Determination 1221023: IRS denies exemption to carbon-offset certification organization

Plain-English summary

The IRS denied exemption under IRC § 501(c)(3) to an organization that planned to certify service-company projects as carbon neutral and resell carbon offsets purchased from a for-profit company. The organization expected to spend most of its time on marketing and administration, and the IRS concluded that selling and certifying a commercial product was not an exempt charitable activity. The IRS also found substantial private benefit to the for-profit offset seller, related companies, and service businesses using the certification. The adverse determination became final after the organization did not file a timely protest.

Ruling snapshot

• Question: Did the carbon-offset certification and resale operation qualify for exemption under IRC § 501(c)(3)?
• Outcome: Denied
• Key authorities: IRC §§ 501(c)(3), 170, and 7428; Treas. Reg. §§ 1.501(c)(3)-1(a)(1), 1.501(c)(3)-1(c)(1), and 1.501(c)(3)-1(d)(1)(ii)

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION

Release Number: 201221023 Contact Person:

Release Date: 5/25/2012

Date: March 1, 2012 Identification Number:

501.00-00

501.03-00 Contact Number:

501.33-00

501.35-00 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.

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.

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, 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.

2

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 G. Lerner
Director, Exempt Organizations

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: March 1, 2012 Contact Person:

Identification Number:
501.00-00
501.03-00 Contact Number:
501.33-00
501.35-00 FAX Number:

Employer Identification Number:

Legend:

Taxpayer
Company

Industry
Service

Products

Related Company 1
Related Company 2
Related Company 3

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 § 501(c)(3). The basis
for our conclusion is set forth below.

Facts

You, Taxpayer, are a nonprofit corporation organized under the laws of the state in which you
reside. Your Articles of Incorporation state that you “may not carry on any . . . activities not
permitted to be carried on by: (a) A corporation exempt from Federal Income Tax under Section
501(c)(3) of the [Internal Revenue] Code . . . ; or (b) A corporation, contributions to which are
deductible under Section 170(c)(2) of the Code... .” Your Articles also provide for the proper
distribution of your assets upon your dissolution.

Your specific purpose, according to your narrative description of activities, is “to promote eco-
friendly Products by commercial Service companies.” You state that you “seek[] to mitigate .. .
emissions [generated by Service companies] through the purchase of carbon offsets via a
partnership with Company... .”. Company is a for-profit retailer of carbon offsets. Company is
not related to you through common control or otherwise. Based on the financial data you
submitted with your Form 1023 application, you predict that between 60 and 80 percent of your

total revenues will be paid directly to Company for the purchase of carbon offsets. The
remainder of your expenses are for professional fees and occupancy expenses.

You “plan[] to provide partner Service businesses with proprietary software that will calculate the
carbon footprint of a [Service] job. The software will then tell the [Service company] how much
of a carbon offset they should purchase to make up for the ecological impact of the [Service]
project. If a job has its carbon impact appropriately mitigated, it will qualify to display a special .
. . logo [owned by you] that certifies that the job was carbon neutral.”

You stated that Industry organizations who apply to have their projects certified by you as
carbon neutral “are required to complete the . .. Business Carbon Audit form. Once this form is
completed, [you] send[] this form to Company where the amount of carbon emitted by the
Service establishment is calculated. Applicants are [then] asked to pay a Certification fee,
which is based on the [size of the organization.]}"

Your office space is provided by Related Company 1, pursuant to a “verbal lease” with no set
term. In your original application for recognition of tax-exempt status, you state that you will pay
a rent of $ per year to Related Company 1. However, in your response to our additional
questions about the lease, you stated that you do not pay any rent. Additionally, you stated that
Related Company 1 is responsible for all utility payments, taxes and improvements of the
facility, and that in exchange, you provide carbon neutral certification for projects performed at
Related Company 2. Although you stated that your landlord is not related to you in any other
way, your President is the Managing Partner of Related Company 1. Your President is also the
President of Related Company 2 and Related Company 3.

In addition, one of your other two directors serves in an executive capacity at Related Company
2 and Related Company 3, and the third serves in an executive capacity at Related Company 2.
In your application for recognition of tax-exempt status, you concede that you, Related
Company 2 and Related Company 3 are under common control. None of your personnel,
including members of your Board of Directors, are compensated by you.

When you were asked to provide a list of all your activities and how much time you will devote to
them, you stated that you will spend 70 percent of your time “marketing to [Industry] companies
and [Industry] purchasers throughout the United States encouraging them to purchase carbon
offsets for their Service projects.” You stated that 20 percent of your time would be spent on
administration and billing, and the remaining 10 percent of your time would be spent “auditing”
companies seeking to purchase offsets from you to determine their offset requirements. You
estimate that between and _ percent of your total revenue will be spent on advertising,
although your statement of revenues and expenses does not reflect any advertising costs.

Law

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

Section 1.501(c)(3)-1(a)(1) of the regulations provides that, in order to be exempt as an
organization described in § 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(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 § 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)(i) of the regulations states that an organization may be exempt as an
organization described in § 501(c)(3) if it is organized and operated exclusively for one or more
of the following purposes: religious, charitable, scientific, testing for public safety, literary,
educational, or prevention of cruelty to children or animals.

Section 1.501(c)(3)-1(d)(1)(ii) of the regulations provides that an organization is not organized or
operated exclusively for exempt purposes under § 501(c)(3) unless it serves a public interest
rather than a private interest.

Section 1.501(c)(3)-1(d)(2) of the regulations defines the term “charitable” as used in § 501(c)(3)
as including the relief of the poor and distressed or of the underprivileged, advancement of
education, combating community deterioration and lessening the burdens of government.

In Rev. Rul. 73-567, 1973-2 C.B. 178 a medical specialty board did not meet the requirements
under § 501(c)(3) because it was not organized and operated for exempt purposes. The
organization’s certification activities primarily served the private interests of the medical
profession rather than providing a public benefit. The organization was instead recognized as
exempt under § 501(c)(6).

In Rev. Rul. 76-204, 1976-1 C.B. 152, an organization was formed for the purpose of preserving
the natural environment. The organization accomplished this purpose by acquiring and
maintaining ecologically significant and undeveloped land such as swamps, marshes, forests,
wilderness tracts, and other natural areas. The organization worked closely with Federal, state,
and local government agencies, and private organizations that were also concerned with
environmental conservation. The ruling reasoned that by preserving “ecologically significant
undeveloped land, the organization is enhancing the accomplishment of express national policy
of conserving the nation's unique natural resources.” Thus, the ruling concluded that the
“organization is advancing education and science and is benefiting the public in a manner that
the law regards as charitable.”

In Better Business Bureau v. United States, 326 U.S. 279 (1945), the Supreme Court stated that
the presence of a single nonexempt purpose, if substantial in nature, will preclude exemption
under § 501(c)(3), regardless of the number or importance of statutorily exempt purposes.

Thus, the operational test standard prohibiting a substantial nonexempt purpose is broad
enough to include inurement, private benefit, and operations that further nonprofit goals outside

the scope of § 501(c)(3).

In Church by Mail v. Commissioner, 765 F.2d 1387, 1392 (9th Cir. 1985), the court in
determining that a non-profit was operated for substantial non-exempt purposes and that
income inured to the benefit of private persons stated that “[t]he critical inquiry is not whether
particular . . . payments to a related for-profit organization are reasonable or excessive, but
whether the entire enterprise is carried on in such a manner that the for-profit organization
benefits substantially from the operation of the [non-profit].”. The court additionally upheld the
Tax Court's determination that the church was operated for substantial nonexempt purpose of
providing a market for services of advertising agency, a for-profit organization owned and
controlled by ministers of church.

In Airlie Foundation v. Commissioner, 283 F. Supp. 2d 58 (D.D.C. 2003), the court concluded
that an organization did not qualify for tax-exemption under § 501(c)(3) because it was operated
for nonexempt commercial purposes rather than for exempt purposes. Among the major factors
the court considered in reaching this conclusion was the organization's competition with for-
profit commercial entities, the extent and degree of below cost services provided, the pricing
policies, and the reasonableness of financial reserves. Additional factors included whether the
organization used commercial promotional methods, such as advertising, and the extent to
which the organization received charitable donations.

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 § 501(c)(3) because its activities
constituted the conduct of a trade or business that is ordinarily carried on by commercial
ventures organized for profit. Its primary purpose was not charitable, educational, nor scientific,
but rather commercial.

In addition, the court found that the organization’s financing did not resemble that of the typical §
501(c)(3) organization. It had not solicited, nor had it received, voluntary contributions from the
public. Its only source of income was from fees from services, and those fees were set high
enough to recoup all projected costs and to produce a profit. Moreover, it did not appear that
the corporation ever planned to charge a fee less than “cost.” And finally, the corporation did
not limit its clientele to organizations that were § 501(c)(3) exempt organizations.

In Indiana Crop Improvement Association, Inc. v. Commissioner, 76 T.C. 394 (1981), the
organization was the official seed certifying agency for the State of Indiana and conducted a
seed certification program pursuant to the delegation of authority by the state legislature. The
Tax Court found that as the official seed certifying agency for the state, the organization directly
assisted the United States Department of Agriculture in enforcing the standards and procedures
established under federal statute. Thus, the Tax Court found that the organization lessened the
burden of the government.

Analysis

Organizations described in § 501(c)(3) must be both organized and operated exclusively for one
or more of the purposes specified in such section. § 1.501(c)(3)-1(a)(1). Pursuant to §

1.501(c)(3)-1(c)(1), an organization will only be regarded as “operated exclusively” for charitable
purposes if it engages primarily in activities that accomplish one or more of such exempt
purposes specified in § 501(c)(3). Similarly, Better Business Bureau v. United States, 326 U.S.
279 (1945) held that a single substantial non-exempt purpose precludes exemption.

You stated that 70 percent of your time will be spent on marketing, 20 percent on administration
and billing, and 10 percent on “auditing.” You also stated that between 20 and 80 percent of
your revenue will be spent on advertising. Advertising and marketing are not exempt purposes
specified in § 501(c)(3). Since advertising and marketing constitute your primary activities, you
are not operated exclusively for charitable purposes.

Your certification of Service projects as carbon-neutral is also not an exempt activity.
Certification of organizations and products is generally not considered an exempt activity. See
e.g. Rev. Rul. 73-567, supra. Exceptions exist when an organization is testing products for
public safety, and when an organization is lessening the burdens of government. §§
1.501(c)(3)-1(d)(1)(i); 1.501(c)(3)-1(d)(2). You are not testing products for public safety
purposes. Moreover, you are unlike the organization described in Indiana Crop Improvement
Association, Inc. v. Commissioner, 76 T.C. 394 (1981), because you are not performing a
governmental function. Instead, you are engaged in the resale of a commercial product.

Your activities do not preserve the natural environment in a way that qualifies you for
recognition as an organization described in § 501(c)(3). Unlike the organization in Rev. Rul. 76-
204, supra, you do not engage in any activities that generate environmental benefits. Instead,
you act as an intermediary that purchases carbon offsets from a commercial enterprise and
resells them to Service businesses. None of your activities actually cause a reduction in carbon
emissions.

The sale of carbon offsets is a trade or business ordinarily conducted by commercial ventures
organized for profit. Such activity is in fact carried on by your partner, Company, for profit.
Thus, like the organizations described in B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 and
Airlie Foundation v. Commissioner, 283 F. Supp. 2d 58, you were formed to conduct a venture
ordinarily conducted for profit. Your primary purpose is not charitable, educational, or scientific,
but rather commercial.

An organization will also not be organized and operated exclusively for exempt purposes if it is
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. § 1.501(c)(3)-1(d)(1)(ii). You are operated primarily to benefit private parties.

You benefit Company by purchasing its carbon offsets to be resold to for-profit organizations.
More than 60 percent of your gross receipts are paid to Company. The resale of commercial
products marketed by a for-profit company is not a charitable purpose. In fact, none of your
revenues are devoted to charitable purposes, and are instead devoted entirely to advertising,
purchasing carbon offsets, professional fees and occupancy.

You provide additional private benefit to Related Company 1. By entering into a “verbal lease”
with Related Company 1 for occupancy expenses totaling $10,000 per year, and with no
evidence that the lease was negotiated at arms’ length or that $10,000 per year is the market
rate for similar space, it appears that the terms of this lease provide substantial rental income to
Related Company 1 without regard to whether you are receiving a commensurate benefit.

You also provide impermissible private benefit to Related Company 2. You provide carbon
neutral certification to Related Company 2 in exchange for utility payments, taxes and
improvements of your facility. You submitted no evidence indicating that these transactions will
occur at arms’ length, or that they will be commensurate with the needs of Related Company 2
for carbon offsets. Thus, after paying your taxes and other expenses, Related Company 2 may
be left with excess carbon offsets, which it could sell for a profit. Furthermore, you provide
substantial private benefit to the unrelated Service companies whose Service operations you
plan to certify. The primary purpose of the certification is to market carbon-neutral Service
through the licensing of your logo.

Based on the foregoing, you operate primarily to benefit private interests in various ways,
contrary to the requirement set forth in § 1.501(c)(3)-1(d)(1)(ii). Various for-profit enterprises
benefit substantially from your operations. Thus, you do not qualify for recognition as an
organization exempt under § 501(c)(3). See Church by Mail v. Commissioner, 765 F.2d 1387.

Conclusion

Based on the facts and information provided, you are not operated exclusively for exempt
purposes as required by sections 1.501(c)(3)-1(a)(1) and 1.501(c)(3)-1(c)(1) of the regulations.
You are operated for a substantial nonexempt purpose in contravention of section 501(c)(3)-
1(c)(1) of the regulations. Any public purposes for which you may operate are only incidental to
this primary nonexempt purpose. You do not serve a public rather than a private interest as
required by section 1.501(c)(3)-1(d)(1)(ii) of the regulations. Therefore, you are not described in
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.

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.gov, 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

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,

Lois G. Lerner
Director, Exempt Organizations