B.S.W. Grp., Inc. v. Comm'r of Internal Revenue
| Decision Date | 30 May 1978 |
| Docket Number | Docket No. 6646-77X. |
| Citation | 70 T.C. 352 |
| Parties | B. S. W. GROUP, INCORPORATED, PETITIONER v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
T is a corporation which plans as its sole activity to offer consulting services for a fee to nonprofit, limited resource organizations engaged in various rural-related activities. T's service consists of obtaining appropriate individuals to perform research projects for the clients. Some of T's clients will be exempt organizations, but others may not be exempt. The fees charged by T will be set at or close to cost, but will in no event be less than T's full cost of providing its services. T will realize a projected net profit in its first year of operation. The administrative record fails to show that T will not be in competition with commercial enterprises. The Commissioner denied T's application for an exemption from taxation under secs. 501(c)(3) and 501(a), I.R.C. 1954. Held, the Commissioner did not err in determining on the basis of facts contained in the administrative record that T does not operate exclusively for charitable, educational or scientific purposes as required by sec. 501(c)(3). Edward L. Williams (an officer), for the petitioner.
Kevin M. Bagley, for the respondent.
Respondent determined that petitioner does not qualify for exemption from Federal income tax under section 501(c)(3), I.R.C. 1954. Petitioner challenges respondent's determination and has invoked the jurisdiction of this Court for a declaratory judgment pursuant to section 7428.1 The issue is whether petitioner is operated exclusively for charitable, educational, or scientific purposes within the meaning of section 501(c)(3).
This case was submitted for decision on the stipulated administrative record under Rule 122, Tax Court Rules of Practice and Procedure. The stipulated administrative record is incorporated herein by this reference. The evidentiary facts and representations contained in the administrative record are assumed to be true for purposes of this proceeding.
Petitioner, the B. S. W. Group, Inc., is a corporation organized under the General Corporation Law of Delaware with its principal place of business in Garrett Park, Md. It filed its application for recognition of exemption under section 501(c)(3) on April 5, 1976, with the Baltimore District Office of the Internal Revenue Service. On July 8, 1976, the Internal Revenue Service issued a final adverse ruling that petitioner is not an organization described in section 501(c)(3). This ruling was reissued by the Service on April 5, 1977.
Petitioner was formed on February 18, 1976, for the purpose of providing consulting services primarily in the area of rural-related policy and program development. Petitioner plans to enter into consultant-retainer relationships with five or six limited resource groups involved with the fields of health, housing, vocational skills, and cooperative management. Petitioner's goal is to help such organizations deal with problems they face regarding the external environments within which they operate, changing priorities, and implementing realistic internal planning and management policies. Another important goal of petitioner is to improve clients' understanding of governmental policy processes and methods for becoming more effective in their work through public and private funding.
Petitioner's service to client organizations will be to furnish consultants to perform basic and applied research for clients. Specific research areas within petitioner's contemplation include vocational skills training, alternative housing, health and health delivery systems, alternative financing for small-scale entrepreneurs, environmental impact programs, solid waste disposal, and multiple uses of organic and inorganic compounds in farm production activities. A large part of petitioner's attention will be directed towards youth groups, women and their reentry into the work force, and minority business and vocational training and placement. Petitioner will not advise clients on managing or improving the administration of their organizations. Much of petitioner's service to clients is intended to be an alternative to full-time staffing of client organizations where budget considerations and lack of expertise would otherwise prevent such staffing.
Petitioner proposes to utilize what it terms “nonformal consulting” as the means of conveying information to clients. As defined by petitioner, nonformal consulting consists of bringing advisors with like interests together with emerging groups or agencies in an informal framework having a flexible agenda, no fee schedule, and no extensive reporting. This form of consulting is tailored to small groups or institutions which need less structured methods for dealing with their problems.
Although petitioner did not have any clients at the time of its application for tax-exempt status, petitioner described in the following terms what it expected to be a typical consulting job:
The B. S. W. Group, Inc. has been approached by a non-profit tax-exempt organization in Pennsylvania which owns a 350-acre site. This organization would like to develop the site into a rural-small farm-demonstration (sic.) and training center. We have been asked to consider doing the basic research and planning for such a center over a 1-year period. Such a study would establish and document the situation and trends concerning key factors in the following primary areas:
—physical resource base
—human resource base
—political/institutional situation
—organization and structure of area agriculture
—agricultural/forestry systems now employed
—basic economics of these systems
—agricultural infrastructure
—land use patterns
—environmental issues
—energy issues
All of petitioner's consulting clients will be tax-exempt organizations and not-for-profit organizations (some of which may not be tax-exempt). Prospective clients will become aware of petitioner primarily through “word of mouth” among peer or cooperative agencies. Petitioner will not advertise its services.
Individuals serving as independent contractors under contract with petitioner will perform the actual consulting services for clients. These individuals will be compensated by petitioner. The B. S. W. Group will charge client organizations a fee for making the arrangements with individual consultants. Petitioner and not the individual consultant will negotiate this fee, which will to some extent be based on the client's ability to pay as well as the value of the services to the client. Although petitioner's general policy will be to provide its consulting services at or close to cost, fees will generally be sufficiently high to enable petitioner to retain at least a “nominal” administrative fee over and above the amount payable to individual consultants.
Petitioner's proposed budget for 1976 and 1977 is as follows:
Petitioner plans to pay no salaries for the first several years of its operation other than the aforementioned amounts which will be paid to individual consultants serving as independent contractors.
All of petitioner's income will be derived from consulting services with no other anticipated sources of income. Petitioner seeks to meet all expenses from its consulting income. It also desires to earn a net profit of no more than $2,000 in its first year to be used as a reserve for contingencies in future years.
Section 501(c)(3) provides, in pertinent part, that in order for a corporation to be exempt from taxation under sections 501(c)(3) and 501(a), it must be both organized and operated exclusively for certain specified exempt purposes, such as religious, charitable, or educational purposes. See also sec. 1.501(c)(3)-1(a), Income Tax Regs. These two requirements are known as the “organizational” and “operational” tests, and petitioner contends that it meets both of them as an educational, scientific, or charitable organization. The Commissioner does not dispute that petitioner is organized exclusively for the required purposes, see sec. 1.501(c)(3)-1(b), Income Tax Regs., but determined and continues to maintain that petitioner does not meet the “operational test” since it is “primarily engaged in an activity which is characteristic of a trade or business.” See sec. 1.501(c)(3)-1(c), Income Tax Regs. The burden is on petitioner to show, upon the basis of materials in the administrative record, that the Commissioner erred in that determination.
The Commissioner ruled adversely to petitioner, relying in part upon Rev. Rul. 72-369, 1972-2 C.B. 245. In that ruling, an exemption was denied to an organization formed to provide managerial and consulting services at cost to unrelated exempt organizations on the ground that it was not “operated exclusively” for exempt purposes under section 501(c)(3). The ruling states:
Providing managerial and consulting services on a regular basis for a fee is trade or business ordinarily carried on for profit. The fact that the services in this case are provided at cost and solely for exempt organizations is not sufficient to characterize this activity as charitable within the meaning of section 501(c)(3) of the Code....
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