department of the treasury internal_revenue_service washington d c tax_exempt_and_government_entities_division release number release date uil date date contact person identification_number 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 sec_501 as an organization described in code sec_501 we made this determination for the following reason s your activities include providing non-permissible benefits discrimination in favor of highly compensated persons and inurement you must file federal_income_tax returns on the form and for the years listed above within file the returns in accordance days of this letter unless you request an extension of time to file with their instructions and do not send them to this office failure_to_file the returns timely may result in a penalty if you disagree with our proposed deletions follow the 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 federal_income_tax status and responsibilities please contact irs customer service at we will make this letter and our proposed adverse determination_letter available for public inspection under code sec_6110 after deleting certain identifying information please read the enclosed notice notice of intention to disclose and review the two attached letters that show our proposed deletions instructions in notice if you agree with our deletions you do not need to take any further action if you have any questions about your or the irs customer service number for businesses the irs customer service number for people with hearing impairments is sincerely lois g lerner director exempt_organizations rulings agreements enclosure notice redacted proposed adverse determination_letter redacted final adverse determination_letter department of the treasury internal_revenue_service washington d c tax exempt and government entities givision i date wi 1g a utl- ut sollaoq9g-00 q dear we have considered your application_for recognition of exemption from federal_income_tax under sec_501 of the intemal revenue code we issued you proposed denial letter dated this letter supercedes that letter _ you were incorporated on under the nonprofit mutual benefit corporation law of the for the purpose of providing post-retirement medical benefits tor the employees of retrament of an employee the retired employee then has the option of electing the following medical benefits - the plan_administrator segregates the value of the retirees’ accounts upon ‘as nonorofit mutual benefit corporation you are formed _ _ reimbursement for the cost of medicare part b the premium for a supplemental medicare policy other medical insurance_policy long payment for out of pocket medical_expenses term care insurance_policy etc the retiree may elect to redirect the distribution of his reimbursements any time during the plan_year in the event of any overfunding of the accounts when all participants are retired the unneeded funds are distributed on a percentage ratio basis to the separate_accounts of the retired participants retirees will never be entitled to cash payments n the event that a retiree and the retiree's dependants die before the balance of his postretirement reimbursement _ account is completely depleted any balance will be distributed to his estate your minimum retirernent age is years with vears of participation are each owners of and the information submitted shows that mr projected medical retirement costs are the dominant share of the total medical retirement costs _ sec_501 of the code exempts from federal_income_tax a voluntary employees’ beneficiary association veba providing for the payment of life sick accident or other_benefits to its members or their dependents or designated beneficiaries and in which no part of its net ‘earnings inures other than through such payments to the benefit of any private_shareholder_or_individual ' sec_1 c9 -1 c of the income_tax regulations provides that substantially_all of the operations of a c organization must be in furtherance of providing permissible benefits sec_1 c -3 a of the ragulations provides that an organization is not described in sec_501 of the code if it systematically and knowingly provides benefits of more than a de_minimis amount that are not permitted by sec_1 c of the regulations sectlon c -3 b of the regulations provides that the term life benefits means a benefit including a burial benefit or a wreath payable by reason of the death of a member or dependent a life benefit may be provided directly or through insurance it generally must consist of current protection but also may include a right to convert to individual coverage on termination of eligibility for coverage through the association or a permanent_benefit as defined in and subject_to the conditions in the regulations under sec_79 a ‘life benefit’ also includes the benefit provided under any iife insurance_contract purchased directly from an mployee-funded association by a member or provided by such an association to a member the term life benefit does not include a pension annuity or similar benefit except that a benefit payable by reason of the death of an insured may be settled in the form of an annuity to the beneficiary in lieu of a lump-sum death_benefit whether or not the contract provides for settlement in a lump sum section c -3 c of the regulations provides that the term sick_and_accident_benefits means amounts fumished to or on behalf of a member or a member's dependents in the event of illness or personal injury to a member or dependent such benefits may be provided through reimbursement to a member or a member's dependents for amounts expended because of illness or personal injury or through the payment of premiums to a medical_benefit or health insurance program similarly a sick and accident benefit includes an amount_paid to a member in lieu of incorne during a period in which the member is unable to work due to sickness or injury sick benefits also include benefits designed to safeguard or improve the health of members and their dependents sick_and_accident_benefits may be provided directly by an association to or on behalf of members and their dependents or may be provided indirectly by an association through the payment of premiums or fees to an insurance_company medical clinic or other program under which members and their dependents are nititled to medical services or to other sick_and_accident_benefits sick_and_accident_benefits may also be furnished in noncash form such as for example benefits in the nature of clinical care services by visiting nurses and transportation furnished for medical_care sec_1 c -3 d of the regulations provides that the term other_benefits includes only benefits that are similar to life sick or accident benefits a benefit is similar to a life sick or accident benefit if - _ itis intended to safeguard or improve the health of a member or a member's dependents or it protects against a contingency that interrupts or impairs a member's earning power sec_1_501_c_9_-3 of the regulations provides that paying vacation benefits providing vacation facilities reimbursing vacation expenses and subsidizing recreational activities such as athletic leagues are considered other_benefits the provision of child-care facilities for preschool and school-age dependents are also considered other_benefits the provision of job _ feadjustment allowances income maintenance payments in the event of economic dislocation temporary living expense loans and grants at times of disaster such as fire or flood supplemental_unemployment_compensation_benefits as defined in sec_501 c d i of the code severance benefits under a severance_pay plan within the meaning of cfr - b and education or training benefits or courses such as apprentice training programs for members are considered other_benefits because they protect against a contingency that interrupts eaming power personal legal service benefits which consist of payments or credits to one or more organizations or trusts described in sec_501 c are considered other_benefits except to the extent otherwise provided in these regulations as amended from time to time other benafits also include any benefit provided in the manner permitted by paragraphs et seq of sec_302 of the labor management relations act of 61_stat_136 as amended u s c c _ sec_1_501_c_9_-3 of the regulations provides that benefits that are not described in paragraphs d of a of this saction are not other_benefits thus other_benefits do not include the payment of commuting expenses such as bridge tolls or train fares the provision of accident or homeowner's insurance benefits for damage to property the provision of malpractice insurance or the provision of loans to members except in times of distress as permitted by sec_1 c -3 e other_benefits also do not include the provision of savings facilitias for members the term other_benefits does not include any benefit that is similar to a pension or annulty payable at the time of mandatory or voluntary retirement or a benefit that is similar ta the benefit provided under a stock bonus or profit-sharing_plan for purposes of sec_501 and these regulations a benefit will be considered similar to that provided under a pension annuity stock bonus or profit-sharing_plan if it provides for deferred_compensation that becomes payable by reason of the passage of time rather than as the result of an unanticipated event thus for example supplemental unemployment benefits which generally become payable by reason of unanticipated layoff are not for purposes of these regulations considered similar to the benefit provided under a pension annuity stock bonus or profit-sharing_plan in sec_1 c -3 g each covered_employee of t is entitled at his or discretion to contribute up to an additional dollar_figure each year to v which agrees in respect of such sum to pay interest at a stated rate from the time of contribution until the time at which the contributing employee's vacation benefit is distributed in addition each employee may elect to leave all or portion of his her distributable benefit on deposit past the time of distribution in which case interest will continue to accrue because the plan more closely resembles a savings arrangement than a vacation plan the benefit payable to the covered employees of tis nota - vacation benefit and is not an eligible other benefit described in sec_501 and sec_1 c -3 d or e sec_1_501_c_9_-4 of the regulations states in part that no part of the net earings of an employees’ association may inure to the benefit of any private_shareholder_or_individual jother than through the payment of benefits permitted by sec_1_501_c_9_-3 whether iprohibited inurement has occurred is a question to be determined with regard to all the facts and circumstances ‘ sec_1_501_c_9_-4 of the regulations provides that any payment to any member of disproportionate benefits where such payment is not pursuant to objective and nondiscriminatory standards will not be considered a benefit within the meaning of section -501 c -3 of the regulations even though the benefit otherwise is one of the type permitted y that section for example the payment to highly compensated personnel constitute prohibited inurement unless the different can be justified on the basis of objective and reasonable standards adopted by the association sec_4976 of the code provides that it is a disqualified_benefit for any portion of ' welfare_benefit_fund to ravert to the benefit of the employer sec_419a of the code provides that post-retirement medical benefits may be provided to covered employees on a deferral basis upon an actuarially determined basis ___ beneficiary association as that term is used in sec_501 of the code based on the information submitted we conclude that you are not a voluntary employees’ sec_1 c -1 of the regulations provides that to be described in section c of the code an organization must provide for the payment of life sick accident or other_benefits to its members or their designated beneficiarles and substantially_all its operations must be in furtherance of providing such benefits in this case medical benefits provided by the trust qualify as sick_and_accident_benefits under sec_1 c -3 c ___ on the other hand the payment of an employee's residual account balance to a designated_beneficiary is not a permissibla veba benefit it is not a life benefit in that there is no current protection no insurance-type protection and no set death_benefit sec_1_501_c_9_-3 for example a retiree has no current or insurance-type life protection if his or her account can be exhausted through medical payments prior to death or if the payout is defined by how much money a person is able to save it is not a sick benefit because itis not paid for health-related reasons _ the payment of a residual account balance also does not come within the description of other_benefits in sec_1 c -3 d or e sec_1_501_c_9_-3 provides that benefits that are not described in paragraphs d or é are not other_benefits and generally provides that the provision of savings facilities for members or payments that are similar to a pension annuity stock bonus or profit-sharing_plan are not other_benefits for these purposes a _ benefit is considered similar to that provided under a pension annuity stock bonus or profit- sharing plan if it provides for deferred_compensation that becomes payable by reason of the _ passage of time rather than as the result of an unanticipated event ‘the benefits are in all cases payable to members their spouses or dependents or their estates because you provide impermissible benefits your earning inure to the benefit of members see sec_1_501_c_9_-4 of the regulations which prohibits such inurement further all assets in a veba belong to the veba and not to the members veba assets are not permitted to vest in members before the time they are paid as permissible benefits the dedication of a portion of veba assets as a permanent account for members that is vested and can be wilied to a beneficiary by the member is inurement of veba assets to the member as such you do not qualify for exemption under sec_501 of the code the information submitted shows that the present dominant cost of your plan is for your owners participants in relationship to all employees it appears that your owners participants will be the only participants that will be receiving separate medical accounts upon retirement based on their age minimum age retirement and the number of years for eligibility thus you have not established that you are not violating the inurement proscription of section - c -4 b of the income_tax regulations in addition you state that the estate of the employee s entitled to any overfunding of participant's medical account upon his death such vested benefits are similar to a deferred_compensation arrangement and thus are impermissible benefits in violation of sec_1_501_c_9_-3 of the income_tax regulations the post-retirement medical_benefit is being funded proportionate to salary because medical_expenses potentially affect all persons equally there is no objective or nondiscriminatory basis for providing a larger medical_benefit to highly compensated persons while there is a rationale for providing benefits in proportion to salary for income replacement benefits like disability and life_insurance there is no rationale for providing a greater medical_benefit to one class of employees over another thus this arrangement would be in violation of section big_number c -4 b of the income_tax regulations because medical benefits that are provided unequaily in favor of highly compensated personnel ara disproportionate per se accordingly based on all the facts and circumstances we conclude that you do not qualify for recognition of exemption from federal_income_tax under sec_501 c of the code you have the right to protest this ruling if you belleve it is incorrect to protest you should submit a statement of your views with a full explanation of your reasoning this statement signed by one of your officers must be submitted within days from the date of this letter _ you also have a nght to a conference in this office after your statement is submitted you must request the conference if you want one when you file your protest statement if you are to be represented by someone who is not one of your officers that person will need to file a proper _ power of attomey and otherwise qualify under our conference and practices requirements _ if we do not hear from you within days this ruling will become final and a copy will be forwarded to the ohio ep eo key district_office thereafter any questions about your federal_income_tax status should be directed to that office either by calling a toll free number or sending correspondence to internal_revenue_service ep eo customer service p o box cincinnati oh ‘when sending additional letters to us with respect to this case you will expedite their receipt by using the following address bo po intemal revenue service constitution ave n w washington d c if you have any questions please contact the person whose name and telephone number are shown in the heading of this letter i - sincerely a iq bcbt fe nooaph chasin manager exempt_organizations technical group


internal_revenue_service number release date index number ----------------------------------------------------- ---------------------------- --------------------------------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact ------------------------------ id no ---------------- telephone number ---------------------- refer reply to cc psi b01 plr-119149-18 date december legend x --------------------------------------------------- ------------------------------------------------------- state date ----------------- ---------------------- dear ---------------- this letter responds to a letter dated date written on behalf of x requesting an extension of time under sec_301_9100-3 of the procedure and administration regulations to file an election under sec_301_7701-3 to be treated as an association_taxable_as_a_corporation for federal tax purposes facts according to the information submitted x was formed under the laws of state x represents that as of date x was a domestic entity eligible to elect to be treated as an association_taxable_as_a_corporation for federal tax purposes x intended to be treated as an association_taxable_as_a_corporation for federal tax purposes effective date however x inadvertently failed to timely file form_8832 entity classification election electing to be treated as an association_taxable_as_a_corporation for federal tax purposes x represents that granting relief will not prejudice the interests of the government and that hindsight is not involved in seeking relief to file a late election furthermore x represents that it acted reasonably and in good_faith plr-119149-18 law and analysis sec_301_7701-3 provides that a business_entity that is not classified as a corporation under sec_301_7701-2 or an eligible_entity can elect its classification for federal tax purposes an eligible_entity with at least two members can elect to be classified as either an association or a partnership sec_301_7701-3 provides that an eligible_entity may elect to be classified other than as provided in sec_301_7701-3 by filing form_8832 with the designated service_center sec_301_7701-3 provides that an entity classification election must be filed on form_8832 and can be effective up to days prior to the date the form is filed or up to months after the date the form is filed sec_301_7701-3 provides that an election made under sec_301 c i must be signed by a each member of the electing entity who is an owner at the time the election is filed or b any officer manager or member of the electing entity who is authorized under local law or the entity's organizational documents to make the election and who represents to having such authorization under penalties of perjury under sec_301_9100-1 the commissioner may grant a reasonable extension of time to make a regulatory election or a statutory election but no more than six months except in the case of a taxpayer who is abroad under all subtitles of the internal_revenue_code except subtitles e g h and i sec_301_9100-1 defines the term regulatory election as including an election whose due_date is prescribed by a regulation published in the federal_register sec_301_9100-1 through provide the standards that the commissioner will use to determine whether to grant an extension of time to make an election sec_301_9100-1 sec_301_9100-2 provides automatic extensions of time for making certain elections sec_301_9100-3 provides rules for requesting extensions of time for regulatory elections that do not meet the requirements of sec_301_9100-2 requests for relief under sec_301_9100-3 will be granted when the taxpayer provides evidence to establish that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government conclusion based solely on the facts submitted and representations made we conclude that x has satisfied the requirements of sec_301_9100-1 and sec_301_9100-3 and therefore it is granted an extension of time of days from the date of this letter to file a form_8832 plr-119149-18 to elect to be treated as an association_taxable_as_a_corporation for federal tax purposes effective date a copy of this letter should be attached to the election a copy is enclosed for that purpose this ruling is contingent on x and the owner of x filing within days of this letter all required income_tax and information returns for all open years consistent with the requested relief being effective date a copy of this letter should be attached to any such returns except as specifically set forth above we express no opinion concerning the federal tax consequences of the facts described above under any other provision of the internal_revenue_code this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representatives sincerely holly porter associate chief_counsel passthroughs special industries by laura c fields laura c fields senior technician reviewer branch office of associate chief_counsel passthroughs special industries enclosures copy of this letter copy of this letter for sec_6110 purposes


t c memo united_states tax_court leonard pipeline contractors ltd petitioner v commissioner of internal revenue respondent docket no filed date marc l spitzer and james p powers for petitioner susan e seabrook for respondent memorandum findings_of_fact and opinion jacobs judge leonard pipeline contractors ltd petitioned the court to redetermine respondent’s determination of an dollar_figure deficiency in its income_tax for its taxable_year ended date and additions to tax pursuant to sec_6653 in the amount of dollar_figure and sec_6653 in the amount of percent of the interest on dollar_figure the deficiency is based on respondent's determination that dollar_figure of the dollar_figure petitioner deducted as compensation paid to its president richard l leonard was unreasonable following respondent’s concession of the additions to tax the sole issue for decision is the amount of compensation paid_by petitioner that is reasonable and thus deductible as a sec_162 business_expense all section references are to the internal_revenue_code in effect for the year in issue and all rule references are to the tax_court rules_of_practice and procedure except where indicated by the notation candollar_figure standing for canadian all dollars are u s dollars findings_of_fact some of the facts have been stipulated and are found accordingly the stipulation of facts and the attached exhibits are incorporated herein by this reference at the time petitioner leonard pipeline contractors ltd filed its petition herein its principal_place_of_business was in scottsdale arizona petitioner filed its federal_income_tax return based on a fiscal_year ending date petitioner's history petitioner was incorporated in canada on date from its incorporation through the year in issue petitioner engaged in pipeline construction and related activities either directly or through joint ventures in the united_states canada saudi arabia and mexico mr leonard has been petitioner’s president since its inception leonard baun holdings ltd lbh another canadian corporation originally owned percent of petitioner’s common_stock and percent of its preferred_stock the remaining percent of petitioner’s voting_stock and percent of its preferred_stock were owned by an unrelated publicly held company at the time petitioner was organized mr leonard owned percent of the lbh stock and r w baun owned percent in date lbh sold to petitioner all of its assets except for its participation right in three major pipeline construction contracts for candollar_figure million and its goodwill for candollar_figure in two additional canadian corporations were organized r l leonard holdings ltd rllh and r l leonard consultants rllc mr leonard owned all the stock in these corporations in lbh was renamed leonard pipeline holdings ltd lph in a new canadian corporation was formed leonard pipeline construction ltd lpc this corporation was owned by lph which was owned by rllh in lph rllh and rllc consolidated rllh was the surviving corporation with mr leonard its sole shareholder rllh owned percent of both lpc and petitioner mr baun's stock in leonard baun holdings ltd was redeemed in petitioner became a u s_corporation on date by filing an application_for certificate of registration and articles of continuance under wyoming law these documents list casper wyoming as petitioner's corporate address after the application and certificate of registration were filed all of petitioner's u s tax returns state a scottsdale arizona mailing address on date mr leonard incorporated leonard pipeline construction co lpcc an s_corporation with petitioner consenting to the use of its corporate name in date petitioner merged into the s_corporation accordingly during the year in issue petitioner’s sole shareholder was rllh whose sole shareholder was mr leonard petitioner’s financial statements petitioner’s financial statements for fiscal years through were prepared using the percentage-of-completion method_of_accounting for long-term construction contracts its income_tax returns however were prepared on the completed- contract method consequently the amounts reflected on its financial statements vary from those reflected on its income_tax returns petitioner reported the following amounts on its financial statements prior to becoming a u s_corporation petitioner filed forms 1120f u s income_tax return of a foreign_corporation fiscal after-tax dividends year assets gross revenue gross_profit net_income paid dollar_figure dollar_figure dollar_figure dollar_figure --- big_number big_number big_number big_number dollar_figure big_number big_number big_number big_number --- big_number big_number big_number big_number --- big_number big_number big_number big_number --- big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number --- total n a big_number n a big_number big_number the full amount of the compensation paid to mr leonard as well as the amount of the distribution of a in-kind dividend that had been treated as a loss for financial_accounting purposes have been taken into account in calculating petitioner's aggregate after-tax net_income the aggregate before-tax net_income was slightly over dollar_figure million petitioner reported the following amounts on its forms 1120f u s income_tax return of a foreign_corporation for fiscal years and forms u s_corporation income_tax return for taxable_income after compensation deduction but before fiscal total gross gross nol and dividends year assets sales profit special_deductions paid dollar_figure dollar_figure dollar_figure dollar_figure n a big_number big_number big_number big_number n a big_number big_number big_number big_number n a big_number big_number big_number big_number n a big_number big_number big_number big_number n a big_number n a n a big_number n a big_number n a n a big_number n a big_number big_number big_number big_number n a petitioner's taxable_income before the compensation deduction was dollar_figure dividends petitioner paid rllh a candollar_figure dividend in and a candollar_figure dividend in date out of petitioner's capital_account under canadian tax law at the time when a dividend was paid out of a capital_account the distribution was not taxable because it represented the nontaxable portion of capital_gain shareholder's equity petitioner reported shareholder's equity on its audited financial statements as follows fiscal_year shareholder's equity dollar_figure big_number we ignore earlier years due to the conversion of a portion of shareholder's equity into long-term liabilities richard l leonard at all relevant times mr leonard was petitioner’s president chief operating officer and chief financial officer mr leonard has extensive experience in the pipeline industry he began his career as a laborer at a kansas city pipeline firm after serving as an aviator in world war ii mr leonard returned to transmission pipeline work for midwestern constructors in tulsa oklahoma working on major postwar projects he held various positions for pipeline contractors in the 1950's serving as chief inspector for truckline gas co mr leonard was later appointed a superintendent by anderson brothers pipeline contractors where he was responsible for finding and bidding on construction jobs and handling public relations work in mr leonard moved to canada to assume the position of general superintendent for majestic contractors where he conducted all of the contract bidding and estimates during this time mr leonard was involved in the transcanada pipeline the first large diameter gas pipeline across canada in mr leonard became a shareholder and chief operating officer of canadian parkhill ltd parkhill during his tenure with parkhill the company constructed over miles of pipeline across the united_states and canada in mr leonard co-founded joyce leonard canada ltd joyce leonard he successfully negotiated a joint_venture contract for the company to perform miles of double jointing3 on the trans-alaska pipeline project following this project joyce leonard was awarded contracts for pipeline construction in australia and indonesia mr leonard became sole owner of joyce leonard in and renamed the company leonard pipeline contractors ltd the predecessor to petitioner in date mr leonard secured for petitioner a joint_venture contract for miles of double jointing and yard coating of pipe in saudi arabia in addition mr leonard facilitated the fulfillment of petitioner’s contracts for the construction or reconditioning of over miles of pipeline in the united_states canada and mexico between petitioner's pipeline work was slow in early mr leonard secured the all american pipeline project for petitioner4 wherein petitioner contracted to coat insulate and wrap miles of pipeline in texas arizona and california mr leonard developed the double-jointing process this process consists of cleaning and joining together two lengths of pipe using semi-automatic welding it is done in a covered facility under controlled conditions with the joined pipes then transported to the field mr leonard ultimately pleaded guilty to a criminal information filed against him in the southern district of texas for obtaining the all american pipeline contract through fraud he was sentenced to years of unsupervised probation and fined dollar_figure in february of that year petitioner formed a joint_venture with anchor wate co to perform this contract mr leonard personally guaranteed a dollar_figure million debt by petitioner to the royal bank of canada in connection with this project mr leonard was directly responsible for petitioner’s growth and success over the years despite his criminal conviction see infra note mr leonard had a favorable reputation in the pipeline construction industry petitioner relied entirely upon mr leonard and on his personal guaranty to obtain the necessary financial backing to participate in large pipeline construction projects compensation paid to mr leonard petitioner contracted for mr leonard’s management and consulting services through rllc for calendar years pursuant to a contract between rllc and petitioner rllc paid mr leonard for the services that he provided to petitioner for these years despite this financial arrangement mr leonard considered petitioner to be his employer mr leonard received the following amounts through the corporate entities and joint ventures with which he was involved petitioner was not permitted to pay compensation to mr leonard in and due to restrictions imposed by the royal bank of canada in connection with the line of credit extended to petitioner year payor amount not specified dollar_figure can rllc big_number can lph big_number can rllc big_number can lph big_number can personal_use of corporate car big_number can rllc big_number can rllc big_number can petitioner big_number can petitioner big_number can petitioner anchor wate joint_venture big_number petitioner texas coating supply big_number joint_venture petitioner anchor wate joint_venture big_number petitioner texas coating supply big_number petitioner bonus big_number wages big_number environmental builders inc big_number lpcc big_number the reasonableness of the dollar_figure dollar_figure bonus plus dollar_figure wages payment to mr leonard from petitioner in is at issue herein we note that mr leonard also received dividends from rllh in and in the respective amounts of candollar_figure and candollar_figure petitioner issued a check to mr leonard on date and mr leonard deposited it in his personal bank account simultaneously mr leonard transferred dollar_figure of the bonus back to petitioner while the record is unclear as to why mr leonard remitted the dollar_figure to petitioner it appears he believed that he owed petitioner this amount other circumstances mr leonard had open-heart surgery in and around he considered himself substantially retired in mr leonard’s doctor recommended that he limit his work to hours a day in pincite years of age mr leonard limited his work to hours a day days a week in mr leonard underwent a divorce pursuant to a date temporary support order of the superior court of arizona mr leonard was required to cause one of his corporations to pay his estranged wife a salary accordingly petitioner paid mrs leonard dollar_figure a month even though she did not work for petitioner in date the maricopa county superior court entered a decree of dissolution of marriage with regard to the leonards mr leonard and his estranged wife agreed to a property settlement divorce and separation agreement pursuant to this agreement mrs leonard received from mr leonard money and property valued at dollar_figure she also received a mercedes benz automobile which had previously been owned by petitioner as well as big_number class a shares of rllh stock following his divorce mr leonard decided to restructure his companies in light of his imminent retirement mr leonard retired in mid-1988 william t perks william t perks is a canadian chartered accountant and attorney who served as mr leonard's tax and legal adviser mr perks advised mr leonard on the formation and reorganization of his pipeline industry entities and on subsequent transactions mr perks also worked for petitioner in date mr leonard approached mr perks about the prospect of petitioner's paying mr leonard a bonus mr leonard believed that he was entitled to a bonus because the all american pipeline project was completed and petitioner had unencumbered financial resources to compensate him and petitioner’s activities were going to cease shortly mr leonard also believed he should receive from petitioner an amount equal to the value of the money and property dollar_figure awarded to his former wife in their divorce proceedings in connection with mr leonard’s request mr perks consulted with arthur andersen co arthur andersen in milwaukee wisconsin in may and date arthur andersen representatives prepared a written analysis r l leonard-analysis of reasonable compensation-lpc ltd ’s y e this analysis discussed nine factors relevant to whether compensation is reasonable and provided arthur andersen’s opinion with respect to the application of those factors to the proposed bonus arthur andersen concluded that five factors supported the reasonableness of the proposed bonus one was undeterminable and three contradicted the reasonableness of the proposed bonus arthur andersen recommended that petitioner document that part of the bonus was payment for past services rendered to petitioner and the reasons why prior years’ compensation levels were inadequate board approval of the bonus petitioner's board_of directors consisted of mr leonard and his son on date petitioner’s board_of directors held a special meeting to discuss the arthur andersen analysis and to determine the appropriate bonus to be paid to mr leonard the board understood that petitioner could deduct the bonus as an expense under u s tax law the board considered mr leonard’s service to petitioner and his prior compensation to determine the amount of the bonus the minutes of the board meeting prepared by mr perks state in pertinent part as follows the president through his efforts as early as and resultant personal and business contacts acquired from those efforts was able to have the corporation placed on the bidding list for all american pipeline company the president having acquired expertise in the coating and insulation of pipe in saudi arabia during through to was able to develop a new insulation process starting in which process was ultimately successful in securing the all american contract the contract the corporation notwithstanding the successful insulating process would have been unable to complete the contract without the financial backing of a public corporation or a joint_venture partner with financial backing the president through his thirty years association with the president of the permanent concrete ltd was able to secure a financially strong joint_venture partner for the corporation which partner secured for the joint_venture five million dollars dollar_figure of financing and obtained approximately twenty-three million dollars dollar_figure of bonding this was accomplished without giving up more than fifty percent of the participation which would have otherwise been the case the president the corporation’s share of the bank financing and indemnified the joint_venture partner anchor wate a subsidiary of permanent concrete ltd in respect of the bonding and further pledged his assets in support of the guarantee guaranteed personally the president has received no compensation from the corporation for and in addition the corporation was unable to pay compensation to its president in those years due to royal bank of canada credit line restrictions which credit line was also personally guaranteed by him not until now with the contract completed and the benefits from subsequent grading and fencing contracts awarded being realized is the corporation in a position to adequately compensate its president for his unique and extremely profitable contribution to the corporation accordingly the board unanimously agreed to pay mr leonard a dollar_figure bonus notice_of_deficiency respondent determined in the notice_of_deficiency that only dollar_figure of the dollar_figure compensation bonus and wages that petitioner paid mr leonard in was reasonable accordingly the notice_of_deficiency disallows the remainder of petitioner's claimed deduction for mr leonard's compensation opinion sec_162 permits a corporation to deduct a reasonable allowance for salaries or other compensation_for_personal_services actually rendered as an ordinary and necessary business_expense compensation payments are deductible under sec_162 if they are reasonable and paid purely for services rendered to the business sec_1_162-7 income_tax regs more specifically bonuses paid to employees are deductible only when made in good_faith and as additional compensation_for services actually rendered by the employees provided that when added to the salaries they do not exceed reasonable_compensation for the services rendered rapco inc v commissioner tcmemo_1995_128 affd 85_f3d_950 2d cir sec_1_162-9 income_tax regs courts generally focus on the reasonableness requirement 716_f2d_1241 9th cir revg and remanding tcmemo_1980_282 whether an expenditure that is claimed as a sec_162 deduction is reasonable is a factual question that must be decided considering all the facts and circumstances 399_f2d_603 9th cir affg tcmemo_1967_7 95_tc_525 affd 965_f2d_1038 11th cir petitioner bears the burden to show that it is entitled to a compensation deduction larger than that allowed by respondent rule a 290_us_111 503_f2d_359 9th cir affg tcmemo_1971_200 should petitioner prove respondent’s determination incorrect then we must decide the proper amount of reasonable_compensation based upon the entire record 61_tc_564 affd 528_f2d_176 10th cir courts consider numerous factors when determining the reasonableness of compensation the u s court_of_appeals for the ninth circuit to which an appeal in this case would lie uses the five-factor test enumerated in elliotts inc v commissioner supra pincite8 the employee’s role in the company a comparison of the compensation paid to the employee with the compensation paid to similarly situated employees in similar companies the character and condition of the company whether a conflict of interest exists that might permit the company to disguise dividend payments as deductible compensation and whether the compensation was paid pursuant to a structured formal and consistently applied program no single factor is dispositive pacific grains inc v commissioner supra pincite respondent essentially posits that mr leonard was regularly and fully compensated through petitioner's affiliated entities for the services he performed mr leonard controlled his means of compensation using whatever method was most tax advantageous in fact respondent argues mr leonard treated the various companies as his personal pocketbook further petitioner declared dividends over the years which also benefited mr leonard respondent argues that the payment to mr leonard was not intended to compensate him for personal services but rather to remove capital from petitioner because of mr leonard's imminent retirement respondent thus argues that the dollar_figure petitioner deducted as compensation_for its fiscal_year is not reasonable and that mr leonard was not undercompensated in prior years respondent contends at trial and on brief that petitioner is not entitled to deduct more than dollar_figure as total compensation_for however respondent alternatively argues that should the court determine that mr leonard was also entitled to a retirement benefit then petitioner would be entitled to deduct up to dollar_figure as total reasonable_compensation petitioner argues that it paid mr leonard inadequate compensation_for its first years of existence after consulting with qualified_tax advisers it decided to pay mr leonard dollar_figure in salary and bonus in as compensation_for the significant services he had provided over the years petitioner contends that mr leonard’s exceptional service to petitioner justifies the amount_paid bearing in mind the parties’ arguments we shall analyze and apply the factors enunciated by the u s court_of_appeals for the ninth circuit in order to determine reasonable_compensation for mr leonard role in company the first factor focuses on the compensated employee's importance to the success of the business pertinent considerations include the employee's position hours worked duties performed and the general importance of the employee to the company 536_f2d_289 9th cir affg in part and revg in part 59_tc_231 where a large salary increase is at issue such as here it is useful to compare past and present duties and salary payments elliotts inc v commissioner supra pincite whether an employee has personally guaranteed his employer’s debt is also a factor to be examined in this context in some instances an employee’s personal guaranty of his employer’s debt may entitle the employer to compensate the employee with additional salary 819_f2d_1315 ndollar_figure 5th cir affg tcmemo_1985_267 acme constr co v commissioner tcmemo_1995_6 boca constr inc v commissioner tcmemo_1995_5 the history of mr leonard's contributions to petitioner must be considered rather than just his contributions during the year in issue because the compensation petitioner paid to mr leonard during the year in issue represents in part an attempt to rectify prior undercompensation respondent readily admits that mr leonard was petitioner's key_employee and the main reason for its success as president he was the driving force behind the business from its inception and his personal services were almost single-handedly responsible for its success mr leonard developed cost-effective methods of double jointing and coating that gave petitioner a competitive advantage in the pipeline construction industry his contacts and experience contributed to petitioner's business by his ability to obtain contracts from all over the world mr leonard was dedicated to his work and essential to petitioner's business while mr leonard was the driving force behind petitioner he was in the process of retiring during the year in issue and reduced his workload to hours a day days a week while these hours are less than he worked in previous years mr leonard's reduced workload must be balanced against hi sec_40 years of knowledge and experience in the industry we are mindful that petitioner's sole activity during the year in issue was to report income which had previously been earned on a contract-completed basis however because part of the bonus was attributable to mr leonard's past services we consider this fact unimportant finally mr leonard personally guaranteed petitioner’s dollar_figure million debt to the royal bank of canada while mr leonard testified that guaranteeing debts was his normal method of conducting business we believe that the personal guaranty further illustrates mr leonard's importance to petitioner see owensby kritikos inc v commissioner supra this factor favors petitioner external comparison this factor compares the employee’s compensation with that paid_by similar companies in similar industries for similar services elliotts inc v commissioner f 2d pincite see sec_1 b income_tax regs both parties rely on expert opinions for purposes of determining external comparison as the trier of fact we must weigh the evidence presented by the experts in light of their demonstrated qualifications in addition to all other credible_evidence 480_f2d_171 9th cir affg 54_tc_493 97_tc_496 however we are not bound by any expert opinion that is contrary to our judgment 227_f2d_753 6th cir affg tcmemo_1954_139 92_tc_312 84_tc_722 we may be selective in deciding to accept or reject expert opinion in its entirety or accept selective portions of it 304_us_282 813_f2d_837 7th cir affg 85_tc_56 102_tc_149 we may reach a decision based on our own analysis of all the evidence in the record 538_f2d_927 2d cir affg tcmemo_1974_285 respondent’s expert emmett james brennan iii prepared a report and testified as to compensation in corporate pay practices mr brennan is president of a compensation consulting firm who has testified before this court on numerous occasions see eg pmt inc v commissioner tcmemo_1996_303 lumber city corp v commissioner tcmemo_1996_171 pulsar components intl inc v commissioner tcmemo_1996_129 alondra indus ltd v commissioner tcmemo_1996_32 guy schoenecker inc v commissioner tcmemo_1995_539 mad auto wrecking inc v commissioner tcmemo_1995_153 boca constr inc v commissioner tcmemo_1995_5 l b pipe supply inc v commissioner tcmemo_1994_187 mortex manufacturing co v commissioner tcmemo_1994_110 thomas a curtis m d inc v commissioner tcmemo_1994_15 automotive inv dev inc v commissioner tcmemo_1993_298 diverse indus inc v commissioner tcmemo_1986_84 owensby kritikos inc v commissioner tcmemo_1985_267 mr brennan determined that dollar_figure was the highest maximum amount of total compensation_for the highest-paid position that could be attributed to mr leonard for tax_year ending date he further concluded that the highest average amount of total compensation_for the highest-paid position that could be attributable to mr leonard was dollar_figure mr brennan based these conclusions on surveys of the amounts fabricated metals manufacturing companies and general construction companies with revenues equal to petitioner’s would pay a chief_executive_officer none of these industries was specifically involved in the pipeline construction industry mr brennan computed his compensation figures based solely upon gross_sales revenues his report neither included an amount representing retirement benefits for mr leonard8 nor analyzed amounts paid to mr leonard in prior years at trial mr brennan testified that petitioner substantially underpaid mr leonard prior to mr brennan also admitted that providing a financial guaranty would justify mr leonard's eligibility for those highest average and highest maximum numbers that he determined petitioner relied on two pipeline industry experts michael wagner and michael kesner both testified as to the unique features of the pipeline construction industry and its relatively small size mr wagner has been employed as a senior executive officer in major canadian pipeline construction companies and at the time of trial was an industry consultant his testimony regarding large bonus payments was based solely upon his personal receipt of a dollar_figure bonus from his employer o j pipelines in and was not tied to any specific formula in mr wagner's opinion a the gross_sales revenue figure mr brennan used for petitioner was incomplete it did not include any part of either the net_income or the gross revenue from the all american contract in the event we determine which we do that mr leonard is entitled to a retirement benefit mr brennan would allocate dollar_figure for such benefit o j pipelines' gross revenues exceeded dollar_figure million reasonable range for mr leonard's base salary was dollar_figure- dollar_figure a reasonable range for his bonus was dollar_figure- dollar_figure mr kesner is an expert specializing in compensation matters for arthur andersen in chicagodollar_figure he concluded that mr leonard’s compensation was reasonable for three alternative reasons mr leonard was undercompensated by dollar_figure-dollar_figure in prior years the compensation was a deal bonus for locating and delivering profitable business opportunities and part of the bonus was a lump-sum payment in lieu of a formal retirement_plan mr kesner used survey data and assumed revenues of dollar_figure million for each of the years we are unpersuaded by the analyses performed or opinions expressed by either respondent’s or petitioner’s experts as in previous cases we do not accept mr brennan's conclusions because they are not based on data from businesses that are sufficiently similar to petitioner’s or that have the significant characteristics of a specialized industry messrs wagner and kesner were also unconvincing because they were not objective and simply promoted petitioner’s position see 92_tc_101 we do not accept their conclusions mr kesner was not involved in arthur andersen's advice to mr perks and petitioner character and condition of company the next factor considers the company's character and condition relevant considerations are the company’s size as measured by its sales net_income or capital value the complexities of the business and general economic conditions elliotts inc v commissioner f 2d pincite see 93_f2d_816 9th cir petitioner a relatively large company was engaged in the highly specialized pipeline construction business the pipeline construction industry is noted for periods of growth and subsequent decline mr leonard's double-jointing process which was a unique method at the time helped promote petitioner's business petitioner's income stream was dependent upon mr leonard's ability to successfully bid and perform lucrative contracts the ratio of mr leonard's bonus to gross_sales for that year i sec_29 percent dollar_figure divided by dollar_figure the ratio of mr leonard's bonus to petitioner's taxable_income before the compensation deduction i sec_34 percent dollar_figure divided by dollar_figure these percentages are reasonable in light of mr leonard's work for petitioner over the years as well as the prior years' undercompensation this factor favors petitioner conflict of interest the next factor considers potential conflicts of interest this factor examines whether a relationship exists between the company and employee that might permit the company to disguise nondeductible corporate_distributions as sec_162 deductible compensation we must closely scrutinize cases where the paying corporation is controlled by the compensated employee owensby kritikos inc v commissioner f 2d pincite4 elliotts inc v commissioner supra pincite7 however the mere existence of such a relationship when coupled with an absence of dividend payments does not necessarily lead to the conclusion that the amount of compensation is unreasonably high id pincite we adopt the perspective of an independent investor to determine whether the investor would be satisfied with the company’s return on equity after the compensation at issue was paid id pincite return on equity is calculated by dividing taxable_income before net operating losses by the shareholder’s equity id pincite mr leonard was not a direct shareholder of petitioner rather he indirectly owned all of petitioner's stock by virtue of his ownership of rllh thus this is a scenario that we must closely scrutinize for the effects of a conflict of interest while petitioner declared dividends to rllh in and petitioner neither directly paid dividends to mr leonard nor paid dividends during the year in issue petitioner's compensation scheme was bonus-heavy and salary-light which may suggest masked dividends see rapco inc v commissioner f 3d at however in evaluating the compensation payment from the perspective of a hypothetical investor we divide taxable_income before net operating losses by the shareholder's equity for each fiscal_year taxable_income shareholder's return on fiscal_year before nol's equity_investment dollar_figure dollar_figure -15 big_number big_number petitioner's rate of return for would surely satisfy a hypothetical investor see elliotts inc v commissioner supra pincite an average return on equity of percent would satisfy an independent investor the evidence bearing on this factor weighs in both directions petitioner did not declare dividends in and mr leonard's compensation was bonus-heavy and salary-light on the other hand a hypothetical investor would be satisfied with the annual return we thus consider this factor neutral internal consistency the final factor focuses on whether the compensation was paid pursuant to a structured formal and consistently applied program bonuses not paid pursuant to such plans are suspect id the record does not indicate that petitioner determined mr leonard’s bonus based on any consistently applied formula or plan neither is there information in the record regarding petitioner's other employees it is however permissible to pay and deduct compensation_for services performed in prior years see 281_us_115 american foundry v commissioner t c pincite petitioner did not compensate mr leonard during and for two reasons first the pipeline construction industry is volatile and petitioner's earning history reflects the classic cycle of boom and bust petitioner was unable to pay mr leonard a bonus prior to because of economic instability secondly petitioner’s board_of directors determined that the restrictions placed by the royal bank of canada prohibited petitioner from compensating mr leonard during these years in the board concluded that petitioner benefited from mr leonard’s securing the right to bid on and participate in large pipeline construction projects as well as his expertise and reputation in the coating and insulation of pipe while we are mindful that petitioner's board consisted only of mr leonard and his son we nonetheless believe and thus hold that petitioner's compensation to mr leonard represented in part an attempt to rectify his and undercompensation see lucas v ox fibre brush co supra and in the fact that mr leonard was compensated by the petitioner-anchor wate joint_venture in and does not continued part an attempt to recoup from petitioner part of the payments mr leonard had made pursuant to his divorce settlement we are also mindful that high compensation is more reasonable when there is a corresponding lack of fringe_benefits such as pension plans or stock_options which might normally be expected 853_f2d_1267 5th cir affg tcmemo_1986_407 in these situations an employer may pay more compensation than it would have paid had it offered a pension or profit sharing plan petitioner did not have any type of retirement_plan here on the one hand there was no formal consistent compensation program and the bonus was partially an attempt to recoup from petitioner part of the payments mr leonard had made pursuant to his divorce settlement on the other hand the compensation was paid in part to correct prior undercompensation and to rectify the absence of a pension_plan accordingly this factor is neutral amount of reasonable_compensation having thoroughly considered the evidence and in light of the factors enunciated by the u s court_of_appeals for the ninth circuit we conclude that petitioner paid excessive_compensation to mr leonard in fiscal_year however in light of the value of continued change this conclusion mr leonard’s services we are persuaded that petitioner is entitled to a greater compensation deduction than that allowed by respondent any attempt to determine reasonable_compensation with mathematical precision is impossible see eg 411_f2d_1282 using our best judgment we conclude that dollar_figure would represent a reasonable amount of compensation to mr leonard for the dollar_figure amount represents dollar_figure as a lump-sum retirement payment and dollar_figure for salary and bonus see 61_tc_564 affd 528_f2d_176 10th cir see also 39_f2d_540 2d cir to reflect concessions and the foregoing decision will be entered under rule


department of the treasury u internal_revenue_service tax exempt ando government entities division uil index washington d c contact person identification_number telephone number set p-te2z legend o j o i l q d i i - z l v l o l t y a o o h i w u dear this responds to a letter from m’s authorized representatives who have requested rulings under sec_501 and sec_512 of the internal_revenue_code on m's behalf facts the information submitted indicates that m a non-profit organization is recognized as exempt from federal_income_tax as a business league within the meaning of sec_501 of the code m has more than x member institutions from many countries membership in m is open to institutions and entities involved in the b industry as part of its tax-exempt purposes m seeks to promote practices conducive to the efficient conduct of the business of its members in b including the development and maintenance of standard documentation for b and sound f management practices to inform its members of legislative and administrative developments affecting b and to create a forum for the discussion of issues of relevance to participants in b transactions m works with other organizations to amend statutory law to achieve a greater recognition of the enforceability of early termination and c provisions of contractual arrangements m also provides information and guidance to foreign bodies and national authorities with responsibility for financial activity on how to reform existing legal structures to eliminate obstacles to the effective use of collateral in contractual arrangements m has published various standard agreements and sets of definitions for use in documenting b transactions m’s master agreements have been used by many dealers and end users of b around the world to facilitate cross-product e and to document their transactions the master agreements allow two parties to document a wide variety of privately negotiated b transactions under a single contract the master agreements permit the designation of an early termination_date of all transactions under a single agreement following the occurrence of an event of default after the occurrence of an event of default by one party and the early termination of a master agreement by the other party that master agreement provides for the other party to calculate a single lump sum amount reflecting the then positive or negative values of all transactions documented under that master agreement this calculation of a single lump sum amount is commonly referred to as c m has sought advice from leading law firms in various jurisdictions around the world concerning the enforceability of c in bankruptcy for several reasons first it is necessary to know whether c is enforceable in bankruptcy in order to appropriately measure and manage f second in order for banks acting as b dealers to maintain capital against their b positions with individual counterparties on a net rather than a gross basis regulators in the united_states and other major jurisdictions require that banks have available legal opinions addressing the enforceability of cin bankruptcy those regulators also require that the c opinions d be updated annually m commissions the requisite d on behalf of its members the d cover c laws in jurisdictions and bilateral and multibranch transactions in jurisdictions where dealers and end users contract substantial amounts of b business these d enable m's members to reduce their f and the capital required to support their businesses m is the only organization providing d to entities regularly engaging in b transactions m and n an unaffiliated limited_liability partnership formed p in order to make use of and deliver an on-line legal information service known as q to m's members m entered into the transaction in order to promote its tax-exempt purposes in a more simple and efficient manner m has a percent interest in p's net_income and net losses qis an exclusive on-line legal information service and software product that extracts specific and limited data from and provides access to the d legal memoranda on several jurisdictions and a library compilation of relevant c legislation the data extracts identify key issues for regulatory capital and f management purposes enable the user to determine quickly and efficiently whether the relevant country covered by the d permits gc and refer the user to specific locations in the d for detailed answers q does not provide the user with legal advice on the laws of the jurisdiction covered by the d q and annual updates of q are available only to m's members through the use of a password- protected website maintained by m on behalf of p members subscribing to q are charged an annual access fee based upon the type of membership in m rather than the frequency of use of or benefit received from q all subscribing members receive the same access to q regardless of the amount of the access fee paid m will continue to provide the d and the annual updates to all of its members only through a password-protected portion of its own website n is permitted to develop and sell software outside of p tailored to the specifications of individual members of m and non-members based upon e advice obtained by them and addressing e issues in jurisdictions not covered by m's d a management committee consisting of two members appointed by m and two members appointed by n manages the day-to-day business affairs of p determinations of the management committee require the unanimous consent of the committee members the management committee has appointed an individual employed by an affiliate of n to serve as the chief operating officer to conduct the business of p but p will bear only percent of his salary and all related costs not to exceed dollar_figure annually p has also agreed to pay the salary and related costs of any employee of m or n spends substantially_all of his or her time marketing q at the request of the management committee m anticipates that such employee if any will spend no more than percent of his or her time on p activities otherwise neither m nor n will be charging p for the time of its officers partners or employees devoted to p's business activities or its affiliates if that employee all voting and other rulings requested the following rulings have been requested m's share of net_revenues from p will not be characterized as unrelated_business_taxable_income under sec_512 of the code m's share of net_revenues from p will not jeopardize m's tax-exempt status under sec_501 of the code ’ law sec_501 of the code exempts from federal income_taxation organizations described in sec_501 sec_501 of the code describes business_leagues not organized for profit and no part of the net_earnings of which inures to the benefit of any private_shareholder_or_individual sec_511 of the code imposes a tax on the unrelated_business_taxable_income of organizations described in sec_501 sec_512 of the code provides that the term unrelated_business_taxable_income means the gross_income derived by any organization from any unrelated_trade_or_business regularly carried on by it less certain deductions which are directly connected with the carrying on of such trade_or_business both subject_to certain modifications sec_512 of the code requires a tax-exempt_organization with a partnership_interest in a partnership regularly carrying on an unrelated_trade_or_business to include its share of the partnership’s gross_income and related deductions arising from such unrelated_trade_or_business in computing its unrelated_business_taxable_income 200500uz9 sec_1_513-1 of the income_tax regulations provides that a tax-exempt organization's gross_income subject_to tax under sec_511 is includible in the organization's computation of unrelated_business_taxable_income if the income is derived from a trade_or_business such trade_or_business is regularly carried on by the organization and the conduct of such trade_or_business is not substantially related other than through the production of funds to the organization's performance of its exempt functions sec_1_501_c_6_-1 of the regulations states that a business league within the meaning of sec_501 of the code is an association of persons having some common business_interest the purpose of which is to promote such common interest and not to engage ina 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 revrul_66_338 1966_2_cb_226 describes an organization formed to promote the interests of a particular retail trade by advising members on their individual business problems the organization's field representatives not only advise the members on improvements to the stores but also inform them about office and store supplies fixtures and display accessories and merchandising and electronic services available to its members at low prices the ruling finds that the organization provides individual members with an economy and convenience in the conduct of their individual businesses by making the supplies and services available at a cheaper price than what the members would pay if they obtained the supplies and services on their own therefore the activities constitute particular services to individual members as distinguished from activities aimed at improving the business conditions of the trade as a whole revrul_67_182 1967_1_cb_141 describes a nonprofit organization formed to establish and maintain a private library of electric logs maps oil publications and oil information services for its members’ use and as an aid in their oil exploration businesses the material for the library is furnished by the members membership in the organization is limited to a small_group the ruling finds that the organization is making specialized information available to its members on a cooperative basis this serves as a convenience and economy in the conduct of their businesses operation of the library is an activity which constitutes the performance of particular services for individual persons furthermore since membership is limited and the facilities of the organization are made available only to participating members the organization's activities are not aimed at the improvement of business conditions in the industry as a whole accordingly the ruling holds that the organization does not qualify for exemption under sec_501 of the code revrul_69_106 1969_1_cb_153 describes a nonprofit organization formed and operated by a group of manufacturers to carry on research_and_development projects of common interest to their industry a committee of the membership agrees on what projects will be undertaken no research is conducted for any particular member all research projects are financed solely by the dues of the members the results of the research are made available only to members although membership in the organization is open to all businesses in the industry on an equal basis not all of the businesses in the industry are members the ruling finds that in order to be exempt under sec_501 of the code a research organization must make the results of its research available to all of the members of an industry since the organization distributes the results of its research only to its members its activities are not aimed at the improvement of business conditions for the entire industry accordingly the ruling holds that the organization does not qualify for exemption from federal_income_tax under sec_501 in revrul_73_386 1973_2_cb_191 a nonprofit membership_organization secures and supplies businesses with job injury histories of prospective employees upon request the service is available to member and non-member businesses alike and a charge which was set at an amount calculated to return the organization a profit on the undertaking is made for the service the ruling points out that the services involved go well beyond any mere development and promotion of efficient business practices in respect to a business community as a whole in providing the service in question the organization is furnishing individual members of the business community with a regular commercial-type business service required and utilized in day-to-day operations of the businesses that request the service as such the service is not one that promotes the business interests of the members in common or as a whole but rather is an activity that constitutes the performance of a particular service of a commercial nature for individual businesses and thus constitutes income from unrelated_trade_or_business within the meaning of sec_513 of the code revrul_78_51 1978_1_cb_165 concerns a local bar association that is exempt under sec_501 of the code as one of its activities the association purchases standard legal forms from the state bar association and sells them to its member attorneys at a percent markup on cost these forms are also available to all attorneys through the state bar association the ruling finds that by selling standard legal forms to its members the association is furnishing individual members with a regular commercial service the service does not promote the improvement of business conditions in one or more lines of business and therefore does not contribute importantly to the accomplishment of the association’s exempt functions under sec_501 accordingly the ruling holds that the sale of standard legal forms by the association to its members is unrelated_trade_or_business within the meaning of sec_513 693_f2d_525 5th cir concerned a business league exempt from taxation under sec_501 of the code the league’s membership consists of credit unions in the state of louisiana the league maintained and published a loose-leaf library service of all statutes regulations and other legal materials relating to the operation of a credit_union alternatives to the service were limited and the league made the service available to its members for a fee data processing services and debt collection services through commercial third party providers to its members for a fee based upon the extent of a member's use of the services some members did not subscribe to the data processing and debt collection services because they in addition the league provided either had these services internally or obtained the services from a different commercial provider the court set out a two-step test for determining whether business activities have a substantial relationship to the exempt purposes of an organization under this test an income- producing activity is substantially related to the exempt_function of the organization if the activity is unique to the organization’s tax-exempt purpose and direct benefits flowing from a business league’s activities inure to its members in their capacities as members of the organization the court stated that the publication and maintenance by the league of a loose-leaf library service compiling all the statutes regulations and other legal materials pertinent to the operation of a credit_union would exemplify the sort of service unique to the league’s tax- exempt_function such a service provided to league members for a subscription fee would bear a unique relationship to the league’s purpose of promoting the development of credit unions presumably alternative access to such a service would be limited and its narrow scope would make it singularly useful to member credit unions any business league activity so distinctively oriented toward members seemingly would bear a substantial relationship to its purpose next the court stated that in evaluating the relationship between the activities and purposes of a business league the capacity in which benefits are received by the organization’s members is as important as the unique character of the organization’s activities for a substantial relationship to exist any direct benefits flowing from a business league’s activities must inure to its members in their capacities as members of the organization thus when a business league’s uniquely relevant activities produce inherently group benefits that accrue to its members as members a substantial relationship exists within the meaning of sec_513 of the code finally the court found that the data processing and debt collection services provided a benefit to only participating members and did not promote the common interest of all its members as a result the court affirmed that such activities were not substantially related to the league's tax- exempt purposes 869_f2d_884 sth cir concerned a trade_association that is tax-exempt under sec_501 of the code membership in the association was open to owners of multi-family units and service companies the association regularly developed reviewed and published a landlord manual containing updated information on texas landlord and tenant law not present in other commercially available landlord manuals and standard real_estate lease forms containing comprehensive legal provisions not present in other standard forms the association sold the manual and the forms only to its members and used the materials in its educational and legislative programs the court found the association's development and updates of the manual and forms to be unique in addition the court found that the materials and the association's educational programs and legislative efforts contributed to the standardization of rights and duties under texas landlord- tenant law and the improvement of landlord practices and legislation in texas the court held that the association's activities were substantially related to the association's tax-exempt purposes even though the association charged its members fees for the manual and forms and the fees were in direct proportion to the immediate benefit received from the materials analysis at issue is whether m’s provision of q through p solely to its members is unrelated_trade_or_business or jeopardizes m’s status as an organization described in sec_501 of the code if the activity of providing q is determined to be related to m’s exempt_purpose then the income m receives from p is not income derived from an unrelated_trade_or_business under sec_512 and m’s exemption under sec_501 c is not at risk if m engages in the activity the facts presented show that m obtains d from lawyers in various countries concerning the enforceability of c in bankruptcy such d are updated annually m commissions the d on behalf of its members mis the only organization providing d q will provide on-line access to the d legal memoranda and legislation as well as improved searching capabilities generally gross_income of an exempt_organization subject_to the tax imposed by sec_511 of the code is includible in the computation of unrelated_business_taxable_income if it is income from a trade_or_business such trade_or_business is regularly carried on by the organization and the conduct of such trade_or_business is not substantially related other than through the production of funds to the organization’s performance of its exempt functions trade_or_business p is engaged in a trade_or_business within the meaning of sec_1_513-1 of the regulations by selling q to m’s members the d and the status of c legislation in various countries will continue to be available through a password-protected portion of m’s website to members at no additional_charge p offers data extracts and text of the d legal memoranda and legislative updates of various countries for an annual access charge that varies according to the member’s type of membership moreover p will allocate all of its net losses from the sale of q equally between m and n and percent of its net_income to m therefore p can be deemed to be selling q with the intent of generating income for its partners m and n regularly carried on in addition m will continually contribute the right to use the the sale of q will be regularly carried on because p will offer q and updates of q to m’s members on an ongoing basis updated d and related advice it commissions to p n will develop new releases of q software based upon such annual updates and its own information resources p will be offering these new releases of q to m’s members m and n will carry out marketing activities set forth by the management committee at least initially although p will only sell q to m’s members and not to members of the public the marketing and sales activities of p will be of such frequency and continuity that they will be considered to be regularly carried on within the meaning of sec_1_513-1 of the regulations substantially related to exempt purposes in determining whether there is a substantial relationship between the business activities in question and the accomplishment of m’s exempt purposes it is necessary to understand m’s tax-exempt purposes m’s purposes include promoting practices conducive to the efficient conduct of the business of its members in b including the development and maintenance of standard documentation for b practice and informing members of legislative and administrative developments affecting the b industry as a means of accomplishing its purposes m obtains d on behaif of its members which cover c laws and bilateral multibranch transactions these d enable members to reduce their f and the capital required to support their businesses q provides access to the d legal memoranda on several jurisdictions and a library compilation of relevant c legislation according to louisiana credit_union league supra two factual elements are critical to finding the necessary substantial relationship between q and m’s purposes the unique nature of q vis-a-vis m’s purposes and the capacity in which benefits are received by m’s members m’s activities in connection with the sale of q satisfy the uniqueness test because there is no alternative service similar to q available and q will be available only to m’s members and will not be distributed to the public in a commercial manner q is a unique service because it is an exclusive on-line resource containing d and legal memoranda on c laws and various jurisdictions worldwide alternatives to q and the d are not available elsewhere because only m's members will receive access to q through a password- protected website maintained by m on behalf of p q will not be distributed to the public in a commercial manner q is an extension of m's efforts to promote the development and maintenance of sound f management practices and the efficient conduct of b transactions by its members in a new simple and efficient manner q enables members to determine more easily the status of c legislation the enforceability of c provisions and the extent the d can be used to reduce legal and f in b transactions because m is the only organization providing d to its members m's continuous review compilation and update of c legislation and the d for q are analogous to the compilation of the loose-leaf library service in louisiana credit_union leaque supra or the compilation of the landlord manual and sale of real_estate lease forms in texas apartment ass’n supra and unique to m’s exempt purposes the d and q are distinguishable from the standard commercially-available legal forms sold by the bar association in revrul_78_51 supra in evaluating the relationship between q and the purposes of m the capacity in which benefits are received by m’s members is important for a substantial relationship to exist any direct benefits flowing from q must inure to the members of m in their capacities as members because q serves the common business_interest of m’s members and because the benefits resulting from it accrue to the members in their membership roles a substantial relationship exists between q and m’s exempt_purpose the benefits received by members will not be directly proportional to the membership dues paid and the activities will not be those commonly provided by for-profit organizations although m will charge its members a fee to access q the fee will be based upon the type of membership in m and not upon the frequency of use or amount of benefit received from using q this is not an instance of m providing individualized advice or services tailored to the specific needs of individual members as was the case in revrul_66_338 and revrul_73_386 supra in revrul_73_386 for instance an individual member could request the organization to obtain job injury histories on that member’s perspective employees thus the organization was performing a particular service for an individual member in the day-to-day operation of its business in contrast q is not tailored to the specific needs of each subscribing member q provides an additional resource to the online access of the text of the d annual updates and status of c legislation the members already have simply as part of their membership benefits all members subscribing to q will have access to the same materials regardless of the fee paid q will not be providing members with legal advice or particularized services members using q would still need to analyze independently whether a particular d applies to their individual transactions therefore q does not provide m's members with individualized service at an economy or convenience the benefits of q are not proportionate to the fees paid_by m's members and the service is not commercially available elsewhere accordingly m's activities in connection with q are unique in promoting the efficient conduct of business in the b industry and are substantially related to m’s exempt purposes the provision of the d and q to m’s members is distinguishable from the activities described in revrul_67_182 supra n that ruling the organization operated as a cooperative arrangement among a limited group of industry members to share material among themselves in m’s case m obtains the d itself for the benefit of all its members unlike the closed group described in revrul_67_182 m’s membership rolls are open to any entity dealing in b m has more than x members the services described in revrul_69_106 supra appear similar at first glance to m’s d services and q the organization in revrul_69_106 was formed by a group of manufacturers to carry on research on development projects agreed upon by a committee of the membership the ruling concludes that a research organization must make the results of its research available to all members of an industry in order to be exempt under sec_501 of the code however the facts in the ruling are distinguishable from the facts concerning m m is not a research organization and does not carry out research projects at the behest and for the benefit of individual members or subgroups of members rather m secures d from private attorneys worldwide the d are valuable to the entire b industry not just to certain members m makes the d available to all members as a member benefit q merely provides enhanced access to d and other information that is already available to m’s members through their membership based on the foregoing m’s involvement in p which entails providing q to m’s members is related to m’s exempt purposes therefore the income derived by m from p will not be deemed income derived from unrelated_trade_or_business within the meaning of sec_512 of the code additionally m’s activities with respect to q and consequently the income m derives from p will not jeopardize m’s exemption under sec_501 conclusion accordingly based on the information submitted we rule as follows m’s share of net_revenues from p will not be characterized as unrelated_business_taxable_income within the meaning of sec_512 of the code 2005060k8 m’s involvement in p including the provision of q to m’s members and m’s receipt of a share of p’s net_revenues will not jeopardize m’s exemption as an organization described in sec_501 c of the code these rulings are made on the understanding that there will be no material changes in the facts upon which they are based except as specifically ruled upon above no opinion is expressed concerning the federal_income_tax consequences of the transactions described above under any other provision of the code this ruling letter is directed only to the organization that requested it sec_6110 of the code provides that it may not be used or cited as precedent pursuant to a power_of_attorney on file in this office a copy of this letter is being sent to m’s authorized representative a copy of this letter should be kept in m’s 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 sincerely joseph chasin manager exempt_organizations technical group