Internal Revenue Service
Revenue Ruling
Rev. Rul. 67-5
1967-1 C.B. 123
Sec. 501
IRS Headnote
A foundation controlled by the creator's family is operated to enable the
creator and his family to engage in financial activities which are
beneficial to them, but detrimental to the foundation. This has resulted in
the foundation's ownership of non-income-producing assets which prevent its
carrying on a charitable program commensurate in scope with its financial
resources. Held , the foundation is operated for a substantial non-exempt
purpose and serves the private interests of the creator and his family, and
therefore is not entitled to exemption from Federal income tax under
section 501(c)(3) of the Internal Revenue Code of 1954.
Full Text
Rev. Rul. 67-5
The question has been raised whether a foundation organized and operated in
the manner described below qualifies for exemption from Federal income tax
under section 501(c)(3) of the Internal Revenue Code of 1954.
A foundation was created under a trust agreement between the donor and
members of his family as trustees. The trust agreement sets forth
exclusively charitable purposes and directs the trustees to pay over the
entire net income to charity.
The creator and his family contributed a few shares of common stock in
their family-owned corporation to the foundation shortly after its
inception. At this point the corporation, whose capital structure consisted
solely of common stock, was recapitalized. A first and a second class of
preferred stock, each having voting rights equal to the common, was
authorized. The first class was sold to members of the family; the second
class was issued as a dividend on the common stock.
In the years following the recapitalization, the foundation acquired a
substantial majority of the common stock. The larger portion of this stock
was purchased from the creator and members of his family. In this manner
the sellers realized appreciation in value of the corporation's assets, as
reflected in its common stock, the gain being taxable at capital gains
rates. The foundation also obtained additional common stock in the
corporation through donations from the creator and his family. The donors
claimed deductions as charitable contributions for the appreciated value of
these gifts.
As a result of these transactions, the corporation's common stock became
the foundation's principal asset. Concurrent with the sales and donations
of the common stock to the foundation, the creator and his family increased
their ownership of the corporation's preferred stock. This was accomplished
by authorization and purchase of new issues of preferred, stock dividends
on existing preferred, and various reorganizations between the corporation
and other corporations controlled by the creator and his family.
Throughout this entire period the corporation consistently paid full
dividends on its first preferred and partial dividends on its second
preferred. No dividend was ever paid on the common stock. Since the
corporation's common stock was the foundation's principal asset, the
foundation's income was negligible in relation to the net asset value of
its total holdings. As a result, the foundation was able to carry out only
minimal charitable activities.
Despite the absence of dividends, the trustees of the foundation continued
to purchase the corporation's common stock and failed to invest any sizable
portion of the foundation's funds in other assets productive of income.
Although the foundation was an important stockholder in the corporation,
its trustees never exercised their fiduciary duty to the foundation by
attempting to require the payment of dividends on the common stock or to
prevent the issuance of additional preferred stock which diluted the
underlying value of the common stock and inhibited the payment of dividends
on it.
Section 501(c)(3) of the Code provides for the exemption from Federal
income tax of organizations organized and operated exclusively for
charitable purposes.
Section 1.501(c)(3)-1(c)(1) of the Income Tax Regulations provides that an
organization will be regarded as `operated exclusively' for one or more
exempt purposes only if it engages primarily in activities which accomplish
one or more of such exempt purposes specified in section 501(c)(3) of the
Code.
Section 1.501(c)(3)-1(d)(1)(ii) of the regulations provides that an
organization is not organized and operated exclusively for the purposes
specified in section 501(c)(3) unless it serves a public rather than a
private interest. To meet this requirement, an organization must establish
that it is not organized or operated for the benefit of private interests
such as the creator or his family, or persons controlled, directly or
indirectly, by such private interests.
Members of the family of the creator of the foundation control the
operation and investment policies of the foundation in their capacity as
trustees. Through this control, the foundation has been operated to enable
the creator and his family to engage in financial activities beneficial to
them.
By a series of financial transactions involving the corporation, the
creator and his family have succeeded in shifting the economic advantages
and voting control in this company from the common stock held by the
foundation to the preferred stock held by the creator and his family. The
members of the family acting as trustees of the foundation have acquiesced
in these transactions. As a result, the foundation owns non-income
producing assets and is prevented from carrying on a charitable program
commensurate in scope with its financial resources. Thus, these activities
have not only resulted in favorable tax consequences to the creator and his
family, but their effect has also been detrimental to the charitable
purposes of the foundation.
The use of the foundation as a vehicle for activities advantageous to its
creator and his family and as a source of funds to finance such activities,
the resulting investments by the foundation in assets which fail to produce
income for a charitable program commensurate in scope with its financial
resources, the continued failure of its trustees to protect the value of
these investments, and their failure to make them income-producing, all
establish that the foundation is operated for a non-exempt purpose,
substantial in nature. That purpose is to serve the private financial
interests of its creator and his family. The presence of such purpose is
fatal to exempt status. See Better Business Bureau of Washington, D.C.,
Inc. v. United States , 326 U.S. 279 (1945) Ct. D. 1650, C.B. 1945, 375.
Furthermore, the foundation fails to serve a public, rather than a private,
interest and therefore is not operated exclusively for charitable purposes.
Accordingly, the foundation fails to qualify for exemption from Federal
income tax under section 501(c)(3) of the Code.
