Determination 1205013: IRS denies exemption to a religious product distributor

Plain-English summary

The IRS finalized its denial of tax-exempt status to an organization that sold religious books, music, DVDs, and related materials through churches and religious bookstores. The organization argued that distributing these materials advanced religion and educated believers. The IRS concluded that the organization operated in a commercial manner because it purchased products, marked them up, advertised them, paid sales commissions, and generated all of its revenue from sales. The IRS therefore found that the organization was not operated exclusively for charitable, educational, or religious purposes under IRC § 501(c)(3). The organization did not protest within the stated 30-day period, so the proposed adverse determination became final.

Ruling snapshot

• Question: Whether the organization qualified for exemption under IRC § 501(c)(3).
• Outcome: denied
• Key authorities: IRC §§ 501(a), 501(c)(3), 170, 6104(c), and 6110; Treas. Reg. §§ 1.501(c)(3)-1(a)(1) and 1.501(c)(3)-1(c)(1); Rev. Ruls. 60-351 and 66-147; Fides Publishers Assn. v. United States, 263 F. Supp. 924 (1967); B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352, 356-7 (1978).

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION
Release Number: 201205013 Contact Person:
Release Date: 2/3/2012
Date: November 9, 2011 Identification Number:
UIL Code: 501.36-01
504.00-00 Contact Number:
513.04-00
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 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.

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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,

Lois Lerner
Director, Exempt Organizations

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

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Catalog Number 47632S

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

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION
Date: September 21, 2011 Contact Person:

Identification Number:

Contact Number:

FAX Number:

Employer Identification Number:
LEGEND: UIL:
B= state 501.36-01
C= date 504.00-00
D = church 513.04-00

E = denomination
F = denomination
G = denomination

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.

Issue
Do you qualify for exemption under section 501(c)(3) of the Code? No, for the reasons
given below.

Facts

You were incorporated on C in the state of B. Your articles of incorporation state you
are organized exclusively for religious purposes.

You indicate a close connection with D, an established G church with over 5000 *
congregants and over 100 churches nationwide. You have stated that you established a
network with D to expand the distribution of materials. You indicate no further
relationship with D in your Articles of Incorporation.

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You have submitted Bylaws which govern your internal affairs. Subject to any limitations
in the Articles of Incorporation or Bylaws relating to action requiring approval by the
members or D, your temporal activities, business, and affairs shall be managed, and all
corporate powers shall be exercised, by or under the direction of your board. The
authorized number of directors shall be three. The qualifications of these directors are
that they 1) must agree with D’s statement of faith, 2) must have had a relationship with
the church a period of 5 years minimum serving as a volunteer, employee, and/or
contractor in any area with D, and 3) be familiar and understand the principles of D’s
vision and mission.

Your Bylaws indicate that you are not a subordinate to any religious entity, however,
you follow the doctrine of the E church and D.

You distribute and sell religious products (books, music, CD’s and other related items)
through a customer sales network of churches and religious book stores throughout the
United States. Customers are obtained through advertising that includes radio,
magazines and the internet. You provided a sample of an advertisement which included
select items for sales as well as your web site. You also submitted a catalog of all your
materials available for sale including prices. Your website shows the items that are
available for sale, lists various religious and musical tours, contains music video clips,
audio files for download and photo galleries, and has a link for purchasing items.

The distribution of these products is achieved through sales on a wholesale level
conducted by your employees who take the sales orders and ship the products. These
product sales are directed to the F speaking religious population and are administered
from your warehouse. Your facilities are leased from D.

Your products are distributed at the purchase price of the item sold plus an overhead
factor. The overhead factor defrays administrative costs which include rent, payroll,
insurance and office expenses. Your customers generally pay 25 percent to 30 percent
less than market prices. Although you have stated that your sales are only to
bookstores and churches, as sales to the general public would be at too high of a cost,
products are available through ordering on your web site. Bookstores and churches who
purchase your products then distribute them at retail to the public.

Your products are primarily purchased, but you do record some music and video tape
worship services for DVD sales. This portion represents less than five percent (5%) of
total sales. The proceeds from these sales help defray your operating

expenses. Religious books and music are obtained from approximately 15 religious
evangelical publishers. Products are purchased in volume to take advantage of
discounts and maintain low costs.

Your products are generally not distributed free of charge but you will provide a one

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time sample of music, DVD or book to an organization or individual at no cost. The free
sample provides hands on experience of your product quality and mission to educate
and attract new believers by providing messages through books, music (CDs) and
instructive audio.

Your revenue consists solely of the sales of these products. Your main expenses
include cost of sales for the purchase of product, contracted labor, commissions and
advertising.

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
religious purposes.

Section 1.501 (c)(3)-1 (a)(1) of the Income Tax Regulations states that, in order to be
exempt as an organization described in section 501 (c)(3) of the Code, 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 (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.

In Revenue Ruling 60-351, 1960-2 C.B. 169, a corporation is organized and operated on a
non-profit basis. It publishes a foreign language magazine containing fiction, poetry, book
reviews and articles which it states is of a literary, scientific and educational character.
The magazine is available to the general public through regular paid subscriptions. The
corporation's income is derived mainly from subscriptions and sales of individual copies of
the publication, and some is from advertising and contributions. Its expenditures consist of
fees paid to authors for their works, salaries, printing, advertising, shipping packing,
postage and other operating costs incurred in the publication of the magazine. It is devoted
to publishing a magazine and selling it to the general public in accordance with ordinary
commercial publishing practices. It is held that the corporation is not an exempt
charitable, scientific, literary or educational organization within the meaning of section
501(c)(3) of the Code.

In Revenue Ruling 66-147, 1966-1 C.B. 137, an organization’s specific purpose is to
inform the interested public of current developments appearing in scientific and medical
literature. The organization employs technical personnel who survey the world's
medical and scientific publications as soon as they are published. They select and

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abstract articles appearing in this literature. The abstracts are compiled in monthly
publications and are distributed free of charge to anyone having particular interest in the
subject matter. This organization qualifies for exemption from federal income tax under
section 501(c)(3) of the Internal Revenue Code of 1954

In Better Business Bureau of Washington, D.C. v. United States. 326 U.S. 179 (1945),
the Supreme Court held that the presence of a single non-exempt purpose, if
substantial in nature, will destroy a claim for exemption regardless of the number or
importance of truly exempt purposes.

in Fides Publishers Assn. v. United States, 263 F. Supp. 924 (1967) the government
retroactively revoked the taxpayer's exempt status, concluding that, for the previous five
years, the taxpayer was engaged primarily, if not solely, in publishing activities. The
court noted that, to qualify for section 501(c)(3) exemption, the taxpayer must be
"organized and operated exclusively for" an exempt purpose. The court rejected the
taxpayer's argument that, rather than its primary activity, the court should focus on the
end to which that activity was taken, namely, religious education. The court pointed out
that the taxpayer's sole activity and purpose was the carrying on of the publishing trade
and held that the taxpayer's purpose, rather than its goals, were the focus of section
501(c)(3).

B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352, 356-7 (1978), describes an
organization whose sole activity was to provide consulting services for a fee to nonprofit
organizations. It provided qualified persons to perform research projects for its clients.
The fees charged by the organization were set at or close to cost but were not less than
the organization's full cost of providing its service. The organization was denied
exemption because it operated in a commercial, nonexempt manner. The provision of
managerial and consulting services on a regular basis for a fee is a trade or business
ordinarily carried on for profit. The Court held that the organization was not operated
exclusively for charitable, educational or scientific purposes within the meaning of
section 501 (c)(3) of the Code.

Application of Law

You are not operated exclusively for charitable, educational, or religious purposes
consistent with Section 501(c)(3) of the Code nor Section 1.501(c)(3)-1(a)(1) of the
Income Tax Regulations and therefore fail to meet the operational test. Specifically, the
facts above indicate that you are not operated for exempt purposes but that you are
operated in a commercial manner.

You are not described in section 1.501(c)(3)-1 (c)(1) of the regulations because more
than an insubstantial part of your activities are devoted to non-exempt purposes. While
you may indirectly advance religion in distributing your products, your primary concern

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is the sale of religious publications. The purchase, sale, and distribution of religious
products is not a charitable, educational or religious activity within the meaning of
section 501 (c)(3) of the Code if done in a commercial manner. You provide a markup
on products sold, advertise publicly to sell those products, and provide sales
commissions which are all factors indicative of a commercial publishing operation. The
sale of these materials, however religiously inspired, involves you directly in the conduct
of a trade or business. You operate in a manner that is not distinguishable from a
regular for profit publisher regarding the purchase, advertising, promotion and sales of
your products. You have not demonstrated that the services you provide or fees
charged for those services are offered in a noncommercial manner.

You are like the organization in Revenue Ruling 60-351, that publishes a foreign
language magazine containing articles which it states are of a literary, scientific and
educational character. The corporation's income was derived mainly from subscriptions
and sales of individual copies of the publication, and some from advertising and
contributions. Similar to this organization, you distribute and sell religious products
(books, music, CD’s and other related items) through a customer sales network of
churches and religious book stores throughout the United States. Your income is
derived from a markup on the cost of these items to cover expenses. The organization in
this revenue ruling was held not to be an exempt organization within the meaning of
section 501(c)(3) of the Code due to the publishing and selling of a magazine in
accordance with ordinary commercial publishing practices. As seen in Revenue Ruling
66-147, the distribution of products free of charge differentiated that organization from
operating as a commercial entity. Here, the sale and distribution of your products are in
accordance with commercial distribution practices where a purchase is made, the
merchandise is marked up and sold.

You are similar to the organization in Fides Publishers Assn. v. United States, which
printed, published and sold products to promote religious culture. These products were
sold at cost plus a markup. The organization argued that, rather than focusing on its
primary activity, the court should focus on the end to which that activity was taken,
namely, religious education. You have indicated your purpose to be advancing religion
through the distribution of products. Much like the organization in this case you mark up
and sell your products to generate enough revenue to cover operating costs which
include salaries and commissions. The end result of your distributions may ultimately be
religious education but your purpose is to purchase and distribute goods, not advance
religion. For this reason your publishing activity is furthering a commercial rather then
an exempt purpose under 501(c)(3) and you do not qualify.

You are similar to the organization in Better Business Bureau of Washington, D.C.. Inc.
v. United States. 326 U.S. 179 in which the Supreme Court held that the presence of a
single non-exempt purpose, if substantial in nature, will destroy a claim for exemption
regardless of the number or importance of truly exempt purposes. Your activity of

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administering the sales and distribution of religious products is substantial and is an
activity that is primarily carried on for the purpose of conducting a commercial business.
The purpose of this activity is not exempt under section 501(c)(3).

You are similar to the organization described in the B.S.W. Group, which provided
services to nonprofit organizations and was not exempt under section 501(c)(3). Your
sole purpose is to administer the sale and distribution of religious products. You are
dependent on the overhead markup that you charge to operate. The sale and
distribution of religious products on a regular basis denotes the carrying on of a trade or
business in a regular manner. Selling at cost lacks the donative element necessary to
establish your activities as charitable versus commercial. Distributing religious products
at cost plus markup is not sufficient to characterize the activity as religious. You do not
qualify for exemption because you operate in a commercial manner rather than
exclusively for charitable or religious purposes.

Applicant’s Position

In order to further your exempt purpose, the communication of G beliefs and the word of
God must include the distribution of religious resources that inspire and educate many
congregations through distributors, bookstores and G churches where materials are
sent to the different states across the nation. The faiths of all religions require
nourishing through worship that is supplemented by books, worship, music and other
inspirational products. In these difficult times, mankind can only improve through the
nourishment of the human spirit through worship, and a continuing Christian education
that uplifts and inspires. Your products provide this G education and inspiration through
your books, bibles, music, and DVD's.

Service Response to Applicant’s Position

The distribution of religious products, (books, bibles, music, and DVD's) can provide
religious education and inspiration. However, the method by which these products are
distributed must be reviewed in determining qualification under section 501(c)(3).
Because of the commercial manner in which you distribute your products, as described
in the preceding facts and analysis, you do not qualify for exemption under section
501(c)(3) of the Code.

Conclusion

Based on the information provided, you do not qualify for exemption under section 501
(c)(3) of the Code. You are not organized and operated exclusively for charitable or
religious purposes within the meaning of section 501 (c)(3) of the Code because you
operate in a commercial manner.

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.

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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 that 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’. These items include:

1. The organization's name, address, and employer identification number;
2. A statement that the organization wants to appeal the determination;
3. The date and symbols on the determination letter;
4. A statement of facts supporting the organization's position in any contested
   factual issue;
5. A statement outlining the law or other authority the organization is relying on; and
6. A statement as to whether a hearing is desired.

The statement of facts (item 4) must be declared true under penalties of perjury. This
may be done by adding to the appeal the following signed 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. To be
represented 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. For more information about representation, see Publication 947, Practice

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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.

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 to you. That letter will provide information about filing tax returns
and other matters.

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 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,

Lois Lerner
Director, Exempt Organizations

Enclosure, Publication 892

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