IRS respects taxable subsidiaries as separate entities from an exempt health maintenance organization

Plain-English summary

A tax-exempt health maintenance organization planned to create two taxable subsidiaries and transfer employees and administrative contracts to one of them. The IRS considered whether the subsidiaries' activities would be attributed to the exempt organization for its qualification under IRC § 501(c)(4) or for unrelated business income tax. It ruled that both subsidiaries had genuine business purposes, distinct activities, and sufficiently separate governance and operations. The subsidiaries therefore would be treated as separate taxpayers, and their activities and income would not be attributed to the exempt organization for its exemption or its liability under § 511. The ruling did not address whether dividends or interest received from the subsidiaries would themselves be unrelated business taxable income.

Ruling snapshot

• Question: Would the activities of the two taxable subsidiaries be attributed to the exempt health maintenance organization?
• Outcome: Approved.
• Key authorities: IRC §§ 501(c)(4), 511, 512, and 513; Treas. Reg. § 1.501(c)(4)-1(a)(2)(i); Gregory v. Helvering, 293 U.S. 465; Higgins v. Smith, 308 U.S. 473; Moline Properties v. Commissioner, 319 U.S. 436; Britt v. U.S., 431 F.2d 227; Krivo Industrial Supply Co. v. National Distillers and Chemical Corp., 483 F.2d 1098; Geisinger Health Plan v. Commissioner, 30 F.3d 494

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

November 13, 2013

Contact Person:
Number: 201406019
Release Date: 2/7/2014
Identification Number:
Telephone Number:
Employer Identification Number:
UIL: 501.04-00; 501.04-02; 511.01-00

Legend:

b =
c =
d =
M =
N =
O =
P =
Dear :

We have considered your letter of May 13, 2013, (as supplemented by your letters of July 16,
2013, and August 8, 2013) in which you request rulings on the federal tax consequences of the
transactions described below.

Facts

Purpose, Organization and Governance

You are a nonprofit corporation that is exempt from federal income taxation under

I.R.C. § 501(a) as an organization described in § 501(c)(4). You are a health maintenance
organization (HMO) that provides the following healthcare and healthcare-related services:

e Behavioral healthcare to individual subscribers who qualify for publicly funded services
under Title XIX of the Social Security Act (Medicaid)

e Healthcare to individual subscribers who qualify for publicly funded services under Title
XXI of the Social Security Act (CHP)

e Healthcare to low-income individual subscribers under a Medicare Advantage plan under
Title XVIII of the Social Security Act (Medicare Advantage)

e Coordinated case management and administrative services in State 1 and State 2

e Administrative services for certain programs in State 1 under Title XIX and Title XXI of
the Social Security Act

Except for administrative functions B will assume under a contract, you will continue to engage
in the activities listed above.

You are a membership organization. Your members currently consist of L, M, and N and O,
jointly. You intend, in the near future, to replace joint members, N and O, with P (or an entity
affiliated with P). L is a managed care network. M and P are hospitals. O is the centralized
clinical faculty practice plan of the faculty affiliated with medical school Z. Each of L, M, O and P
is an organization exempt from tax under § 501(c)(3). N recently elected to terminate its
exemption under § 501(c)(3) on its last filed Form 990-N e-Postcard. Even though N terminated
its exemption under § 501(c)(3), it continues to exist under State 1 corporations law and
remains an affiliate of Z.

You are managed by a nine-member board of directors, consisting of three Class A directors,
three Class B directors, one Class C director, one Class D director and one Class E director.
Each member nominates a Class A director who represents the member that nominated him or
her. The Class B directors represent the community at large and may not be drawn from
employees, officers or directors of a member. In addition, no Class B director may be an
employee, officer or directors of an entity that is concurrently represented on the board by a
director of any other class. For example, so long as an employee, officer or director of L is
serving as a Class A director, no one else who is employed by or is an officer or director of L
can serve as a Class B director. The Class C director must have expertise in the field of
behavioral health for the underserved population. The Class D director represents the interests
of O. The Class E director represents the interests of a Federally Qualified Health Center.

Election of a Class A director requires the unanimous vote of your members. Class A directors
serve for an indefinite term, subject to removal or resignation. Directors other than Class A
directors are elected by a majority vote of your directors and serve for two-year terms, with the
terms of the Class B directors being staggered.

Your elected officers consist of a chair of the board, one or more vice chairs, a secretary and a
treasurer. Your other executive officers, including the president/chief executive officer, chief
financial officer, medical director and vice presidents, are employees. The president/chief
executive officer and chief financial officer may be hired only with the consent of your board of
directors.

Proposed Reorganization

State 1 created an American Health Benefit Exchange, within the meaning of 42 USCS

§ 18031(b) (the “Exchange”). Your board of directors authorized you to create one or more
insurance products that may be offered on the Exchange. To that end, you created two taxable
subsidiary corporations, A and B, which are described below. In connection with the formation of

A and B, you will reorganize your operations by transferring your employees and certain
contracts to BSub.

A

1. Shareholders. A’s Articles of Incorporation provide for the issuance of the following three
   classes of stock, with the rights described below:

a. Founder Stock. A is authorized to issue 1,000,000 shares of Founder Stock. All Founder
Stock will be issued only to you. As the holder of Founder Stock, you are entitled to
dividends and a share of the net assets remaining available for distribution if A is ever
liquidated. Each share of Founder Stock entitles you to one vote in matters requiring a
shareholder vote, other than the election of directors. Founder Stock votes as a class to
elect the number of directors equal to one less than the aggregate number of directors
elected by the Director Stock and the Investor Stock. Currently, you elect two members
of A’s five-member board of directors.

b. Director Stock. A is authorized to issue three shares of Director Stock. The Director
Stock is held collectively by your three members, L, M, and O and N (to be replaced by
P). Director Stock is not entitled to dividends or a share of the net assets remaining
available for distribution if A is ever liquidated. Each share of Director Stock entitles its
holders to one vote in matters requiring a shareholder vote, other than the election of
directors. Director Stock votes as a class to elect three directors; subject to the condition
that if a holder of Director Stock acquires sufficient Investor Stock to control the election
of one director by the Investor Stock class, the number of directors elected by the
holders of the Director Stock will be reduced by one.

c. Investor Stock. A is authorized to issue up to 1,000,000 shares of Investor Stock.
However, A has no immediate plans to issue Investor Stock. The holder of Investor
Stock would be eligible to receive dividends at the same rate per share as Founder
Stock. In addition, a holder of Investor Stock would be entitled to a ratable share of the
net assets remaining available for distribution if A were ever liquidated. Each share of
Investor Stock would entitle its holder to one vote in matters requiring a shareholder
vote, other than the election of directors. Investor Stock would vote as a class to elect
the number of directors determined by a resolution of the board of directors, but not to
exceed four.

2. Governance.

a. Board of Directors. A’s board of directors is elected as described above. While your
officers, directors and key employees (within the meaning of § 416(i)(a)(A)) may serve
on A’s board of directors, A’s bylaws provide that such individuals may not comprise the
majority of A’s board.

b. Officers. A’s officers consist, at a minimum, of a president, secretary and treasurer, and
are elected by A’s board of directors. A’s board of directors may create additional officer
positions. Any person, including your officers, directors or key employees, may hold two

3.

100

or more offices; provided, however, that your officers, directors or key employees may
not, in the aggregate, hold a majority of the officer positions. In supplemental
correspondence, you stated that the person who serves as your president and chief
executive officer currently serves as A’s president: The persons serving as A’s secretary
and treasurer are not among your directors, officers or key employees.

Capitalization. Funds you paid for your shares of Founder Stock provided A's start-up
funding and its initial insurance reserves. You contemplate that the only payments you will
receive from A will be as dividends in respect of your ownership of the shares of A.

Activities. A is licensed by the State 1 Division of Insurance to provide insurance products
under the Exchange. A will bear the insurance risk with respect to the products. A will not
limit its insurance risk through the use of capitation or sub-capitation agreements with
providers. A will not limit the sale of its products to low-income, high-risk, medically
underserved or elderly individuals. Furthermore, premiums A will charge will not be
established on a community-rated basis. Nonetheless, you anticipate that A will attract low-
income, high-risk, medically underserved or elderly individuals because of their familiarity
with you. You contemplate that you will market A’s products in a manner that creates a link
between you and A, to attract individuals who already possess a familiarity with the
healthcare benefits you provide to family members who qualify for your services. In
addition, you anticipate that family members of your subscribers and former subscribers who
cease to qualify to acquire healthcare services through your programs may purchase health
insurance from A. You expect that this will be due, in part, to their familiarity with you or your
trade name. Furthermore, you also anticipate that A will specifically reach out to that
population through its marketing program.

You will not transact business directly with A. You anticipate that A will contract with BSub
for administrative services.

Shareholders. B’s Articles of Incorporation provide for the issuance of the following two
classes of stock, with the rights described below:

a. Founder Stock. B is authorized to issue 1,000,000 shares of Founder Stock. Founder
Stock will be issued only to you. As the holder of Founder Stock, you are entitled to
dividends and a share of the net assets remaining available for distribution if B is ever
liquidated. Each share of Founder Stock entitles you to one vote in matters requiring a
shareholder vote, other than the election of directors. Founder Stock votes as a class to
elect the number of directors equal to one less than the number of directors elected by
the Director Stock. Currently, you elect two members of the five-member board of
directors.

b. Director Stock. B is authorized to issue three shares of Director Stock. One share of
Director Stock will be issued to each of your members. Director Stock is not entitled to
dividends or a share of the net assets remaining available for distribution if B is ever
liquidated. Each share of Director Stock entitles its holder to one vote in matters

requiring a shareholder vote, other than the election of directors. Director Stock votes as
a class to elect three directors.

2. Governance.

a. Board of Directors. B’s board of directors is elected as described above. While your
officers, directors and key employees may serve on B’s board of directors, B’s bylaws
provide that such individuals may not comprise the majority of B’s board.

b. Officers. B’s officers consist, at a minimum, of a president, secretary and treasurer, and
are elected by its board of directors. The board of directors may create additional officer
positions. Any person, including your officers, directors or key employees, may hold two
or more offices; provided, however, that your officers, directors or key employees may
not, in the aggregate, hold a majority of the officer positions. In supplemental
correspondence, you stated that the person who serves as your president and chief
executive officer currently serves as B’s president. The persons serving as B’s secretary
and treasurer are not among your directors, officers or key employees.

3. Capitalization. Your payment to acquire your Founder's Stock provided B's start-up funding.
   In supplemental correspondence, you explained that you also extended short-term loans to
   B, which B will use to cover operating costs prior to recouping those costs in its ordinary
   billing cycle. You anticipate that B will fully repay the loans, with interest, prior to the end of

4. The interest rate is the same rate that you pay on short-term debentures you issue to
   your members from time to time. You contemplate that, other than interest and principal paid
   on short-term loans, the only payments you will receive from B will be as dividends in
   respect of your ownership of the shares of B.

5. Activities. B will be administered as a holding company that will initially be the sole member
   of BSub. BSub will be organized as a member-managed limited liability company.

a. Contractual Relationships. All of your employees will be transferred to BSub. In addition,
you will transfer certain administrative functions to BSub. You will retain all contracts
pertaining specifically to your social welfare activities (such as Medicaid, CHP and
Medicare Advantage). You will enter into a contractual agreement with BSub, under
which BSub will provide you with various administrative services. A also will enter into a
separate contractual agreement with BSub, under which BSub will provide administrative
services to A in connection with its insurance business.

In supplemental correspondence, you state that the amounts that you and A will pay to
BSub in exchange for administrative services are intended to reflect the reasonable fair
market value of those services according to an arms-length standard. You explain that,
although BSub has prepared various projections of its operating costs in order to derive
the fair market value of such services, reliable comparable data for such projections is
not available. Accordingly, BSub will charge you and A for services based upon (i) a
ratable allocation of direct costs generated by the services being rendered, (ii) a ratable
allocation of indirect overhead costs incurred, and (iii) a profit margin of one percent.

You further state that the one-year term of the contractual agreements with BSub
creates an opportunity annually to adjust the pricing for BSub’s services. If the
leadership of the contracting parties determines that the proposed pricing structure fails
or ceases to reflect the price at which such services would be provided between
unrelated parties, the terms of the contracts can be adjusted at that time.

b. Services Provided. BSub will administer your social welfare contracts and agreements.
In addition, BSub will administer A’s insurance products. BSub’s administrative services
will include, but will not be limited to, claims processing, managerial services, general
administration, insurance, and information technology.

c. Logos: Business Cards. BSub will display logos and signage for you and for A, but not
for itself. BSub’s employees will carry business cards showing your and/or A’s logo, but
not its own.

d. Potential Future Affiliations. B’s board of directors contemplates and intends that B will
remain the sole member of BSub. However, B may also acquire interests in other for-
profit ventures, such as telemedicine and third-party administration for self-funded
medical plans. You anticipate that such entities will obtain administrative services from
BSub under separately negotiated contracts.

Rulings Requested
You have requested the following ruling:

Subsequent to the proposed reorganization, the activities of your taxable subsidiaries, A and
B, will not be attributed to you for the purposes of your continued qualification for exempt
status or liability for unrelated business income tax under § 511.

Law

I.R.C. § 501(c)(4) describes, in part, organizations that are operated exclusively for the
promotion of social welfare.

I.R.C. § 511(a) imposes a tax on the unrelated business taxable income of organizations
described in § 501(c).

I.R.C. § 512(a)(1) provides that the term “unrelated business taxable income” means the gross
income derived by any organization from any unrelated trade or business (as defined in § 513)
regularly carried on by it, less allowable deductions and certain modifications.

I.R.C. § 512(b)(1) generally modifies § 512(a)(1) to exclude dividends and interest from the
definition of “unrelated business taxable income.”

I.R.C. § 512(b)(13) establishes special rules for certain payments received from a controlled
entity in the form of interest, annuities, royalties and rents. Such a payment is included in

unrelated business taxable income under § 512(b)(1) to the extent it reduces the net unrelated
income of the controlled entity (or any net unrelated loss of the controlled entity).

Treas. Reg. § 1.501(c)(4)-1(a)(2)(i) provides that an “organization is operated exclusively for the
promotion of social welfare if it is primarily engaged in promoting in some way the common
good and general welfare of the people of the community.”

In Gregory v. Helvering, 293 U.S. 465, 55 S.Ct. 266 (1935) the taxpayer created a subsidiary
corporation for the sole purpose of receiving taxpayer's shares of another corporation and then
immediately redistributing those shares to herself in a liquidation of the new corporation. After
the transfers were complete, the new corporation dissolved without ever engaging in any
business activities. The Court held that this use of a corporation would not qualify as a
“reorganization” within the meaning of the statute that would exempt from tax, gain arising from
a transfer of assets by one corporation to another incident to a plan of reorganization. The Court
found that the new corporation had no business or corporate purpose and was “a mere device
which put on the form of a corporate reorganization as a disguise for concealing its real
character.” Gregory v. Helvering, 293 U.S. at 469, 55 S.Ct. at 268. Even though a new and valid
corporation was created under state law, it was “nothing more than a contrivance.” Id. The
separate existence of the new corporation was disregarded for tax purposes. The amounts
realized by shareholder in the transaction were recast as a dividend from the parent corporation.

In Higgins v. Smith, 308 U.S. 473, 60 S.Ct. 355 (1940), the taxpayer created a wholly owned
corporation to engage in securities transactions with him. The transactions were structured
solely to provide a tax benefit to the sole shareholder. His ultimate beneficial interests in, and
control over, the securities or the proceeds of their sale, were unchanged by the transactions.
The Court held that the transactions between the sole shareholder and his corporation lacked a
business purpose, other than to reduce tax liability. Accordingly, the corporation and its sole
shareholder were treated as the same person for tax purposes. Higgins v. Smith, 308 U.S. at
476, 60 S.Ct. at 357.

In Moline Properties v. Commissioner, 319 U.S. 436, 63 S.Ct. 1132 (1943), the Court held that,
as a general rule for federal income tax purposes, a parent and its subsidiary corporations are
separate taxable entities so long as the purposes for which the subsidiary is formed are the
equivalent of business activities. When a corporation is organized with the genuine intention that
it will have real and substantial business activities, its existence will not be disregarded for tax
purposes. However, the separate identity of a corporation can be disregarded, for tax purposes,
when the circumstances of its creation or its transactions with a sole shareholder show that the
corporation was not created for any business purpose, but was merely a device to achieve a
particular tax result. Moline Properties, 319 U.S. at 439, 63 S.Ct. at 1134, citing Higgins v.
Smith, 308 U.S. 473, 477-78, 60 S.Ct. 355, 357-58 (1940), and Gregory v. Helvering, 293 U.S.
465, 469, 55 S.Ct. 266, 267 (1935). The shareholder in Moline Properties had created the
corporation upon the advice of a creditor. The shareholder then transferred his shares in the
corporation to a voting trustee appointed by the creditor. Shares of the corporation were
retained by the trustee until the loan was repaid. After the loan was repaid, the shareholder
‘continued to use the corporation to engage in transactions involving the real property. Moline
Properties, 319 U.S. at 437, 63 S.Ct. at 1133. Upon the sale of the corporation’s final asset, the

shareholder argued that the separate existence of the corporation should be ignored. If the
corporation’s separate existence were disregarded, the shareholder would obtain a more
desirable result than if the gain were taxable to the corporation. Id. The Court found that, in
satisfying the demands of a creditor, the corporation served a valid business purpose.
Therefore, the shareholder could not later disregard the existence of the corporation for his own
convenience.

Britt v. U.S., 431 F.2d 227 (5th Cir. 1970) involved three corporations created to hold interests in
a family business operated as a de facto partnership. The corporations were formed to
encourage the children of one original partner to take an interest in the business and to facilitate
each original partner’s estate planning. The partnership continued to manage the family's citrus
groves. Corporate formalities were respected. Each corporation joined as a party to various
banking transactions affecting the partnership’s business activities. Id. at 230. In his
concurrence, Judge Tuttle noted that all actual business activities were undertaken at the
partnership level by the original individual partners, and that the corporations took no active role
in the day to day management of the business. Id. at 238. Nonetheless, a subsidiary or related
corporation can be created to “to serve the creator's personal or undisclosed convenience, [and]
so long as that purpose is the equivalent of business activity or is followed by the carrying on of
business by the corporation, the corporation remains a separate taxable entity.” Id. at 234, citing
Moline Properties v. Commissioner, 319 U.S. at 438-39, 63 S.Ct. at 1133-34. The court in Britt
found that only a minimal level of business activity is required for the corporation to be
recognized as a separate taxable entity. Britt v. U.S., 431 F.2d at 237. Because the activities of
the corporations in question met that low threshold, the separate existence of each corporation
was respected.

Krivo Industrial Supply Company v. National Distillers and Chemical Corporation, 483 F.2d 1098
(5th Cir. 1973) examined the “instrumentality doctrine,” which allows the courts to disregard the
separate legal existence of a corporation when it is a mere instrumentality of a dominant entity.
In Krivo Industrial Supply Company, the Court of Appeals was called upon to determine whether
a creditor corporation should be held liable for debts of its borrower, where the financial
circumstances of the borrower put the creditor in a position to exert substantial influence over
the operations of the borrower. Id. at 1101. The corporate form is not lightly disregarded;
however, a subservient corporation’s separate existence may be disregarded if the subservient
corporation exists to further the purposes of the parent/dominant corporation and the
subservient corporation has no separate, independent existence of its own. Id. at 1102. Direct
and actual operative control of the subservient corporation is required to apply the
instrumentality doctrine. The court will look past stock ownership to the specific facts to
determine whether the dominant entity, in fact, possessed full control over the subservient
corporation and whether, through its manipulation of the subservient corporation, a third party
was harmed. Id. at 1104. The court held that the “absence of an independent corporate purpose
is most apparent in those cases in which the dominant corporation, to further its own corporate
purposes, either organized or acquired the subservient corporation.” Id. at 1105. In Krivo
Industrial Supply Company, the court found that the creditor lacked the level of control over the
borrower for the instrumentality doctrine to apply. Id. at 1114.

Geisinger Health Plan v. Commissioner, 30 F.3d 494 (3rd Cir. 1994) analyzed the basis on
which the separate corporate existence of an entity created by a tax-exempt organization could
be disregarded to entitle the subordinate organization to vicarious exemption through its exempt
parent. In denying vicarious exemption to the subordinate organization, the court cited Moline
Properties v. Commissioner, 319 U.S. at 438-39, 63 S.Ct. at 1133-34, for the principle that a
separately incorporated entity must generally qualify for exemption on its own merits. The court
noted that the subordinate organization was organized as a separate corporation for reasons its
organizers found “administratively and politically advantageous.” Geisinger Health Plan v.
Commissioner, 30 F.3d at 499. Although the subordinate organization was closely related to,
and was controlled by the exempt parent, the subordinate organization engaged in a line of
business that was distinct from that of the parent. Furthermore, the court found that determining
each entity's tax status based upon its own organizational structure is “less complex and more
certain for courts and administrators." Id.

Analysis
The analysis of the requested ruling involves three issues.

1. Whether the activities of your taxable subsidiary A will be attributed to you for the purposes
   of your continued qualification for exempt status.

A is separately incorporated entity and its separate existence should be respected for tax
purposes.

You formed A to engage actively in a line of business distinct from your own. You provide
healthcare services to a specific population comprised of individuals and families who
qualify for Medicaid, CHP or Medicare under your contracts with State 1. A will issue health
insurance policies through the Exchange. This factor distinguishes A from the entities
described in Gregory v. Helvering, 293 U.S. 465, 55 S.Ct. 266 (1935), and Higgins v. Smith,
308 U.S. 473, 60 S.Ct. 355 (1940). The corporations in those cases were created solely to
achieve an advantageous tax result for the sole shareholder while lacking any business
purpose. In addition, since A will actively engage in a business with the public, its business
activities exceed the level required to satisfy the minimal standard established by the court
in Britt v. U.S., 431 F.2d 227 (5th Cir. 1970).

You and A are related, but possess materially different governance structures. You are a
nonprofit membership corporation. Your membership is limited to organizations that are
exempt under § 501(c)(3) or § 501(c)(4). Your board of directors includes representatives of

• See Gregory v. Helvering, 293 U.S. 465, 55 S.Ct. 266 (1935), Higgins v. Smith, 308 U.S. 473,
  60 S.Ct. 355 (1940), Moline Properties v. Commissioner, 319 U.S. 436, 63 S.Ct. 1132 (1943),
  Britt v. U.S., 431 F.2d 227 (5th Cir. 1970), and Krivo Industrial Supply Company v. National
  Distillers and Chemical Corporation, 483 F.2d 1098 (5th Cir. 1973); cf. Geisinger Health Plan v.
  Commissioner, 30 F.3d 494 (3rd Cir. 1994).

10

the community at large, as well as an expert in behavioral medicine relevant to the
population that you serve. A is a for-profit corporation whose Articles of Incorporation create
a capital structure that allocates rights among three classes of shareholders. Although it has
not yet done so, A’s Articles of Incorporation authorize it to issue Investor Shares.

You appoint a minority of A’s directors. In addition, A’s bylaws prevent a majority of its
directors from being drawn from your officers, directors or key employees. Therefore, while
you participate in A’s management, you cannot exert direct management control over A. The
interests of constituencies ensured of participation in your operations (such as the
community at large) are at most indirectly represented on A’s board. Furthermore, A’s
bylaws permit, but do not require, that your directors, officers or key employees may serve
as A's corporate officers. However, A’s bylaws also prohibit a majority of its officers from
concurrently serving as your directors, officers or key employees. You represent that your
president and chief executive officer currently serves as the president of A, but that the
secretary and treasurer of A are not your directors, officers nor are they currently key
employees of yours. Accordingly, you do not possess the level of control over A’s operations
that would justify ignoring A’s separate corporate existence under the instrumentality
doctrine.

2. Whether the activities of your taxable subsidiary B will be attributed to you for the purposes
   of your continued qualification for exempt status.

As stated above with respect to A, B is a separately incorporated entity and its separate
legal existence should be respected. °

B, acting through BSub, will actively engage in business activities different from your
activities. BSub will assume responsibility for the administrative activities that you previously
engaged in for your own benefit. You will cease to engage in those activities. BSub will also
acquire your employees. Even though the activities of B will continue to serve your interests,
BSub will also concurrently provide services to A. Furthermore, B intends to investigate and
potentially pursue additional businesses, such as telemedicine and third-party administration
of self-insured health plans. Therefore, B’s business activities exceed the low threshold to
support B’s separate corporate existence.’

You and B are subject to significantly different governance. As with A, your officers,
directors and key employees are precluded from comprising a majority of B’s board of

? Krivo Industrial Supply Company v. National Distillers and Chemical Corporation, 483 F.2d
1098 (5th Cir. 1973).

3 See Gregory v. Helvering, 293 U.S. 465, 55 S.Ct. 266 (1935), Higgins v. Smith, 308 U.S. 473,
60 S.Ct. 355 (1940), Moline Properties v. Commissioner, 319 U.S. 436, 63 S.Ct. 1132 (1943),
Britt v. U.S., 431 F.2d 227 (5th Cir. 1970), and Krivo Industrial Supply Company v. National
Distillers and Chemical Corporation, 483 F.2d 1098 (5th Cir. 1973); cf. Geisinger Health Plan v.
Commissioner, 30 F.3d 494 (3rd Cir. 1994).

‘ Britt v. U.S., 431 F.2d 227 (5th Cir. 1970).

11

directors. Key constituencies entitled to direct representation on your board of directors are
only indirectly represented on B’s board of directors, owing to your right to elect a minority of
B’s directors. Furthermore, you will not be the only customer of BSub. A will also purchase
services from BSub, as may other businesses that B may acquire in the future.

Creating B and transferring your employees and administrative functions to BSub is
consistent with your desire to establish a clear separation between yourself and A. At the
same time, obtaining administrative services from BSub potentially enables you to realize
efficiencies. The separate contracts between you and BSub and between A and BSub will
allocate BSub’s costs and overhead in a manner that reflects the value of goods and
services provided to you and A’s respectively. The contractual agreements also reflect the
separate existence of each contracting party. Accordingly, so long as B operates in
accordance with its contractual relationships with you and A, it should not be recast as an
instrumentality of you.°

3. Whether you will have unrelated business taxable income tax under § 511 because of the
   activities of A or B.

As discussed above, the factors necessary to disregard the separate corporate existence of
either A or B are not present. Accordingly, A or B will be treated as separate taxpayers.
They will report their items of income and expense on their respective corporate tax returns.
Consequently, neither the activities of A and B nor the gross income derived from those
activities will be attributed to you for the purposes of § 511.

You have not asked us to address the issue of whether payments you may receive from A
or B, such as in the form of dividends or interest, will themselves be treated as unrelated
business taxable income. Therefore we are not ruling specifically on the effect of

§§ 512(b)(1), or 512(b)(13) on income arising from loans you have made to B, or any loans
you may, in the future, make to A or B.

Conclusion
In light of the foregoing, we rule as follows:

Subsequent to the proposed reorganization, the activities of your taxable subsidiaries, A and
B, will not be attributed to you for the purposes of your continued qualification for exempt
status or liability for unrelated business income tax under § 511.

This ruling will be made available for public inspection under § 6110 after certain deletions of
identifying information are made. For details, see enclosed Notice 437, Notice of Intention to
Disclose. A copy of this ruling with deletions that we intend to make available for public
inspection is attached to Notice 437. If you disagree with our proposed deletions, you should
follow the instructions in Notice 437.

° Krivo Industrial Supply Company v. National Distillers and Chemical Corporation, 483 F.2d
1098 (5th Cir. 1973).

12

This ruling is directed only to the organization that requested it. Section 6110(k)(3) provides that
it may not be used or cited by others as precedent.

This ruling is based on the facts as they were presented, without consideration of alternative
plans of proposed transactions, without consideration of hypothetical situations, and on the
understanding that there will be no material changes in these facts. This ruling does not
address the applicability of any section of the I.R.C. or Treas. Reg. to the facts submitted other
than with respect to the sections described. Because it could help resolve questions concerning
your federal income tax status, this ruling should be kept in your permanent records.

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

In accordance with the Power of Attorney currently on file with the Internal Revenue Service, we
are sending a copy of this letter to your authorized representative.

Sincerely,

Steven B. Grodnitzky
Manager, Exempt Organizations
Technical Group 1

Enclosure
Notice 437