t c no united_states tax_court the limited inc and consolidated subsidiaries petitioner v commissioner of internal revenue respondent docket no filed date p’s subsidiary d a domestic_corporation is a credit card bank issuing private label credit cards to customers of p fl is a controlled_foreign_corporation with respect to p f2 is a foreign_subsidiary of fl fl funded f2 which purchased certificates of deposit cds from d held the cds are u s property within the meaning of sec_956 i r c and not deposits with persons carrying on the banking business within the meaning of sec_956 a i r c held further the cds are attributed to fl pursuant to sec_1_956-1t temporary income_tax regs fed reg date held further p must include the increase of investment in u s property in gross_income pursuant to sec_951 b i r c joel v williamson roger j jones frederic l hahn daniel a dumezich russel r young neil b posner james p fuller kenneth b clark ronald b schrotenboer william f colgin jr and patricia a yurchak for petitioner kristine a roth james e kagy donald k rogers and john budde for respondent halpern judge petitioner is the common parent_corporation of an affiliated_group_of_corporations making a consolidated_return of income the affiliated_group by notice_of_deficiency dated date the notice respondent determined deficiencies in federal_income_tax for the affiliated_group for its taxable years ended date and date and respectively in the amounts of dollar_figure and dollar_figure respectively many of the adjustments giving rise to the deficiencies determined in the notice have been settled and this report addresses only whether certain transfers during were investments in u s property for purposes of those provisions of the internal_revenue_code dealing with controlled_foreign_corporations unless otherwise indicated all section references are to the internal_revenue_code in effect for the years in issue findings_of_fact introduction some of the facts have been stipulated and are so found the stipulations of facts filed by the parties with accompanying exhibits are incorporated herein by this reference petitioner has its principal_place_of_business in columbus ohio business of petitioner petitioner is one of the largest specialty retailers in the united_states during the years at issue it sold its merchandise both in its own stores and by catalog among the well-known stores owned by petitioner were the limited lane bryant lerner new york victoria’s secret and abercrombie fitch petitioner earned its income primarily from the sale of garments a foreign_subsidiary of petitioner manufactured many of those garments or contracted with others for their manufacture payments by customers merchandise sold by petitioner is paid for with cash by check or by credit card petitioner accepts two types of credit cards petitioner’s private-label credit card which is honored only in one or more of petitioner's stores and a in the stipulations the parties have adopted the convention of referring to the affiliated_group as petitioner hereafter we will use the term petitioner to refer both to the affiliated_group and to any member so long as specific identification of that member is unnecessary credit card issued by a third-party bank or other financial_institution and honored by many merchants petitioner’s private-label credit cards prior to petitioner issued no credit cards in petitioner acquired two retailers of women’s clothing that had preexisting open-end credit plans e credit plans providing for repeated extensions of credit with no fixed dates for repayment petitioner organized two new subsidiary corporations to take over the operation of those credit plans those two corporations were limited credit services inc limited credit a delaware corporation and world financial network inc wfn also a delaware corporation limited credit administered petitioner's open-end credit operations wfn funded the consumer credit associated with the open-end credit systems through a receivables financing facility eventually limited credit and wfn came to operate credit plans for some of petitioner's other stores the credit plans operated by limited credit were established under the retail installment_sales acts enacted in each of the states the district of columbia and puerto rico limited credit was required to comply on a state-by-state basis with varying limitations on interest rates minimum finance_charges delinquency charges uncollectible check fees and methods for calculating the average daily balance of accounts organization of world financial network national bank in ralph e spurgin spurgin joined petitioner’s organization and became president of limited credit spurgin believed that petitioner could increase the profitability of its credit card operations if it could avoid the various states' retail installment_sales acts in particular he believed that if petitioner could avoid setting interest rates on a state-by- state basis and charge a uniform rate it could earn an additional dollar_figure million dollars in revenue spurgin believed that a way to avoid the states’ retail installment_sales acts was in some manner to employ a national bank to extend credit to customers of the stores a bank that would not be subject_to the various states' retail installment_sales acts the bank_holding_company act of bhca ch 70_stat_133 currently codified pincite u s c secs concerns the ownership of banks in general bhca prohibits companies that own banks from engaging in any busine sec_2 a national banking association is permitted to charge interest for any extension of credit at the rate permitted by the state in which it is located or alternatively a rate percent greater than the 90-day discount rate in effect in the federal reserve district in which the national banking association is located whichever is higher u s c sec_85 c f_r sec 439_us_299 prior to the decision in marquette the majority of analysts assumed that a national bank was not permitted to export the interest rate permitted by the state in which it was located but rather was subject_to the usury restrictions imposed by each of the states in which its credit card customers resided other than banking or a business closely related to banking see u s c sec in in part to deal with the problem of nonbank banks institutions regulated as banks but exempt from key provisions of bhca because of their failure to meet the definition of a bank under bhca congress amended bhca see the competitive equality banking act of ceba publaw_100_86 sec b 101_stat_552 ceba broadened the s rept accompanied s 100th cong 1st sess which substantially as passed by the senate became publaw_100_86 101_stat_552 competitive equality banking act of ceba publaw_100_86 stat see h conf rept immediately prior to ceba the bank_holding_company act of bhca ch 70_stat_133 currently codified pincite u s c secs defined a bank as an institution that both accepted demand deposits and made commercial loans u s c c and the senate comm on banking housing and urban affairs the committee believed that that definition created a loophole the nonbank loophole for a bank that refrained from one of those two activities and thus was not considered a bank for purposes of bhca for instance the committee believed that a nonbank bank could offer interest bearing now accounts rather than demand deposits and escape regulation under bhca s rept supra pincite the committee found the impetus for nonbank banks stems primarily from large diversified companies wanting to invade the banking business while avoiding the regulatory restraints of the bank_holding_company act thus some of the nation’s largest retailing securities and insurance_companies have been able to enter the banking business through the nonbank loophole while banks are prevented from entering those businesses by the bank_holding_company act id pincite the committee believed that a failure to close the nonbank loophole would cause a number of problems in the banking system including creating new competitive inequalities for bank holding_companies whose activities under bhca must be closely continued definition of a bank for purposes of bhca but excluded from that definition institutions engaging only in credit card transactions credit card banks thus a company like petitioner which was engaged in neither banking nor a banking related business could own a credit card bank without violating bhca ceba cleared the way for petitioner to own a bank that could charge a uniform rate of interest on credit card sales as of date world financial network national bank wfnnb was organized under the national bank act see u s c continued related to banking id pincite to close the nonbank loophole congress expanded the definition of the term bank in bhca to include any bank whose deposits are insured by the federal deposit insurance corp as well as any institution that accepts demand deposits or deposits that the depositor may withdraw by check or similar means for payment to third parties and engages in the business of making commercial loans see u s c sec c as amended by ceba sec_101 sec_101 stat congress maintained certain express exclusions from the definition of the term bank and provided certain additional limited exceptions for among other institutions credit card banks see u s c sec c s rept supra pincite an institution qualifies as a credit card bank if it engages only in credit card operations does not accept demand deposits or deposits that the depositor may withdraw by check or similar means for payment to third parties or others does not accept any savings or time deposits of less than dollar_figure except for certain deposits held as collateral maintains only one office that accepts deposits and does not engage in the business of making commercial loans u s c sec c f see supra note in ralph e spurgin believed that the comptroller of the currency had put a moratorium on the organization of nonbank banks that would issue credit cards sec_24 on date the comptroller of the currency issued a charter certificate to wfnnb authorizing it to commence the business of banking as a national banking association the articles of association of wfnnb the articles state that the association 1s organized to carry on the business of banking under the laws of the united_states the articles incorporate in full the ceba credit card institution restrictions see supra note in pertinent part article third provides the association will engage only in credit card operations will not accept demand deposits or deposits that the depositor may withdraw by check or similar means for payment to third parties or others will not accept any savings or time deposit of less than dollar_figure iv will maintain no more than one office that accepts deposits v will not engage in the business of making commercial loans petitioner subscribed to big_number shares of the common_stock of wfnnb par_value dollar_figure million in consideration of receipt of those shares petitioner contributed all of the stock of limited credit and wfn to wfnnb which corporations were thereafter liquidated and dissolved wfnnb is a wholly owned subsidiary_corporation of petitioner credit operations of world financial network national bank upon receipt of its charter wfnnb entered into agreements the merchant agreements with the stores the merchant agreements concerned credit cards to be issued by wfnnb to customers of the stores and embodied the contractual relationship between wfnnb and the stores with respect thereto among other things the merchant agreements entitled wfnnb to issue credit cards bearing the name and logo of each store to customers of that store also upon receipt of its charter wfnnb sent notices change_of terms notices to holders of the credit cards previously issued under the credit plans operated by limited credit and wen the change_of terms notices among other things informed such credit card holders that wfnnb would be the extender of credit on their account and for credit card holders in certain states there would be an increase in the interest rate on their accounts as of date wennb had opened million credit card accounts and it had outstanding credit card loans in excess of dollar_figure million wennb capitalization and liguidity needs wfnnb had cash liquidity needs that could not be met without borrowing limited service corp limited service another member of the affiliated_group performed the treasury function for wfnnb that function included assisting wfnnb in meeting its liquidity needs limited service had access to funds generated by petitioner’s sale of its commercial paper initially wfnnb’s liguidity needs were met from within the -- - affiliated_group on date limited service granted wennb a line of credit in the amount of dollar_figure million on date limited service increased to dollar_figure billion the line of credit it granted to wfnnb at various times wfnnb obtained funds from limited service pursuant to various other long- and short- term_loan agreements wfnnb also borrowed money from and was granted lines of credit by various unrelated outside lenders on date wfnnb was granted a dollar_figure million line of credit by a syndicate of banks wfnnb never drew on that line of credit because it could obtain funds less expensively from limited service certificates of deposit wfnnb first issued sold a certificate of deposit cd on date that cd was sold to limited service for dollar_figure the minimum acceptable time deposit pursuant to the ceba restrictions incorporated in the articles on date by letter agreement the letter agreement wfnnb appointed merrill lynch pierce fenner smith inc merrill lynch as its agent for its customers who desired to purchase cds the letter agreement provided that the cds would be sold in denominations of dollar_figure or integral multiples thereof during date and date wfnnb acting through its agent merrill lynch sold cds receiving dollar_figure million those cds comprised transferable individual time deposit accounts of dollar_figure each each of those accounts was insured by the federal deposit insurance corp mfe netherlands antilles n v mfe n v is a netherlands antilles corporation on date mfe n v purchased eight cds from wfnnb in the total amount of dollar_figure million the mfe n v cds each mfe n v cd was for a term of year showed an annual interest rate of percent annual yield of dollar_figure percent and provided that it was a non- negotiable and non-transferable time deposit hach also provided this time deposit shall renew automatically for a like term unless and until notice of withdrawal is presented at the bank within seven calendar days after the maturity_date reduction of indebtedness to limited service on date wfnnb transferred the dollar_figure million received from mfe n v on the sale of the cds to limited service to reduce the balance outstanding under the line of credit extended to wfnnb by limited service petitioner’s indirect ownership of mfe n v mfe n v is a fourth tier subsidiary of petitioner the relationship of mfe n v to petitioner as well as the relationship of wfnnb limited service and petitioner's stores to petitioner is shown in the following diagram simplified corporation organizational structure date the limited inc us world financial mast ee limited service store divisions network national holding corporation us many bank us corporation limited service us wennb us mast industries inc mi i mo mast industries far east ltd hong kong mfe lf mfe netherlands antilles n v netherlands antilles ‘ mfe n v organization and operation of mfe and mfe n v in mast industries inc mii organized mast industries far east ltd mfe as a hong kong corporation at all times here pertinent mfe had its headquarters and principal_place_of_business in hong kong mfe is a controlled_foreign_corporation of petitioner within the meaning of sec_957 a mfe is a contract manufacturer for petitioner it operates throughout asia manufacturing or contracting for the manufacture of garments to be sold by petitioner's stores mfe declared no significant dividends from the early 1980s through resulting in accumulated_earnings_and_profits in excess of dollar_figure million at the end of on date the directors of mfe resolved to organize and capitalize mfe n v among the stated purposes were engaging in group financing activities and providing for a means of investing and reinvesting liguid assets and funds the directors of mfe further resolved to make a capital_contribution to mfe n v of dollar_figure million mfe n v had no employees during date on date mfe transferred dollar_figure million by wire to mfe n v that dollar_figure million was used to purchase the mfe n v cds opinion i introduction world financial network national bank wfnnb a national banking association is a wholly owned subsidiary of petitioner in wfnnb was organized and today operates as a credit card bank to issue credit cards to customers of petitioner’s stores mast industries far east ltd mfe a hong kong corporation also is a wholly owned subsidiary of petitioner mfe is a controlled_foreign_corporation within the meaning of sec_957 and with respect to mfe petitioner is a u s shareholder within the meaning of sec_951 mfe netherlands antilles n v mfe n v a netherlands antilles corporation is a wholly owned subsidiary of mfe on date mfe n v purchased eight certificates of deposit cds from wfnnb in the total amount of dollar_figure million the mfe n v cds we must determine whether as a result of those purchases petitioner must include dollar_figure in gross_income under sec_951 b on account of the investment by mfe of its earnings in u s property see sec_956 the record does not explain the discrepancy between the dollar_figure million purchase_price and the dollar_figure adjustment_to_gross_income il internal_revenue_code and regulations the principal provisions of the internal_revenue_code at issue are sec_951 and sec_956 sec_951 and sec_956 are found in subpart_f of part iii subchapter_n chapter of the internal_revenue_code subpart_f subpart_f concerns itself with controlled_foreign_corporations the term controlled_foreign_corporation is defined in sec_957 ’ sec_951 provides that each u s shareholder of a controlled_foreign_corporation shall include in gross_income certain amounts including his pro_rata share determined under sec_956 of the corporation’s increase_in_earnings_invested_in_united_states_property in pertinent part sec_956 provides a general rules ---for purposes of this subpart---- amount of investment the amount of earnings_of a controlled_foreign_corporation invested in united_states_property at the sec_957 provides general_rule --for purposes of this subpart the term controlled_foreign_corporation means any foreign_corporation if more than percent of-- the total combined voting power of all classes of stock of such corporation entitled to vote or the total value of the stock of such corporation is owned within the meaning of sec_958 or is considered as owned by applying the rules of ownership of sec_958 by united_states_shareholders on any day during the taxable_year of such foreign_corporation close of any taxable_year is the aggregate amount of such property held directly or indirectly by the controlled_foreign_corporation at the close of the taxable_year to the extent such amount would have constituted a dividend determined after the application of sec_955 if it had been distributed pro_rata share of increase for year b united_states_property defined --- in general --for purposes of subsection a the term united_states_property means any property acquired after date which is-- a tangible_property located in the united_states b stock of a domestic_corporation c an obligation of a united_states_person or d any right to the use in the united_states of-- a patent or copyright an invention model or design whether or not patented a secret formula or process or iv any other similar right which 1s acquired or developed by the controlled_foreign_corporation for use in the united_states exceptions --for purposes of subsection a the term united_states_property does not include-- a obligations of the united_states money or deposits with persons carrying on the banking business -- - b property located in the united_states which is purchased in the united_states for export to or use in foreign countries c any obligation of a united_states_person arising in connection with the sale or processing of property if the amount of such obligation outstanding at no time during the taxable_year exceeds the amount which would be ordinary and necessary to carry on the trade_or_business of both the other party to the sale or processing transaction and the united_states_person had the sale or processing transaction been made between unrelated persons d any aircraft railroad rolling_stock vessel motor_vehicle or container used in the transportation of persons or property in foreign_commerce and used predominantly outside the united_states eb an amount of assets of an insurance_company equivalent to the unearned premiums or reserves ordinary and necessary for the proper conduct of its insurance_business attributable to contracts which are not contracts described in sec_953 f the stock or obligations of a domestic_corporation which is neither a united_states_shareholder as defined in sec_951 of the controlled_foreign_corporation nor a domestic_corporation percent or more of the total combined voting power of which immediately after the acquisition of any stock in such domestic_corporation by the controlled_foreign_corporation is owned or is considered as being owned by such united_states_shareholders in the aggregate g any movable property other than a vessel_or_aircraft which is used for the purpose of exploring for developing removing or transporting resources from ocean waters or under such waters when used on the continental shelf of the united_states emphasis added in pertinent part sec_1_956-1t temporary income_tax regs fed reg date provides treatment of certain investments of earnings in united_states_property special rule for purposes of b of the regulations which as pertinent paraphrases sec_956 a controlled_foreign_corporation will be considered to hold indirectly at the discretion of the district_director investments in u s property acquired by any other foreign_corporation that is controlled by the controlled_foreign_corporation if one of the principal purposes for creating organizing or funding through capital contributions or debt such other foreign_corporation is to avoid the application of sec_956 with respect to the controlled_foreign_corporation tit summary of arguments of the parties a respondent’s arguments mfe controls mfe n v and respondent argues that a principal purpose for creating organizing or funding mfe n v was to avoid the application of sec_956 thus respondent would exercise his discretion to consider mfe as owning indirectly any investment in u s property acquired by mfe n v see sec_1_956-1t temporary income_tax regs respondent considers the mfe n v cds to be u s property within the meaning of sec_956 c u s property thus respondent concludes that mfe a controlled_foreign_corporation increased its earnings invested in u s property and - - petitioner the sole u s shareholder of mfe must include dollar_figure in gross_income pursuant to sec_951 b respondent has numerous arguments why the mfe n v cds are not deposits with persons carrying on the banking business within the meaning of sec_956 a sometimes sec_956 deposits principally respondent argues that to be in the banking business for purposes of sec_956 a an institution must first be a bank within the meaning of sec_581 definition of bank for purposes of rules of general application to banking institutions and since wfnnb does no more than operate a private label credit card business its activities are too narrow to put it into the banking business respondent also argues that the mfe n v cds did not constitute deposits as that term is used in sec_956 a alternatively respondent argues that because in substance the mfe nv cds are the repatriation of earnings_of a controlled_foreign_corporation they should be treated as such no matter what steps petitioner took to color them as something else b petitioner’s arguments petitioner denies that mfe n v was created organized or funded to avoid the application of sec_956 moreover petitioner argues that the mfe n v cds do not constitute u s property since they qualify for an exception to that term as --- - deposits with persons carrying on the banking business pursuant to sec_956 a petitioner argues that the term the banking business has no special meaning and that wfnnb was organized as a bank is operated as a bank is regulated as a bank and is considered a bank by various experts in banking finance and economics petitioner likewise argues that the term deposits has no special meaning and the mfe n v cds are deposits both in form and substance iv discussion a introduction as will be explained below the provisions of subpart_f here in question were enacted to tax as dividends the repatriated earnings_of controlled_foreign_corporations an exception was made for deposits with persons carrying on the banking business given the limited purpose of wfnnb to issue credit cards to customers of the stores we find that the mfe n v cds are not deposits with persons carrying on the banking business as congress used those words in sec_956 a we independently reach the same conclusion based on the relationships between and among petitioner wfnnb mfe and mfe n v therefore we find that the dollar_figure in question was invested in u s property the details of our reasoning are as follows -- - b deposits with persons carrying on the banking business in arguing whether the mfe n v cds constitute sec_956 deposits the parties expend considerable effort addressing whether wfnnb is a bank respondent would have us define the term bank as it is defined in sec_581 and argues that wfnnb cannot qualify under that definition since taking deposits from unrelated parties does not constitute a substantial part of its business petitioner’s argument is somewhat more elaborate petitioner argues that since banks are in the business of banking and wfnnb is a bank wfnnb must be in the business of banking petitioner supports its minor premise wfnnb is a bank by showing that wfnnb was organized to carry on the business of banking is authorized by the comptroller of the currency to do business as a national banking association and derives its authority from and is governed by the national bank act currently codified in title u s c petitioner points out that wfnnb may not legally engage in any activity but the business of banking petitioner concludes the language enacted by congress is unambiguous wfnnb is a bank it is therefore a priori engaged in the banking business as a matter of law it can do nothing else we do not accept either party’s argument that we can determine whether wfnnb is in the banking business simply by determining whether wfnnb is a bank the question is not whether - - wfnnb is a bank congress did not provide an exception for deposits with banks it provided an exception for deposits with persons carrying on the banking business congress did not define the term banking business and although petitioner presented expert testimony with respect to banks and banking none of petitioner’s experts claim that the term banking business is a term of art or has a well-defined meaning indeed petitioner’s expert robert l clarke comptroller of the currency from date through date testified during the time i served as comptroller of the currency the issues of what it means to be a ‘bank’ and exactly what constitutes the ‘banking business’ regularly confronted the office of the comptroller of the currency 'occ' congress and the court system including the supreme court we conclude that the term deposits with persons carrying on the banking business is ambiguous cf 513_us_251 n determining that comptroller of the currency may determine what is an incidental powe r necessary to carry on the business of banking for purposes of u s c sec_24 we expressly hold the ‘business of banking’ is not limited to the enumerated powers in sec_24 the parties dispute not only the meaning of the term deposits with persons carrying on the banking business but also the meanings of the subordinate terms deposits and banking business we conclude that the subordinate term banking business is ambiguous that is sufficient for us to conclude that the superior term deposits with persons carrying on the banking business is ambiguous -- - seventh and that the comptroller therefore has discretion to authorize activities beyond those specifically enumerated cc court’s function in interpreting the internal_revenue_code this court's function in interpreting the internal_revenue_code is to construe the statutory language to effectuate the intent of congress see 310_us_534 109_tc_463 94_tc_863 affd 954_f2d_653 11th cir 88_tc_177 affd 865_f2d_750 6th cir both a textual analysis of the statute anda consideration of congress’ purpose in enacting subpart_f are warranted and appropriate to determine whether deposits with wennb whose activities were predominantly limited to credit card transactions and which is a wholly owned subsidiary of petitioner are sec_956 deposits see 491_us_440 we begin by considering congress' purpose in enacting subpart_f d tax reform acts of and subpart_f was added to the internal_revenue_code of by sec_12 of the revenue act of publaw_87_834 76_stat_960 h_r 87th cong 2d sess h_r is the bill that when enacted became the revenue act of the committee reports accompanying h_r both in the house of - - representatives the house and in the senate discuss the impetus for subpart_f to wit to end the tax_deferral resulting from the failure of our income_tax system to tax the foreign_source_income of american controlled_foreign_corporations until such income is distributed to the corporation’s american shareholders as dividends h rept 87th cong 2d sess 1962_3_cb_405 s rept 87th cong 2d sess 1962_3_cb_707 the committees did not attempt to eliminate such tax_deferral completely but they did address certain tax_haven devices see s rept supra c b pincite with respect to that portion of subpart_f dealing with investments in u s property the repatriation provision the committee on finance said generally earnings brought back to the united_states are taxed to the shareholders on the grounds that this is substantially the equivalent of a dividend being paid to them s rept supra c b pincite accord h rept supra c b pincite with respect to the exceptions to u s property for sec_956 deposits which both tax writing committees referred to as bank accounts and the other items contained in sec_956 the committee on finance explained the exceptions however are believed to be normal commercial transactions without intention to permit the funds to remain in the united_states indefinitely except in the case of the last category where full u s corporate tax is - - being paid s rept supra c b pincite accord h rept supra c b pincite because u s property was defined to include in general all tangible and intangible_property located in the united_states the scope of the repatriation provision proved too broad for congress which in limited it see tax reform act of publaw_94_455 90_stat_1525 adding sec_956 f and g h_r 94th cong 2d sess is the bill that when enacted became the tax reform act of the committee reports accompanying h_r both in the house and the senate state the committees’ views that the scope of the repatriation provision is too broad h rept 1976_3_cb_701 s rept 1976_3_cb_57 both reports state that the repatriation provision may have encouraged foreign_corporations to invest their profits abroad with a detrimental effect upon the u s balance of trade for example a controlled_foreign_corporation looking for a temporary investment for its working_capital is by this provision induced to purchase foreign rather as originally enacted sec_956 contained only the exceptions set out as sec_956 a through e plus an exception for assets of the controlled_foreign_corporation equal to certain accumulated_earnings_and_profits already subject_to income_taxation in the united_states ie the last category referred to in the quoted language from the report of the committee on finance the exception set out as sec_956 f was added by the tax reform act of publaw_94_ sec_1021 90_stat_1520 -- p7 - than u s obligations h rept supra c b vol1l pincite s rept supra c b vol pincite the committee on finance explained in the committee’s view a provision which acts to encourage rather than prevent the accumulation of funds offshore should be altered to minimize any harmful balance of payments impact while not permitting the u s shareholders to use the earnings_of controlled_foreign_corporations without payment of tax in the committee’s view since the investment by a controlled_foreign_corporation in the stock or debt obligations of a related u_s_person or its domestic affiliates makes funds available for use by the u s shareholders it constitutes an effective repatriation of earnings which should be taxed the classification of other investments in stock or debt of domestic corporations as the equivalent of dividends is in the committee’s view detrimental to the promotion of investments in the united_states accordingly the committee’s amendment provides that an investment in u s property does not result when the controlled_foreign_corporation invests in the stock or obligations of unrelated u s persons s rept supra c b vol pincite see also h rept supra c b vol pincite by the tax reform act of congress added subparagraph f to sec_956 subparagraph f of sec_956 provides that u s property does not include stock or debt of a domestic_corporation unless the corporation is itself a u s shareholder of the foreign controlled_corporation if the u s shareholders congress also added subparagraph g to sec_956 which deals with certain oil drilling rigs used on the u s continental shelf and is not relevant to our discussion - - of the controlled_foreign_corporation have less than 25-percent control of the_domestic_corporation be analysi sec_1 the banking business the repatriation provision was enacted in on the theory that the repatriation of previously untaxed by the united_states_earnings by a controlled_foreign_corporation was substantially the equivalent of a dividend being paid to the u s shareholders of that corporation dividend egquivalency theory excepted were a group of transactions that the tax writing committees believed were normal commercial transactions without intention to permit funds to remain in the united_states indefinitely s rept supra c b pincite accord h rept supra c b pincite one such exception is for deposits with persons carrying on the banking business the phrase carrying on the banking business is a phrase modifying and thus describing or limiting the noun persons the phrase expresses an action required of such persons that action is to carry on the banking business congress' use of the definite article the to modify the subordinate term panking business indicates a purpose to particularize the activity or activities required of such persons such persons must do something in particular they must carry on é conduct a business not any business but the banking business not a banking business which would suggest a variety of - - businesses that would qualify but the banking business our textual analysis convinces us that congress did not intend that the term persons carrying on the banking business apply to every person that is conducting one or more of the activities that are considered to be part of a banking business by any statute agency or industry therefore it is not sufficient for petitioner to prove that the activities and business that wfnnb carried on were a banking business rather the issue is whether wefnnb was carrying on the banking business as those terms are used in sec_956 a emphasis added from the context of the term the banking business we infer that congress meant a group of activities carried on to aid the domestic business activities of controlled_foreign_corporations for example sec_956 b and c except from the definition of u s property property that is purchased for export and loans to u s sellers or processors of the controlled foreign corporation's property we believe that a person carrying on the banking business for purposes of sec_956 b a must at the very least provide banking services useful to a controlled_corporation engaging in business activities in the united_states our conclusion that congress had a group of business-facilitating activities in mind is bolstered by the tax writing committees’ stated belief that the exceptions to the definition of u s property were for normal commercial transactions without intent to permit the funds to -- - remain in the united_states indefinitely both tax writing committees used the term bank accounts to describe the deposits exception a dictionary definition of the term bank account is an account with a bank created by the deposit of money or its eguivalent and subject_to withdrawal of money as by check or passbook webster' sec_3d new international dictionary similar in second edition while not dispositive of congressional intent the use of the term bank accounts as defined in the dictionary for many years is yet another indication that the deposit exception was meant to encompass banking functions eg the ability to write checks that would facilitate the controlled foreign corporation’s business in h rept the committee on ways and means reported certain exceptions to the house's definition of u s property are made but these apply only where the property located within the united_states is ordinary and necessary to the active_conduct of the foreign corporation's business or substantially the same trade_or_business h rept supra c b pincite emphasis added h_r as passed by the house the house bill dealt more strictly with a controlled foreign corporation’s investment of its earnings than did the provision substituted by the senate which substitute was accepted by the house to escape tax the house bill would have required earnings invested outside of the united_states and the few exceptions for domestic investments to be invested in money --- - or property ordinary and necessary for the active_conduct of a qualified_trade_or_business the active_conduct restriction h_r 87th cong 2d sess sec a the senate eliminated that restriction it retained virtually unchanged however the language of the house bill describing the few permitted domestic investments since the house undoubtedly understood that language to describe investments satisfying the active_conduct restriction it can be inferred by the senate's nearly verbatim adoption of the same language that it also understood that language to describe investments satisfying the active_conduct restriction notwithstanding its elimination of that restriction with respect to all foreign investments and u s investments of earnings that had been subjected to u s taxation we are mindful that the exceptions to the definition of u s property provided in sec_956 a include an exception for obligations of the united_states which of course could include a long-term investment such as a 30-year treasury bond this fact does not alter our conclusion that congress intended to limit sec_956 a in general and the sec_956 deposit exception in particular to business facilitating activities it was only natural for congress to encourage any form of deposit of offshore earnings with the u s government given our conclusion as to the meaning of the term the banking business we are satisfied that the activities of wfnnb - - do not satisfy it wfnnb's articles of association significantly limit its banking activities the association will engage only in credit card operations will not accept demand deposits or deposits that the depositor may withdraw by check or similar means for payment to third parties or others will not accept any savings or time deposit of less than dollar_figure iv will maintain no more than one office that accepts deposits v will not engage in the business of making commercial loans wfnnb is a special purpose institution that is not of much use to a foreign business customer seeking banking services except as the issuer of a private-label credit card or as the recipient of large deposits of funds that are not needed immediately those are insufficient services for us to conclude that wfnnb was carrying on the banking business as congress used that phrase in sec_956 a dividend_equivalence as originally enacted in the repatriation provision classified as u s property virtually all investments by a controlled_foreign_corporation of its earnings in the united_states there was little if any reason for congress to include a related-party restriction in the exception for sec_956 deposits ’ by however the tax writing committees of from the enactment of the bank_holding_company act of bhca publaw_91_607 ch 70_stat_133 currently codified pincite u s c secs until its amendment by the continued - - congress had recognized that the repatriation provisions had discouraged investments that would be favorable to the u s balance of payments congress addressed that problem by adding two additional exceptions to the definition of u s property subparagraphs f certain stock or debt investments and g certain oil drilling rigs the subparagraph f exception is limited to stock or debt of unrelated domestic corporations the committee on finance cautioned that it did not wish the law to be changed to permit the u s shareholders of a controlled_foreign_corporation to use the earnings_of the corporation without payment of tax h rept supra s rept supra congress did not amend the sec_956 deposit exception to except only deposits with unrelated persons that is understandable however since bhca prohibited nonbank holding mh’ continued bank_holding_company act amendments of bhca amendments publaw_91_607 84_stat_1760 a bank_holding_company was defined as a company having control_over two or more banks the bhca would thus not have impeded a nonbanking company such as petitioner from owning a single bank nevertheless petitioner has failed to show us that in when subpart_f was enacted that possibility was any more than theoretical see s rept u s c c a n p accompanying h_r which was enacted as bhca amendments and describing the theoretical freedom of a one-bank holding_company to engage in any business or acquire anything it desires subject_to antitrust laws conf rept u s c c a n p also accompanying h_r and stating that i n the late 1960's nonbank corporations began acquiring one bank thus mixing banking and nonbanking in complete contravention of the purpose of both federal banking laws going back to the 1930's and the bank_holding_company act of - -- companies from owning banks petitioner has offered no policy reason why congress would permit deposits particularly deposits for an indefinite period with a related bank but prohibit investments ina related corporation in response to petitioner's argument that the phrase deposits with persons carrying on the banking business has a plain meaning an argument we reject we note that when the adherence to the plain meaning of a statute produces an unreasonable result plainly at variance with the policy of the legislation as a whole it is proper to follow that purpose rather than the literal words 310_us_534 internal quotation omitted see also 489_us_235 further w le may then look to the reason of the enactment and inguire into its antecedent history and give it effect in accordance with its decision and purpose sacrificing if necessary the literal meaning in order that the purpose may not fail 88_tc_177 affd 865_f2d_750 6th cir we believe that a related_party prohibition is implicit in the exception for sec_956 deposits such a prohibition is necessary to give undoubtedly congress believed that it had foreclosed that possibility in when it enacted bhca amendments see supra note by nonbank companies had found a loophole the nonbank loophole in bhca which congress enacted ceba to close see supra note commercial firms however did not begin to exploit the nonbank loophole until the early 1980s -- - effect to the dividend_equivalence theory that underlies the repatriation provision ’ if we find that the purchase of the mfe n v cds amounts to the use of the earnings_of a controlled_corporation by a u s shareholder we believe that such purchase must be regarded as an increase of earnings invested in u s property and not a sec_956 deposit on date mfe n v purchased the eight mfe n v cds from wfnnb for dollar_figure million each cd was for a term of year showed an annual interest rate of percent and provided that it was a nonnegotiable and nontransferable time petitioner argues that a limitation of the sec_956 deposits exception to unrelated-party deposits would render that exception superfluous in light of sec_956 f according to petitioner because sec_956 f permits a controlled foreign corporation's earnings to escape u s taxation when invested in the obligations of an unrelated u s_corporation it would serve no purpose to interpret the sec_956 deposits exception as accomplishing the same result with respect to obligations in the form of deposits with a domestic_corporation carrying on the banking business the sec_956 a exception however applies to deposits with persons carrying on the banking business whereas the sec_956 f exception applies to obligations of a domestic_corporation a person carrying on the banking business need not be a corporation see eg mass gen laws ann ch sec_1 defining bank to include any individuals association partnership or corporation doing a banking business in the commonwealth see also n d cent code sec defining the terms banking association and state banking association to include limited_liability companies partnerships firms or associations whose business in whole or in part consists of the taking of money on deposit although our interpretation of the sec_956 deposits exception narrows its scope we conclude that it cannot be interpreted to permit deposits by controlled_foreign_corporations with a related_person carrying on the banking business to go untaxed and still remain consistent with the clear overall legislative intent to tax investments in related u s persons - - deposit each also provided this time deposit shall renew automatically for a like term unless and until notice of withdrawal is presented at the bank within seven calendar days after the maturity_date on date wfnnb transferred the dollar_figure million received from mfe n v to limited services to reduce the balance outstanding under a line of credit extended to wfnnb by limited services wfnnb is a wholly owned subsidiary of petitioner and therefore the reduction of wfnnb’s line of credit balance to limited service directly benefited petitioner as we shall explain in the next section of this report we find that respondent did not abuse his discretion in attributing the mfe n v cds to mfe we therefore view the purchase of the mfe n v cds as a repatriation of the earnings_of mfe because that repatriation made the earnings_of mfe a controlled_foreign_corporation available for use by its only u s shareholder petitioner we find that the repatriation was substantially the equivalent of a dividend being paid_by mfe to petitioner the purchase of the mfe n v cds was an investment in u s property the exception for sec_956 deposits is unavailable f sec_1_956-1t temporary income_tax regs sec_1_956-1t temporary income_tax regs fed reg date empowers respondent to attribute to mfe the mfe n v cds if one of the principal purposes for -- - creating organizing or funding mfe n v was to avoid the application of sec_956 with respect to mfe petitioner argues that the purpose of organizing mfe n v was to inject an additional corporate layer between mfe and the deposits to wfnnb to improve the efficacy of the deposits as protection against expropriation by the people’s republic of china which was scheduled to take over hong kong in that was the testimony of kenneth b gilman petitioner’s executive vice president-finance and chief financial officer when asked however why that was the case mr gilman replied that he was not exactly sure timothy b lyons is and during the years in issue was petitioner’s vice president-tax his responsibilities include compliance tax planning and administration of the tax function at petitioner he is intimately familiar with the business activity of mfe like mr gilman he also testified that the purpose of forming mfe n v was to protect against expropriation indeed he testified that it was the sole purpose for organizing mfe n v on cross-examination mr lyon was asked why no consideration had been given to forming a domestic united_states subsidiary of mfe to protect against expropriation he responded it didn’t really accomplish anything from the asset protection side but there is no question it would have been deemed a dividend or something at -- - wia4 that point further petitioner decided to invest mfe’s funds in wfnnb before mfe n v was organized whether mfe n v was organized for asset protection purposes we need not say we do believe however that that was not the sole purpose of organizing mfe n v we believe that a principal purpose of organizing and funding mfe n v was to avoid having the dollar_figure million capital_contribution result in subpart_f_income pursuant to sec_956 further we believe that another principal purpose was to limit any subpart_f_income imposed pursuant to sec_956 to mfe n v 's earnings_and_profits which were negligible thus we find that a principal purpose for creating organizing and funding mfe n v to purchase the mfe n v cds rather than using a domestic_corporation or having mfe purchase the cds directly was to avoid the application of sec_956 mr lyon's testimony supports that conclusion accordingly the mfe n v cds are attributed to mfe pursuant to sec_1 1t b temporary income_tax regs supra g conclusions at the close of mfe held the mfe n v cds the mfe n v cds were u s property and not sec_956 deposits im it is possible that mr lyon's concern related to sec_956 b b pursuant to which mfe's increase in earnings invested in the stock of a domestic_corporation would have resulted in subpart_f_income to petitioner to the extent of such increase v conclusion to the extent respondent determined a deficiency in tax on the basis that petitioner must include dollar_figure in gross_income under sec_951 that deficiency in tax is sustained an appropriate order will be issued


internal_revenue_service department of the treasury index number washington dc number release date person to contact telephone number refer reply to cc dom it a plr-119988-98 date date legend taxpayer decedent state corporation trust date date date property property property cc dom it a plr-119998-98 property property property property property property property property property property property cc dom it a plr-119998-98 property property property property property property property property property property cc dom it a plr-119998-98 property property property property property property property property property property dear cc dom it a plr-119998-98 this letter responds to your submission of date and supplemental correspondence dated date date date and date in which you requested a ruling on behalf of taxpayer specifically you have requested a ruling that decedent’s interests in certain real_estate and in corporation qualify as interests in a closely_held_business for purposes of sec_6166 of the internal_revenue_code code the taxpayer makes the following representations facts in the early 1960s decedent began purchasing vacant lots upon which he developed commercial and residential rental properties on date decedent formed corporation in state in order to assist in the management of the rental properties on date decedent transferred the rental properties as well as all the stock in corporation to trust decedent was the sole beneficiary of trust a grantor_trust for federal tax purposes corporation leases and manages all of the properties owned by trust decedent an employee of corporation until the time of his death was actively involved in the day-to-day operations of corporation and in the management of the properties he maintained an office at corporation and reported there regularly corporation employs six individuals on a full-time basis these employees consist of three leasing agents one accountant and two maintenance workers in addition to the employees of corporation trust employs three individuals on a full-time basis these employees consist of a general contractor a painter and a maintenance worker the trust employees provide services to the same properties that are managed by corporation decedent supervised all employees of corporation and trust at the time of his death decedent a united_states citizen and a resident of state indirectly owned propertie sec_1 through through trust propertie sec_1 through consist of commercial and residential rental properties propertie sec_31 through are undeveloped properties most of the properties are located in close proximity to each other there are commercial and residential units on the properties propertie sec_1 through and the stock of corporation are includable in decedent’s adjusted_gross_estate decedent’s interest in the properties together with the value of his interest in corporation exceed sec_35 of his adjusted_gross_estate the employees of corporation are responsible for managing the properties their duties include interviewing and screening prospective tenants negotiating commercial and residential lease terms collecting rent reviewing invoices preparing required state reports preparing periodic financial reports detailing results of operations on a property-by-property basis signing payroll checks paying taxes and mortgage cc dom it a plr-119998-98 payments reviewing tenant’s insurance coverage for accuracy obtaining competitive bids on property and developing advertising campaigns for all forms of media in addition to managing the properties the employees of both corporation and trust maintain and service all of the commercial and residential income properties maintenance of the properties includes maintaining and repairing the plumbing fixtures and air conditioning units patching or replacing roofs seal coating and striping of parking lots repairing and maintaining interior and exterior walls fixing flooring and performing electrical work further the employees maintain the common areas of the properties provide a 24-hour on-call general contractor and or emergency maintenance worker for the tenants landscape the properties provide trash removal and pest control patrol for abandoned cars and illegally parked cars pressure clean the exterior of buildings awnings sidewalks and windows and provide notary services and self- addressed stamped envelopes for rent payments services provided to tenants include assisting tenants in opening up their businesses by obtaining for them the necessary licenses permits and inspections from governmental authorities assisting tenants by meeting with appropriate governmental officials such as building inspectors or the fire marshal and remodeling the interior of commercial units in order to meet new tenant’s specifications law sec_6166 of the code provides in part that if the value of an interest_in_a_closely_held_business which is included in determining the gross_estate of a decedent who was at the date of his death a citizen or resident_of_the_united_states exceed sec_35 percent of the adjusted_gross_estate the executor may elect to pay part or all of the tax imposed by sec_2001 in two or more but not exceeding ten equal installments if such an election is made the first installment shall be paid on or before the date selected by the executor which is not more than five years after the date prescribed by sec_6151 for payment of the tax sec_6166 of the code defines the term_interest in a closely_held_business to include cc dom it a plr-119998-98 a b c an interest as a proprietor in a trade_or_business carried on as a proprietorship an interest as a partner in a partnership carrying_on_a_trade_or_business if i percent or more of the total capital interest in such partnership is included in determining the gross_estate of the decedent or ii such a partnership had or fewer partners or stock in a corporation carrying_on_a_trade_or_business if i percent of more in value of the voting_stock of such corporation is included in determining the gross_estate of the decedent or ii such corporation had or fewer shareholders sec_6166 of the code provides that the determination under sec_6166 shall be made as of the time immediately before the decedent’s death sec_6166 of the code provides in part that property owned directly or indirectly by or for a_trust shall be considered as being owned proportionately by or for its beneficiaries for purposes of this section a person shall be treated as a beneficiary of a_trust only if such person has a present_interest in the trust sec_6166 of the code provides in part that for the purposes of sec_6166 and in determining the closely_held_business_amount but not for the purpose of sec_6166 the value of any interest_in_a_closely_held_business shall not include the value of that portion of such interest which is attributable to passive_assets held by the business in general the term passive_asset means any asset other than an asset used in carrying_on_a_trade_or_business sec_6166 of the code provides in part that for purposes of sec_6166 interests in two or more closely held businesses with respect to each of which there is included in determining the value of the decedent’s gross_estate percent or more of the total value of each such business shall be treated as an interest in a single closely_held_business revrul_75_365 1975_2_cb_471 holds that rental commercial property rental farm property and notes receivable included in decedent’s gross_estate do not constitute an interest_in_a_closely_held_business under sec_6166 where decedent maintained a fully equipped business office collected rental payments on the properties received payments on notes receivable negotiated leases made occasional loans and by contract directed the maintenance of the properties under these facts decedent’s relationship to the assets was merely that of an owner managing investment_assets to obtain the income ordinarily expected from them revrul_75_366 1975_2_cb_472 holds that where a decedent paid percent cc dom it a plr-119998-98 of the expenses received percent of the crops and actively participated in the important management decisions of a tenant farm included in the decedent’s estate the farm constitutes an interest_in_a_closely_held_business under sec_6166 under these facts the decedent made almost daily visits to inspect and discuss operations and occasionally delivered supplies to the tenants revrul_75_367 1975_2_cb_472 holds that land owned by a decedent that was held for the purpose of building homes decedent’s ownership of stock in a corporation that built homes on such land and a business office and warehouse owned by the decedent and used by both the corporation and decedent qualify as an interest_in_a_closely_held_business under sec_6166 however eight homes built by the decedent’s corporation that were sold and later repurchased by the decedent who collected the rents made the mortgage payments and made the necessary repairs and maintenance to the homes in order to maintain the condition and appearance of the rental homes were not an interest_in_a_closely_held_business because the decedent’s relationship to the properties was merely that of an owner managing investment_assets to obtain the rents ordinarily expected from them analysis according to rev ruls and the determination of what constitutes a trade_or_business within the meaning of sec_6166 should not be made merely by reference to a broad definition of the term for purposes of some other section of the code but should reflect the intent of congress in enacting sec_6166 sec_6166 was enacted to permit the deferral of the payment of the federal estate_tax where in order to pay the tax at one time it would be necessary to sell assets used in a going business and thereby disrupt or destroy the business_enterprise this section was intended to permit deferral of tax on income-producing assets only where the assets formed a part of an active enterprise producing business income rather than income solely from the ownership of property sec_6166 was intended to apply only with respect to a business such as a manufacturing mercantile or service enterprise as distinguished from management of investment_assets as the above revenue rulings suggest the level of the activity is the factor that distinguishes a trade_or_business under sec_6166 from merely managing rental property to obtain the rents ordinarily expected from them in determining the level of activity carried on by a proprietorship partnership or corporation the activities of its agents and employees are taken into account the activities of persons such as independent contractors or lessees who are neither agents nor employees on the other hand are not taken into account corporation corporation is engaged in the business of leasing and managing commercial and cc dom it a plr-119998-98 residential rental real_estate in addition to decedent corporation employed six full- time employees who were actively involved in providing management and leasing services because percent of corporation’s stock is included in determining decedent’s gross_estate decedent’s interest in corporation is an interest_in_a_closely_held_business under sec_6166 properties decedent’s level of activity in connection with propertie sec_1 through as assisted by the employees of corporation and trust determines whether the properties are part of a trade_or_business for purposes of sec_6166 as substantiated by extensive documentation the activities with respect to the properties went substantially beyond the typical activities associated with merely managing investment_assets such as collecting rents paying taxes making mortgage payments and making necessary repairs decedent as assisted by the employees of corporation and trust provided significant services to the tenants of the properties including assisting tenants in opening up their businesses by obtaining for them the necessary licenses permits and inspections from governmental authorities assisting tenants by meeting with appropriate governmental officials such as building inspectors or the fire marshal remodeling the interior of commercial units in order to meet new tenant’s specifications providing a 24-hour on-call general contractor and or emergency maintenance worker maintaining common areas and providing trash removal pest control and landscaping these activities constitute a service enterprise producing business income accordingly decedent’s interests in propertie sec_1 through are interests in a closely_held_business for purposes of sec_6166 properties decedent as assisted by the employees of corporation and trust also engaged in the business of purchasing land and developing commercial and residential rental real_estate all of the income producing properties owned by decedent at the time of his death were ones he purchased as undeveloped land and later developed into commercial and residential rental properties decedent’s land development business constitutes a closely_held_business for purposes of sec_6166 at the time of decedent’s death propertie sec_32 and sec_34 were being used by the tenants of property and corporation was actively pursuing rezoning of property in order to develop the land accordingly decedent’s interest in propertie sec_32 sec_33 and sec_34 are included in determining the closely_held_business_amount for purposes of sec_6166 property has been leased for advertising purposes since date at the time of decedent’s death there were no plans to develop property accordingly cc dom it a plr-119998-98 decedent’s interest in property is not included in determining the closely_held_business_amount for purposes of sec_6166 single closely_held_business under sec_6166 decedent’s interests in corporation the service enterprise including propertie sec_1 through and the land development business including propertie sec_32 through are treated as interests in a single closely_held_business this also is consistent with the fact that these interests were treated as a single integrated business_enterprise during decedent’s lifetime conclusions based on the information provided and the representations made we conclude as follows decedent’s interest in propertie sec_1 through and in corporation are interests in a single closely_held_business for purposes of sec_6166 of the code accordingly provided the other requirements of sec_6166 of the code are met the federal estate_tax attributable to decedent’s interest in the closely_held_business may be paid in installments under sec_6166 decedent’s interest in property is not included in determining the closely_held_business_amount for purposes of sec_6166 except as specifically ruled above no opinion is expressed as to the federal tax treatment of any issue addressed in this ruling under other provisions of the internal_revenue_code and regulations that may be applicable this ruling is directed only to taxpayer sec_6110 of the code provides that it may not be used or cited as precedent cc dom it a plr-119998-98 pursuant to the power_of_attorney on file in this office the original of this letter is being sent to the taxpayer’s authorized representative sincerely david b auclair assistant to the chief branch office of assistant chief_counsel income_tax and accounting enclosures copy of this letter copy for sec_6110 purposes cc


irs department of the treasury internal_revenue_service p o box cincinnati oh number release date date date employer id number contact person id number contact telephone number form you must file tax years uil dear this letter is our final_determination that you don't qualify for tax-exempt status under sec_501 c of the internal_revenue_code the code recently we sent you a proposed adverse determination in response to your application the proposed adverse determination explained the facts law and basis for our conclusion and it gave you days to file a protest because we didn't receive a protest within the required days the proposed determination is now final because you don't qualify as a tax-exempt_organization under sec_501 c of the code donors can't deduct contributions to you under sec_170 of the code you must file federal_income_tax returns for the tax years listed at the top of this letter using the required form also listed at the top of this letter within days of this letter unless you request an extension of time to file we'll make this final adverse determination_letter and the proposed adverse determination_letter available for public inspection as required under sec_6110 of the code 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 if you disagree with our proposed deletions follow the instructions in the notice on how to notify us if you agree with our deletions you don't need to take any further action we'll also notify the appropriate state officials of our determination by sending them a copy of this final letter and the proposed determination_letter under sec_6104 of the code you should contact your state officials if you have questions about how this determination will affect your state responsibilities and requirements letter rev -2014 catalog number 47632s if you have questions about this letter you can contact the person listed at the top of this letter if you have questions about your federal_income_tax status and responsibilities call our customer service number pincite-829-1040 tty for deaf or hard of hearing or customer service for businesses pincite-829-4933 sincerely director exempt_organizations enclosure notice redacted letter proposed adverse determination under sec_501 c redacted letter final adverse determination under rc sec_501 c -no protest letter4038 rev catalog number fj irs department of the treasury internal_revenue_service p o box cincinnati oh legend b state c date d association date june emolover number contact oerson number contact teleohone number contact fax number uil we considered your application_for recognition of exemption from federal_income_tax under sec_501 a of the internal_revenue_code the code based on the information provided we determined that you don't qualify for exemption under sec_501 c of the code this letter explains the basis for our conclusion please keep it for your records issues do you qualify for exemption under sec_501 c of the code no for reasons given below facts you were formed as a corporation in the state of bon c to promote the development of the medical device industry and medical devices for underserved patients in orphan markets you are a membership_organization of qualified medical device professionals your board_of directors consists of three to five members together with your officers your mission is to facilitate meaningful innovations that improve care and or the cost of care for orphan markets that may otherwise be ignored or inappropriately resourced you are open to the broad spectrum of the medical device industry but you intend to focus on the needs of women and products used in rare diseases and conditions it is your belief that non-profit status will help you build the trust necessary to work with innovators and you will be better perceived by non-traditional capital investors to achieve your purpose you give free business counseling to medical product startup companies you educate inventors and medical device innovators on how to get new products to market that would not have a chance under the majority of current_distribution models you go on to say you are targeting technologies that help small market innovation not being addressed in the current market you have counseled several inventors and start_up medical device companies with a focus on un met medical needs the only relevant criterion in being able to receive free services is that the invention be related to health care or medical products the medical device market is highly regulated by the fda because of the high cost of obtaining market approval from the fda a lot of good products are not brought to the market you have reviewed several technologies that would add safety to medical devices but the distribution system would not support the new product because there were no disposable parts the medical device industry relies on disposable parts so sales reps are in constant contact with hospitals customers you are challenging this model by supporting product development that really helps the end users and patients not just the distributor specific examples of counseling including reaching out to the d to review and evaluate the inventions give guidance on patent protections and enter into license arrangements to the inventors could get a new technology to the market you also target technologies that help small markets that are not being addressed you will provide a niche service that directs the financial technical and market development for small market innovations you leverage your corporate status and expertise experience and relationships in the medical device industry you were established as a non-profit to facilitate and encourage financial participation that will be used in providing professional education programs for innovators and interested parties in the healthcare industry you also expect to receive revenue opportunities from products brought to market when you accept a project you will take ownership and assume the risk for the technical financial reimbursement and market development efforts your approach to the resources required for technical development is through a pay-it-forward model you assume there is typically some degree of excess capacity with contract r d contract manufacturing and main stream medical device companies your connections in the industry will enable you to identify vendors willing to invest time and resources on worthy projects with a mutually acceptable commitment for payment at a future date a similar approach for the quality and regulatory requirements will be used a strategy and plan for market execution under your direction for divesting to an interested company will be developed early in the process when the product is ready for market and revenue is established or a buyer is identified your development partners will be prioritized for reimbursement of incurred costs your agreement with the inventor will include some form of royalty tied to revenue their contribution to the development process and timing of settlement with partners participating in the product's development after settlements including royalties you intend to reinvest the remaining and ongoing proceeds into future idea development you will also provide modest compensation_for your principals any product selected will be thoroughly vetted for market need user acceptability and cost impact to the healthcare system related to the product value resources for product development patent and other legal regulatory pathway quality system development and manufacturing will be identified and engaged as required preliminarily a market assessment will be conducted to determine if you will source distribution or will identify a buyer for the technology if the company chooses to initially distribute the product you will identify independent sales resources and or companies that are interested in adding the new product to a complimentary product portfolio marketing may be a combined function of yourself and the distribution channel s chosen or it may be handled exclusively by you or exclusively by the channel s you may determine that licensing the technology or selling the technology to a company will provide the best overall value in these scenarios some or all of the product development regulatory quality and manufacturing responsibility may be transferred to the licensee or acquirer you propose to reimburse the product s inventor based on prevailing market for royalties which currently range from to of revenue or profit the inventor's contribution to product development or other expertise and the length of the negotiated royalty contract there are no other fees unless you are providing a service workshop or other such offering the cost of service offerings will vary based on content time and resources required costs for facilities and outside resources will be passed on at your cost costs for programs will include a nominal profit that will be reinvested into the company's projects you plan to advertise the products and services you offer you will have mailing lists and flyers for program content to advertise your services you will solicit and advertise for potential donation and communicate directly with interested parties you believe that through successful product development you can expand your outreach advertising to important resources if necessary you will advertise products to appropriate media such as convention exhibits product literature mailings and product videos to educate users there will be no distinguishing characteristics between sales of your devices versus those of other competing entities sales proceeds will be managed like any other business but your emphasis will be to put as much back into product development and service offerings development as possible sales will cover product development regulatory pathway costs quality systems development patent and legal expenses royalties cost to manufacture and distribute and nominal management stipends sales will be used to grow the educational seminars and additional research_and_development efforts on orphan products you may license your intellectual_property to generate additional revenue you will determine value using a discounted_cash_flow_method by evaluating the market size the ability to penetrate the market based on a percentage of growth to the market based on the navel product which will allow an approximate total value you will discount the total value to take into account sales and marketing risk time to market based on regulatory approval of fda strength of patents cost of goods and likelihood of success you will use experience in guiding you to a reasonable return on the investment you anticipate additional income from membership fees your expenses will be for network development rent marketing materials program management data management employees and office equipment law sec_501 c of the code describes corporations organized and operated exclusively for charitable purposes no part of the net_earnings of which inures to the benefit of any private_shareholder_or_individual sec_1_501_c_3_-1 of the income_tax regulations states that in order to be exempt as an organization described in sec_501 c of the code an organization must be both organized and operated exclusively for one or more of the purposes specified in such section if an organization fails to meet either the organizational_test or the operational_test it is not exempt sec_501 c -1 c of the regulations provides that an organization will be regarded as operated exclusively for one or more exempt purposes only if it engages primarily in activities that accomplish one or more of such exempt purposes specified in sec_501 c of the code an organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt_purpose sec_1 c -1 d i of the income_tax regulations provides that a scientific_organization as with other organizations described in sec_501 must be organized and operated in the public interest this means that organizations that primarily pursue business purposes or that serve substantial private interests are not entitled to exemption under sec_501 hence scientific research does not include activities of a type ordinarily carried on as an incident to commercial or industrial operations such as the inspection of products or the designing of equipment reg c -1 d ii revrul_65_1 1965_1_cb_226 wl holds that an organization which promotes and fosters the development and design of machinery in connection with a commercial operation and in connection therewith has the power to sell assign and grant licenses with respect to its copyrights trademarks trade_name or patent rights does not qualify for exemption from federal_income_tax under sec_501 c of the internal_revenue_code the successful development of such machinery is expected to ultimately result in reducing the cost of the particular crops to the public 148_f2d_14 d c the bureau has no shares of stock and no part of its earnings inures to the benefit of any private_shareholder_or_individual the bureau work serves primarily to promote ethical business practices nonetheless the supreme court held that since the activities of the bureau are motivated by a commercial purpose the organization does not operate exclusively for educational_purposes note also that business_leagues chambers_of_commerce and boards_of_trade are exempt from income_tax under sec_501 c of the code but are not charitable organizations as described in sec_501 c of the code 70_tc_352 the court found that a corporation formed to provide consulting services did not satisfy the operational_test under sec_501 c of the code because its activities constituted the conduct_of_a_trade_or_business that is ordinarily carried on by commercial ventures organized for profit its primary purpose was not charitable educational or scientific but rather commercial in addition the court found that the organization's financing did not resemble that of the typical sec_501 c organizations it had not solicited nor had it received voluntary contributions from the public its only source_of_income was from fees from services and those fees were set high enough to recoup all projected costs and to produce a profit moreover it did not appear that the corporation ever planned to charge a fee less than cost and finally the corporation did not limit its clientele to organizations that were sec_501 c exempt_organizations 72_tc_687 the court upheld the commissioner's denial of exemption under sec_501 c of the code the organization was organized to operate a pharmacy to sell drugs at discount prices to elderly and handicapped persons the court reasoned that the organization operated its business primarily for commercial purposes in competition with profit-making drug stores the mere fact that products sold by the organization were helpful to health did not necessarily entitle it to exemption under sec_501 c in reaching its conclusion in federation pharmacy services the court reasoned it is clear that petitioner's exclusive purpose for being its raison d'etre is to sell drugs an activity that is normally carried on by a commercial profitmaking enterprise it does not serve as an adjunct to a larger exempt entity it operates in the manner of an old-fashioned cooperative we fail to see how the fact that it happens to deal in drugs can convert it to a sec_501 c organization if it could be so converted then so could a store selling orthopedic shoes crutches health foods or any other product beneficial to health virtually everything we buy has an effect directly or indirectly on our health we do not believe that the law requires that any organization whose purpose is to benefit health however remotely is automatically entitled without more to the desired exemption we have been cited no evidence that congress intended to exercise its grace in such an expansive manner 283_fsupp2d_58 d d c the district_court found that the organization was formed principally to organize host conduct and sponsor educational and other charitable functions on its facilities the organization's patrons were not limited to tax-exempt entities but included patrons of a private and corporate nature the organization paid significant advertising and promotional expenses and derived substantial income from weddings and special events held at its conference center the court determined that the organization's activities competed with a number of commercial as well as non-commercial entities which strongly evidenced a commercial nature and purpose the court concluded that although the organization carried out a number of charitable and educational activities these were incidental to its primary activity of operating a for-profit conference center application of law you are not described in code sec_501 c because you are not operated exclusively for charitable and educational_purposes you do not meet the provisions of sec_1 c -1 a of the regulations and fail the operational_test per sec_1_501_c_3_-1 of the regulations more than an insubstantial part of your activities are devoted to a non-exempt purpose here the identification development promotion and sales of medical devices your activities support the development of medical devices through counseling advising companies you have indicated there are no limitations placed on who may receive these services in terms of a company's charitable qualifications you seek out vendors to invest resources in potential products take ownership for developing and pushing the product forward to market and identify buyers for the product you will advertise the product to expand your outreach increasing resources you have stated your products and sales will not differ from any competitor in the market and proceeds will be managed like any other business while portions of your activities involve education in the form of counseling to start-up businesses more than an insubstantial amount of your activities are devoted to non-exempt purposes under c also per sec_1 c -1 d i of the income_tax regulations you are not serving scientific purposes exempt under c in that you are primarily conducting activities that serve the private interests of businesses and development partners scientific research does not include activities of a type ordinarily carried on as an incident to commercial or industrial operations such as the inspection of products or the designing of equipment you are similar to the organization in revrul_65_1 in that you are promoting the design and development of medical devices with any potential operators and will sell or grant rights to these devices similar to the ruling even though the intent was to generate machinery that would ultimately benefit the public the organization was still found to not be exempt due to the commercial operations undertaken while your products may have the public as the end user benefitting from lowered costs or better products etc your method of operations are not distinguishable from similar commercial operations and therefore do not qualify you are similar to the organization denied exemption in b s w group inc v commissioner more than an insubstantial amount of your activities constitute the conduct_of_a_trade_or_business ordinarily carried on by commercial ventures organized for profit you seek out resources such as vendors of products willing to invest time and resources for commitment to payment at a future time you will have development partners who will be reimbursed for incurred costs you intend on committing royalties once a product generates revenue products selected for development will be vetted for market need and user acceptability if you decide to distribute a product yourself you will identify sales resources or companies looking for new products in all these are indicative of practices that are commercial rather than charitable educational or scientific in nature further you intend on licensing products for revenue- the only other estimated source of funds being member contributions you are similar to the organization in airlie foundation in that the clientele or customer you intend on serving are not limited you will advertise your services products created will provide you with substantial income and you will be competing with other medical devices created and sold by outside commercial entities together these indicate a commercial nature and purpose your purpose is to develop and sell medical devices an activity that is normally carried on by a commercial profitmaking enterprise your primary purpose is not charitable or educational but commercial to develop products to put to market and sell the educational activity of advising companies you are working with is only to help bring a product to market further per federation pharmacy services merely serving the health industry does not immediately entitle an organization to exemption under c as held in the better business bureau case you are not exempt because you are motivated by a commercial purpose of sales to a niche market at a profit to you and the inventors who receive royalties therefore you do not operate exclusively for any c purposes conclusion you do not qualify for exemption under sec_501 c of the internal_revenue_code because you do not meet the operational_test you are serving primarily non-exempt purposes that are commercial in nature if you don't agree you have a right to file a protest if you don't agree with our proposed adverse determination to do so you must send a statement to us within days of the date of this letter the statement must include your name address employer_identification_number ein and a daytime phone number a copy of this letter highlighting the findings you disagree with an explanation of why you disagree including any supporting documents the law or authority if any you are relying on the signature of an officer director trustee or other official who is authorized to sign for the organization or your authorized representative one of the following declarations for an officer director trustee or other official who is authorized to sign for the organization under penalties of perjury i declare that i examined this protest statement including accompanying documents and to the best of my knowledge and belief the statement contains all relevant facts and such facts are true correct and complete for authorized representatives under penalties of perjury i declare that i prepared this protest statement including accompanying documents and to the best of my knowledge and belief the statement contains all relevant facts and such facts are true correct and complete your representative attorney certified_public_accountant or other individual enrolled to practice_before_the_irs must file a form_2848 power_of_attorney and declaration of representative with us if he or she hasn't already done so you can find more information about representation in publication practice_before_the_irs and power_of_attorney we'll review your protest statement and decide if you provided a basis for us to reconsider our determination if so we'll continue to process your case considering the information you provided if you haven't provided a basis for reconsideration we'll forward your case to the office of appeals and notify you you can find more information about the role of the appeals_office in publication how to appeal an irs decision on tax-exempt status if you don't file a protest within days you can't seek a declaratory_judgment in court at a later date because the law requires that you use the irs administrative process first sec_7428 of the code where to send your protest please send your protest statement form_2848 if needed and any supporting documents to the applicable address u s mail street address for deliverv service internal_revenue_service eo determinations quality assurance room p o box cincinnati oh internal_revenue_service eo determinations quality assurance main street room cincinnati oh you can also fax your statement and supporting documents to the fax number listed at the top of this letter if you fax your statement please contact the person listed at the top of this letter to confirm that he or she received it if you agree if you agree with our proposed adverse determination you don't need to do anything if we don't hear from you within days we'll issue a final adverse determination_letter that letter will provide information on your income_tax filing_requirements you can find all forms and publications mentioned in this letter on our website at www irs gov formspubs if you have questions you can contact the person listed at the top of this letter sincerely director exempt_organizations enclosure publication