Determination 1347023: IRS denied § 501(c)(6) exemption to an organization promoting a related health-record system

Plain-English summary

The IRS denied an organization's application for exemption under IRC § 501(c)(6). The organization said it would improve health-data technology and support health-care education, standards, and research, but the IRS found that its activities chiefly promoted one health-record system and benefited a related for-profit company. The IRS also found that the organization lacked a common business interest among its diverse corporate founders and that a substantial loan to the related company allowed organizational earnings to benefit private interests. Because the organization did not improve business conditions in a line of business and its earnings inured to private shareholders or individuals, it did not qualify as a business league. The letter explains the organization's right to protest and request a conference.

Ruling snapshot

• Question: Did the organization qualify as a business league exempt under IRC § 501(c)(6)?
• Outcome: denied
• Key authorities: IRC §§ 501(a), 501(c)(6), and 6110; Treas. Reg. § 1.501(c)(6)-1

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION

Release Number: 201347023 Contact Person:

Release Date: 11/22/2013

Date: August 30, 2013 Identification Number:

UIL: 501.06-00 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)(6).

We made this determination for the following reason(s):

Your activities are not directed to the improvement of business conditions of one or more lines
of business as required under Treas. Reg. § 1.501(c)(6)-1.

You must file Federal income tax returns on the form and for the years listed above within 30
days of this ietter, 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.

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

2

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,

Karen Schiller

Acting Director,

Exempt Organizations
Rulings and 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: April 9, 2013 Contact Person:
Identification Number:
UIL 501.06-00 Contact Number:
FAX Number:

Employer Identification Number:

For-Profit =
System =

cca

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)(6). The basis for our
conclusion is set forth below.

nm

acts

You were incorporated on Date 1 as a State nonprofit corporation under the name M. Later you
filed articles of amendment to change your name to N. Your Bylaws state that your purpose is:

[T]o create a nonprofit health IT venture to oversee the development and
implementation of a that will enable the creation and
widespread use of among consumers, providers,
employers, and health plans. To achieve these efforts in a manner calculated to
reduce costs and increase efficiencies in using [you] will work to develop,
deploy, maintain, and promote the widespread adoption of a nonproprietary,
personal, private, portable infrastructure, including building

the baseline applications, piloting programs among selected workforces, and
developing universally accepted standards for data interchange. As part of these
efforts, [you] may interface with other groups or bodies developing related
standards, infrastructures or technologies.

You stated that your “primary mission’ is to “help all businesses reduce health care cost through
the development and adoption of user-friendly tools to assist consumers/patients/employees
better understand and make better choices about their health and medical services.”

Your Bylaws state that you shall have ten Directors on your Board. Each of your ten Founders
appoints one Board member. The Founders consist of ten corporations, whose business
activities are widely diverse.

Initially, you stated that membership in your organization was limited to large employers.
However, you later stated that you decided not to place a limit on the size of prospective
members. In addition, you stated that your activities do not provide a unique benefit to large
employers, 2s opposed to small- or medium-sized employers.

You stated that your past activities include identifying and expanding technical software and
hardware solutions for storing personal electronic health records, paying for attorneys to explore
the regulatory requirements of federal and state authorities, sponsoring academic research, and
building consensus between member employers on how to best approach the paradigm of

. You stated that in the future, you will reduce your activities aiming to
build a solution for and increase your activities aiming to build
consensus, sponsor research, and resolve privacy and regulatory concerns.

You are closely affiliated with For-Profit. You own 40 percent of the authorized shares of For-
Profit and 90 percent of the outstanding shares of For-Profit. Both of your officers are also
officers of For-Profit. You stated that For-Profit’s purpose is to develop a web-based personal
health platform (System), which allows users to maintain personal, portable health records.
Employers who enroll in System will pay ongoing fees for access.

Previously you worked to develop System. You later determined that it would be in your interest
to transfer the intellectual property related to System to a new corporation, Foundation. You
made several grants to Foundation. Foundation then determined that it would be in its interest to
have System developed on a for-profit basis. Thus, For-Profit was formed. In connection with
For-Profit's formation, Foundation transferred $v in cash and intangible property worth $w to
For-Profit. Foundation was then dissolved, and the original grants you provided to it were
returned to you, with the exception of cash that Foundation had already expended. Foundation
returned shares of For-Profit to you valued at $y. You stated that you may in the future convert
this stock to cash value.

In addition, you extended a loan to For-Profit in the amount of $x. For-Profit is required to make
payments on the loan based on a schedule, and must pay interest, on a non-compounding
basis, of 10 percent per year on the outstanding principal balance of the loan. You stated that
the purpose of the loan was to permit For-Profit to repay principal and interest on other loans.
You stated that the loan was negotiated and approved by your disinterested directors.

You stated that you would partner with health ministries to track member health outcomes using
System. You provided us with a copy of a presentation given by your Executive Director
regarding your partnership with health ministries. It discusses the benefits that the health
ministries experienced through their use of System. We also asked you to provide
documentation pertaining to your education and advocacy activities supporting the integration of
health and medical data with health care applications. Many of the materials you provided
focused on System and its benefits. In addition, it is difficult to tell whether these activities were
conducted on your behalf or on behalf of For-Profit.

You also stated that you were working with a university to facilitate a health care data “learning
agreement’ to use System in the university's lab. Based on the documentation you provided
regarding this learning agreement, its purpose was to expand the functionality of System. In
addition, this appears to have been an activity of For-Profit, rather than your activity, since the
documentation you provided us indicates that For-Profit’s Chief Operating Officer was the point
of contact for the university.

Finally, on page six of your response (dated Date 2) to our request for additional information,
you referred to System as “[your] platform.”

Law

Section 501(c)(6) of the Code provides for the exemption from federal income tax of business
leagues, chambers of commerce, real-estate boards, boards of trade, or professional football
leagues (whether or not administering a pension fund for football players), not organized for
profit and no part of the net earnings of which inures to the benefit of any private shareholder or
individual.

Section 1.501(c)(6)-1 of the Income Tax Regulations (“regulations”) provides that a business
league is an association of persons having some common business interest, the purpose of
which is to promote such common interest and not to engage in a regular business of a kind
ordinarily carried on for profit. It is an organization of the same general class as a chamber of
commerce or board of trade. Thus, its activities should be directed to the improvement of
business conditions of one or more lines of business as distinguished from the performance of
particular services for individual persons. An organization, whose purpose is to engage ina
regular business of a kind ordinarily carried on for profit, even though the business is conducted
on a cooperative basis or produces only sufficient income to be self-sustaining, is not a
business league.

Rev. Rul. 58-294, 1958-1 C.B. 244, describes an organization formed to promote the business
interests of those involved in the manufacture and sale of a particular patented product.
Membership in the organization is limited to those engaged in the manufacture and sale of the
product. The organization owns the controlling interests in the corporation that holds the basic
patents in the product. The revenue ruling holds that such organization does not qualify for
exemption as a business league under § 501(c)(6) since it is engaged in furthering the business
interests of the dealers of a particular product as distinguished from improving business
conditions generally.

In Rev. Rul.-59-391, 1959-2 C.B. 151, exemption under 501(c)(6) was denied to an organization
composed of individuals, firms, associations, and corporations, each representing a different
trade, business, occupation, or profession. The organization was created for the purpose of
exchanging information on business prospects and had no common business interest other than
a desire to increase sales of members. The revenue ruling found that the organization's
activities were not directed to the improvement of business conditions of one or more lines of
business, but rather to the promotion of the private interests of its members.

Rev. Rul. 67-251, 1967-2 C.B. 196, concerns a business league made up of persons employed
in a particular industry. In addition to engaging in activities directed to the improvement of
business conditions in the line of business represented by its members, the league provides
financial aid and welfare services to any member whose employment is involuntarily terminated.
By furnishing financial aid to its members, league allows its net earnings to inuring to the benefit
of private individuals through furnishing financial aid and welfare services to its members.
Therefore, it is held that the league is not exempt from federal income tax under § 501(c)(6),
even though its financial aid to members is minor in relation to its other activities which are
directed to the improvement of business conditions in a line of business.

Rev. Rul. 76-38, 1976-1 C.B. 157, concerns an organization formed to maintain the good will
and reputation of credit unions in a particular State. As its sole activity, the organization
maintains a fund for assistance to credit unions that have financial difficulty or have become
insolvent so that their members will not lose deposits upon liquidation. Interest-free loans are
made to such credit unions, and no restriction is placed upon their use of the funds. Because
the organization makes loans to credit unions, both solvent and insolvent, that may be used in
their general operations, its loan activities are not solely calculated to achieve the goal of
improving the industry’s image by protecting depositors. Rather, the organization may,
consistent with its stated policies, permit its money to be loaned on favorable terms to members
in a manner that would provide little or no additional security to depositors. Such a loan policy
provides a convenience or economy to members in their business, and is not an exempt activity
under § 501¢c)(6). Accordingly, the ruling holds that the organization does not qualify for
exemption under § 501(c)(6).

Rev. Rul. 83-164, 1983-2 C.B. 95, describes an organization whose purpose is to conduct
conferences for the dissemination of information concerning computers manufactured by one
specific company, M. Although membership is composed of various businesses that own, rent
or lease computers made by M, membership is open to businesses that use other brands of
computers. At the conferences, presentations are given primarily by representatives of M, as
well as by other experts in the computer field. Problems related to members’ use of M’s
computers are also discussed and current information concerning M's products is also provided.
The revenue ruling holds that by directing its activities to businesses that use computers made
by one manufacturer, the organization is improving business conditions in a segment of a line of
business rather than in an industry as a whole and is not exempt under § 501(c)(6). The
revenue ruling concludes that by providing a focus on the products of one particular
manufacturer, the organization is providing M with a competitive advantage at the expense of
manufacturers of other computer brands.

Ne

In National Muffler Dealers Association v. U.S., 440 U.S. 472 (1979), the Supreme Court held

that an organization whose membership consisted of the franchisees of one brand of muffler did
not constitute a line of business within the meaning of § 501(c)(6) because a single brand
represented only a segment of an industry. The court concluded that exemption under §
501(c)(6) is not available to aid one group in competition with another within an industry.

In Guide International Corporation v. U.S., 948 F.2d 360 (7th Cir. 1991), aff'g No. 89-C-2345
(N.D. Ill. 1990), the Court concluded that an association of computer users did not qualify for
exemption under § 501(c)(6) because it benefited essentially users of IBM equipment. The court
stated that the organization also served as an influential marketing tool for IBM because the
conferences it held allowed IBM to showcase its products and services.

Analysis

According to Reg. § 1.501(c)(6)-1, to be described in IRC § 501(c)(6) you must be an
association of persons having some common business interest, and your purpose must be to
promote the common business interest of your members and not engage in a regular business
of a kind ordinarily carried on for profit. In addition, your activities should be directed to the
improvement of business conditions in one or more lines of business as distinguished from the
performance of particular services for individual persons. Finally, you would not be described in
§ 501(c)(6) if any part of your net earnings inures to the benefit of any private shareholder or
individual.

Upon consideration of your application, we have determined that you do not qualify for
exemption under § 501(c)(6) because—(1) your activities are not directed to the improvement of
business conditions in one or more lines of business, but merely to a segment of a line of
business; (2) your members lack a common business interest; and (3) your net earnings inure to
the benefit of private shareholders or individuals

Line of business test

Your purpose is not to improve business conditions in one or more lines of business. Rather,
according to your bylaws, your purpose is to “create a nonprofit venture to oversee the
development and implementation of a .... TO achieve these efforts ... you
will work to develop, deploy, maintain, and promote the widespread adoption of a ... Personal
Health Web infrastructure, including building the baseline applications, piloting programs among
selected workforces, and developing universally accepted standards for data interchange.” To
that end, you worked to develop System before it was transferred to For-Profit to develop ona
for-profit basis, and your current activities consist chiefly in promoting and supporting System.

Rev. Rul. 74-147 holds that an organization whose members represent diversified businesses
that own, rent, or lease digital computers produced by various manufacturers and that was
formed to provide a forum for the exchange of information leading to the more efficient utilization
of computers by its members, and thus improving the overall efficiency of the business
operations of each, qualifies for exemption under § 501(c)(6). On the other hand, Rev. Rul. 83-
164 holds that an organization similar to the organization described in Rev. Rul. 74-147, but that
directs it activities only to the users of computers made by one manufacturer, M, does not
qualify for exemption under § 501(c)(6) because its activities provide a competitive advantage to

M and to its customers. Thus, such activities serve only a segment of a line of business rather
than being directed towards the improvement of business conditions in one or more lines of
business as a whole.

National Muffler Dealers Association v. U.S., 440 U.S. 472 (1979) involved an organization
whose members consisted of franchisees of one muffler brand. In concluding that the
organization did not qualify as a business league, the Supreme Court held that § 501(c)(6) does
not describe organizations designed to aid only one segment of an industry. Similarly, Guide
International Corporation v. U.S., 948 F.2d 360 (7th Cir. 1991) describes an association of
computer users that primarily benefited users of IBM equipment, rather than computer tools in
general. The organization served as a marketing tool for IBM because it allowed IBM to
showcase its products.

You are like the organization described in Rev. Rul. 83-164 because your activities serve to
favor and promote System over other applications. Like the organization
described in National Muffler Dealers Association v. U.S., you serve primarily to benefit one
segment of an industry, rather than the industry as a whole. Although there may be incidental
benefits to other software providers as a result of your activities, your
primary purpose is to benefit System.

In addition, you are like the organization described in Guide International. That organization's
stated purposes were: “(a) The promotion of sound professional practices with respect to the
uses of data processing equipment . . . (b) The exchange and dissemination of information
concerning data processing equipment. . . and (c) The participation with manufacturers of data
processing equipment . . . in the improvement and development of products, standards, and
education.” 948 F.2d at 361. Your stated purposes similarly involve education, the development
of standards, and the exchange of information.

Like Guide, you are primarily operated to benefit a particular product: namely, System. The 7"
Circuit affirmed the district court’s holding that “Guide primarily advances IBM's interests and
that any benefit to its members and other data processing companies who use information
prepared by Guide is incidental.” 948 F.2d at 362 (emphasis in original). Similarly, you primarily
benefit System and its users, while the benefit you provide to other electronic health records
companies is incidental. The presentations and other materials you submitted to us suggest that
you largely use such materials to promote System. In addition, your website primarily focuses
on System, and makes little or no distinction between you and For-Profit.

Rev. Rul. 58-294 describes an association organized and operated for the purpose of promoting
uniform business practices in connection with the manufacture and sale of a certain patented -
product. The organization owns a controlling interest in the corporation that holds the basic
patents on the particular product and sells to its members the materials and equipment
necessary. to°™manufacture the product. The Revenue Ruling held that the organization does not
qualify for exemption under § 501(c)(6) since it is engaged in activities which are ordinarily
carried on for profit and since it is engaged in furthering the business interests of the dealers in
the particular patented product, rather than the improvement of business conditions of one or
more lines of business.

You are like the organization described in Rev. Rul. 58-294 because, through your ownership of
90 percent of the outstanding shares of For-Profit, you have a controlling interest in that entity.
For-Profit’s purpose is to develop and sell System. Your activities promote the use of System
and therefore further the business interests of For-Profit. Therefore, you are operating for the
benefit of your related entity, For-Profit, and not for the benefit of promoting your members’
common business interest.

Rather than promoting the adoption of generally, you are promoting
the use of a particular system, System, which you have helped to
create. You and your leadership stand to gain from its adoption, due to your ownership of For-
Profit’s stock and the common control between you and For-Profit. You have a stake in
System’s success, due to the loan you extended to For-Profit that is currently in repayment.

In addition, there is little practical distinction between you and For-Profit. Your officers are all
officers of For-Profit. You provided us with documentation about your activities which shows that
many of those activities were conducted in the name of For-Profit. Other documents do not
specify the entity on behalf of which the activities were performed. You referred to System in
your communication with us as “[your] platform.” Taken together, the facts and circumstances
indicate that the distinction between you and For-Profit is tenuous.

Inurement

You made a loan to For-Profit in the amount of $x, which is approximately half of one year’s
average annual gross receipts in the time period for which you submitted financial data.

Inurement involves an expenditure of organizational funds resulting in a benefit which is beyond
the scope of the benefits which logically flow from the organization's performance of its exempt
function. The exempt function as a § 501(c)(6) organization is to improve business conditions of
one or more lines of business as distinguished from the performance of particular services for
individual persons. Thus, in Rev. Rul. 67-251, the furnishing of financial aid and welfare services
to the members of a business league was said to constitute the inurement of the league's net
earnings to the benefit of private individuals. Again, in Rev. Rul. 76-38, the making of loans to
the members of a business league, loans which may be used in the borrower’s general
operations, was said to be an activity that is not an exempt activity under § 501(c)(6). Similarly,
the making of a loan to For-Profit to enable it to repay principal and interest on other loans does
not serve to improve business conditions of one or more lines of business. Rather, the loan
constitutes a particular service to an individual commercial business, a benefit that is beyond
the scope of the benefits which logically flow from the performance of the exempt functions
described in § 501(c)(6). Thus, in making the loan you have allowed your net earnings to inure
to the benefit of private individuals in violation of the inurement prohibition of § 501(c)(6).

Conclusion

Because your activities are not directed to the improvement of business conditions in one or
more lines of business and because you have allowed your net earnings to inure to the benefit
of private shareholders and individuals, you do not qualify for exemption under § 501(c)(6).

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, | declare that | 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 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:1

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,

° Director, Exempt Organizations
Rulings & Agreements