marketing and selling H and E, which were both created by F. The fact that F still owns
the rights to these items shows that you have a substantial purpose of benefiting F.

You are like the organization described in Rev. Rul. 72-369, 1972-2 C.B. 245 because
you aré operating in a commercial manner. A substantial portion of your activities
consists of marketing and selling commercial goods. The organization described in the
revenue ruling was conducting commercial services only for organizations exempt
under section 501(c)(3) and was still found to be conducting commercial activities. The
fact that you sell commercial products to the general public shows that you are operated
in even more of a commercial manner than the organization described in the revenue
ruling. As explained in the ruling, the fact that the services in this case are provided at
cost is not sufficient to characterize this activity as charitable within the meaning of
section 501(c)(3) of the Code. Furnishing the services at cost lacks the donative
element necessary to establish this activity as charitable.

You are like the organization in Old Dominion Box Co. v. United States, 477 F2d 344
(4" Cir. 1973) cert. Denied 413 U./S. 910 (1973) because you are operating for the
benefit of your founder. This is substantiated by the fact that you market and sell the
products and book created by your founder. Also, your founder owns a substantial part
of the rights. Even the “educational seminars” you conduct appear to simply be a
vehicle to promote and sell these products.

Letter 4036(CG) (11-2005)
Catalog Number 47630W

You are also operating like the organization in Harding Hospital, Inc. v. United States,
505 F2d 1068 (1974). The facts indicate that all of your resources are either directly or
indirectly targeted at the promotion and sales of E. Your activities are conducted ina
commercial manner and you have not met your burden of proving that you are operated
exclusively for charitable purposes.

You are operating like the organization in B.S.W. Group, Inc. v. Commissioner, 70 T.C.
352 (1978) because you are substantially engaged in the commercial activity of
marketing and selling vitamin supplements. This activity constitutes the conduct of a
commercial business of the sort which is ordinarily carried on by commercial ventures
organized for profit.

You are also like the organization in In Living Faith Inc. v Comm’r, 60 T.C.M., 710,
713(1990), aff'd 950 F.2d 365 (& Cir. 1991) because you are operating as a business and
are in direct competition with all other businesses that sell vitamins. You are promoting
and selling E on the dedicated web site G like a commercial business and using pricing
formulas that seem no different than that of a for profit enterprise. You are also using
marketing terms and catch phrases characteristic of a commercial business. This is
evidenced by the phrases displayed on your website described above. Finally, the fact
that you have testimonials of individuals who have achieved success with your product is
also a common technique used by for profit businesses.

Applicant’s Position:

You believe that your activities are educational and promoting health within the meaning
of Section 501(c)(3). You believe that you are not operating in a commercial manner
because you have no obligation to investors. You are an advocate of the people
against entities that may exploit their pain and distress in the name of profit. You are not
organized to yield financial returns to a few.

Service Response to Applicant’s Position:

You have failed to prove that your activities are exclusively educational or charitable within
the meaning of section 501(c)(3) of the Code. Even if some of your activities are
considered to be educational and promoting health, the facts show that you have the
substantial purpose of marketing and selling products in a commercial manner and
substantially benefitting an individual, namely your founder. The fact that you have no
obligation to investors and are not organized to yield financial returns does not prove that
you are not operating in a commercial manner. As explained in Revenue Ruling 72-369,
the fact that the products are provided at cost is not sufficient to characterize this activity
as charitable within the meaning of section 501(c)(3) of the Code. Furnishing the services
at cost lacks the donative element necessary to establish this activity as charitable.

Letter 4036(CG) (11-2005)
Catalog Number 47630W

Conclusion:

You are marketing and selling E, which was created by your founder, F. This activity is
being conducted in a commercial manner. Also, since F shares the rights to these
products with you, your activities inure to the private benefit of F. Therefore, you are not
operating exclusively for charitable purposes within the meaning of Section 501(c)(3).

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. If your statement does not provide a basis to reconsider our
determination, we will forward your case to our Appeals Office. You can find more
information about the role of the Appeals Office in Publication 892, Exempt Organization
Appeal Procedures for Unagreed Issues.

Types of information that should be included in your appeal can be found on page 2 of
Publication 892, under the heading “Regional Office Appeal”. The statement of facts
(item 4) must be accompanied by the following declaration:

“Under penalties of perjury, I declare that I have examined the statement of facts
presented in this appeal and in any accompanying schedules and statements and, to
the best of my knowledge and belief, they are true, correct, and complete.”

The declaration must be signed by an officer or trustee of the organization who has
personal knowledge of the facts.

Your appeal will be considered incomplete without this statement.

If an organization’s representative submits the appeal, a substitute declaration must be
included stating that the representative prepared the appeal and accompanying
documents; and whether the representative knows personally that the statements of
facts contained in the appeal and accompanying documents are true and correct.

An attorney, certified public accountant, or an individual enrolled to practice before the
Internal Revenue Service may represent you during the appeal process. If you want
representation during the appeal process, you must file a proper power of attorney,
Form 2848, Power of Attorney and Declaration of Representative, if you have not
already done so. You can find more information about representation in Publication
947, Practice Before the IRS and Power of Attorney. All forms and publications
mentioned in this letter can be found at www.irs.gov, Forms and Publications.

Letter 4036(CG) (11-2005)
Catalog Number 47630W

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 appeal 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.

We have sent a copy of this letter to your representative as indicated in your power of
attorney.

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

Mail to: Deliver to:
Internal Revenue Service Internal Revenue Service
EO Determinations Quality Assurance EO Determinations Quality Assurance
Room 7-008 550 Main Street, Room 7-008
P.O. Box 2508 Cincinnati, OH 45202

Cincinnati, OH 45201

You may 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.

Letter 4036 (CG) (11-2005)
Catalog Number 47630W

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

Sincerely,

Robert S. Choi
Director, Exempt Organizations
Rulings & Agreements

Enclosure, Publication 892

Letter 4036(CG) (11-2005)
Catalog Number 47630W