Conservation organization's product sales are an unrelated business

Plain-English summary

A tax-exempt conservation organization sold redacted products through an online store, printed catalog, and unrelated retail outlets. The sales resembled those of commercial sellers, included products made specifically for sale, and operated on a scale larger than reasonably needed for the organization's preservation work. The IRS concluded that the sales did not contribute importantly to the organization's charitable or scientific purposes and were not merely sales of by-products from exempt activities. The sales therefore constituted an unrelated trade or business under IRC § 513.

Ruling snapshot

• Question: Are the organization's catalog, online, and retail product sales substantially related to its exempt conservation purposes?
• Outcome: Advice given, the sales are an unrelated trade or business
• Key authorities: IRC §§ 511 through 513; Treas. Reg. §§ 1.501(c)(3)-1 and 1.513-1

Full text (IRS public release)

                     INTERNAL REVENUE SERVICE
           NATIONAL OFFICE TECHNICAL ADVICE MEMORANDUM

                                  September 18, 2015

                                          [Third Party Communication:
                                          Date of Communication: <Month> DD, YYYY]

Number: 201633032
Release Date: 8/12/2016
Index (UIL) No.: 513.00-00
CASE-MIS No.: TAM-109518-15

Director
TEGE Exempt Organizations Examination

   Taxpayer's Name:                       ---------------------------------------
   Taxpayer's Address:                    --------------------------------
                                          ------------------------------
   Taxpayer's Identification No           -----------------
   Year(s) Involved:                      -------
   Date of Conference:                    -------------------

LEGEND:

Organization = ---------------------------------------

ISSUE(S):

Whether Organization’s sale of --------- through its online store, printed catalog, and at
various unrelated retail outlets is an unrelated trade or business within the meaning of §
513 of the Internal Revenue Code.

CONCLUSION(S):

Organization’s sale of --------- through its online store, printed catalog, and at various
unrelated retail outlets is an unrelated trade or business within the meaning of § 513.

FACTS:

Organization is a not-for-profit corporation organized under state law, and is recognized
by the Internal Revenue Service as an organization described in § 501(c)(3).
Organization states that it is organized for the main purpose of preserving-------------------
-------------------------------------------so that ------ will not become extinct and can be used
TAM-109518-15 2

for future ---------------------------------. Organization’s Articles of Incorporation provide that
Organization is organized “for the literary, charitable and educational purposes of
promoting research, acquiring and disseminating information and educational materials,
promoting awareness and discussion of the problems of ------------------------------------------

-----------------------------------------------------------------------------------------------------, attempting
solutions to these problems through the development of ------------------------------------------
-------------------------------------------, and providing publications to serve as educational
tools, guides and communications networks for individuals and organizations interested
in the conservation of -----------------------.”

Organization’s Bylaws provide that Organization is “conserving and promoting
America’s diverse but endangered ------------------------heritage for future generations by -
-------------------------------------------------------------------------------.” The Bylaws further
provide that Organization “is formed for the literary, charitable, educational, and
scientific purposes of -----------------------------------------------------------------------.”

Organization’s activities include providing publications regarding -------------------------------
-------------------------, providing research and education about conserving ---------------------
--------------------------------------- to keep ------- from being extinct, and helping to develop --
----------------------------------------, and ------------ networks for ---------------------------------------
-------------------.

Organization collects and preserves ---------------------------- from donors, such as families
whose ----------------------------------------------------------------. Organization’s headquarters
are -------------------------where Organization ------------------------------------------------------------

------------------------------------------------------------------------------------------------------------. The
-------serves ---------------------- where --------------------------------------------------------------------

are collected and stored.

Organization conducts workshops, seminars, conferences, and other events that are
open to members and the general public. A visitor’s center at -------------has information
displays regarding -------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------------. There
are ------------------------------------ near the visitor’s center which serve to explain
Organization’s mission and organizational purpose.

Organization maintains a public website. The website explains Organization’s mission,
activities, and membership opportunities. The educational portion of the website
instructs about -----------------, how to donate ----------------------to Organization for
preservation, how to preserve ---------, and how to participate in -----------------------. -------
TAM-109518-15 3

--------------------- Members can share stories about the history and characteristics of -----
-----------------------.

In addition, Organization sells -------------------------------------------------to the public through
its ------- catalog (available both online and in print) and through unrelated retail outlets.
The ------- --------- manager, in consultation with the preservation staff, determines which
------------------------- to offer for sale. The publication of the annual catalog is a ------------
------------------------. The sale of a ------------------------------------------------------------------------
------------------------------------------------------------------------------------------------commences
once ----------------------------------------------- are on hand.

About twenty percent of ---------------sold by Organization are produced at ------------.
These operations are conducted by employees of Organization. The remainder is
produced by -----------------------under contract with Organization. Organization provides
these ------------ with the ----------------and inspects and monitors ----- -----------------------
including performing quality control checks on -------------------------------------------------------

------------------------------------------------------------------------------------------------------. The
processing of ------------ orders and the packaging and distribution of --------------occur ----
------------.

--------- are sold in standard ------- packages. The front of the package shows a picture
of ------------. The back of the package provides ----------------------------- instructions
typical of commercial ------- packages, plus one or two sentences on -------------------------
----------. Organization’s office and website addresses are also listed, in small print, on
the back of the packages.

A prominent link on the home page of Organization’s website connects visitors directly
to the online store where -------------------------books, and ----------------related products are
sold. A person can also link directly to the online store through online search engines.
The ---------------------is published ------------. Recent catalogs comprise approximately ---
----- pages. Aside from a few pages with information about Organization, its ---------------
-----------programs, and how to -----------------------------, the catalog is similar to the -------
catalogs published by for-profit ------- companies.

-------- packages are also sold throughout the country from ----------------located in ---------
--------------------------------------------------------------retail outlets. Retailers can request a ----
-------------------------------------------------from Organization.

LAW AND ANALYSIS:

Section 501(c)(3) describes as exempt from federal income tax organizations
organized and operated exclusively for charitable, scientific, or educational purposes,
TAM-109518-15 4

no part of the net earnings of which inures to the benefit of any private shareholder or
individual.

Section 511 imposes a tax on the unrelated business taxable income of an exempt
organization that is otherwise exempt from federal income tax pursuant to § 501(c)(3).

Section 512(a)(1) defines the term “unrelated business taxable income” as gross
income derived by any organization from any unrelated trade or business (as defined in
§ 513) regularly carried on by it, less the allowable deductions which are directly
connected with the carrying on of such trade or business, both computed with the
modifications provided in § 512(b).

Section 513(a) defines the term “unrelated trade or business” as any trade or business
whose conduct is not substantially related (aside from the need of such organization for
income or funds or the use it makes of the profits derived) to the exercise or
performance by such organization of its charitable, educational, or other purpose or
function constituting the basis for its exemption under § 501.

Section 513(c) explains that, for purposes of § 513, the term “trade or business”
includes any activity which is carried on for the production of income from the sale of
goods or the performance of services. For purposes of the preceding sentence, an
activity does not lose identity as a trade or business merely because it is carried on
within a larger aggregate of similar activities or within a larger complex of other
endeavors which may, or may not, be related to the exempt purposes of the
organization. Where an activity carried on for profit constitutes an unrelated trade or
business, no part of such trade or business shall be excluded from such classification
merely because it does not result in profit.

Section 1.501(c)(3)-1(d)(5) provides, in part, that the term “scientific,” as used in §
501(c)(3), includes the carrying on of scientific research in the public interest. For
research to be scientific within the meaning of section 501(c)(3), it must be carried on in
furtherance of a scientific purpose. Scientific research does not include activities of a
type ordinarily carried on as an incident to commercial or industrial operations, as, for
example, the ordinary testing or inspection of materials or products or the designing or
construction of equipment, buildings, etc.

Section 1.513-1(a) provides that the gross income of an exempt organization subject to
the tax imposed by § 511 is includible in the computation of unrelated business taxable
income if: (1) it is income from trade or business; (2) such trade or business is regularly
carried on by the organization; and (3) the conduct of such trade or business is not
substantially related (other than through the production of funds) to the organization's
performance of its exempt functions.
TAM-109518-15 5

Section 1.513-1(b), provides that, for purposes of § 513, the term “trade or business”
has the same meaning it has in § 162, and generally includes any activity carried on for
the production of income from the sale of goods or performance of services. Thus, the
term “trade or business” in § 513 is not limited to integrated aggregates of assets,
activities, and good will which comprise businesses for the purposes of certain other
provisions of the Internal Revenue Code. Activities of producing or distributing goods or
performing services from which a particular amount of gross income is derived do not
lose identity as trade or business merely because they are carried on within a larger
aggregate of similar activities or within a larger complex of other endeavors which may,
or may not, be related to the exempt purposes of the organization.

Section 1.513-1(d)(1) provides that gross income derives from unrelated trade or
business, within the meaning of § 513(a), if the conduct of the trade or business which
produces the income is not substantially related (other than through the production of
funds) to the purposes for which exemption is granted. The presence of this
requirement necessitates an examination of the relationship between the business
activities which generate the particular income in question – the activities, that is, of
producing or distributing the goods or performing the services involved – and the
accomplishment of the organization’s exempt purposes.

Section 1.513-1(d)(2) provides, in part, that trade or business is “related” to exempt
purposes only where the conduct of the business activities has a causal relationship to
the achievement of exempt purposes (other than through the production of income), and
is “substantially related” for purposes of § 513, only if the causal relationship is a
substantial one. Thus, for the conduct of a trade or business from which a particular
amount of gross income is derived to be substantially related to purposes for which
exemption is granted, the production or distribution of the goods or the performance of
the services from which the gross income is derived must contribute importantly to the
accomplishment of those purposes. Where the production or distribution of the goods
or the performance of the services does not contribute importantly to the
accomplishment of the exempt purposes of an organization, the income from the sale of
the goods or the performance of the services does not derive from the conduct of
related trade or business. Whether activities productive of gross income contribute
importantly to the accomplishment of any purpose for which an organization is granted
exemption depends in each case upon the facts and circumstances involved.

Section 1.513-1(d)(3) provides that in determining whether activities contribute
importantly to the accomplishment of an exempt purpose, the size and extent of the
activities involved must be considered in relation to the nature and extent of the exempt
function which they purport to serve. Thus, where income is realized by an exempt
organization from activities which are in part related to the performance of its exempt
functions, but which are conducted on a larger scale than is reasonably necessary for
performance of such functions, the gross income attributable to that portion of the
activities in excess of the needs of exempt functions constitutes gross income from the
TAM-109518-15 6

conduct of unrelated trade or business. Such income is not derived from the production
or distribution of goods or the performance of services which contribute importantly to
the accomplishment of any exempt purpose of the organization.

Section 1.513-1(d)(4)(ii) provides that, ordinarily, gross income from the sale of products
which result from the performance of exempt functions does not constitute gross income
from the conduct of unrelated trade or business if the product is sold in substantially the
same state it is in on completion of the exempt functions. Thus, in the case of an
organization described in § 501(c)(3) and engaged in a program of rehabilitation of
handicapped persons, income from the sale of articles made by such persons as a part
of their rehabilitation training would not be gross income from conduct of unrelated trade
or business. The income in such case would be from the sale of products, the
production of which contributed importantly to the accomplishment of purposes for
which exemption is granted the organization – namely, rehabilitation of the
handicapped. On the other hand, if a product resulting from an exempt function is
utilized or exploited in further business endeavor beyond that reasonably appropriate or
necessary for disposition in the state it is in upon completion of exempt functions, the
gross income derived therefrom would be from conduct of unrelated trade or business.

Section 1.513-1(d)(4)(iii) provides that, in certain cases, an asset or facility necessary to
the conduct of exempt functions may also be employed in a commercial endeavor. In
such cases, the mere fact of the use of the asset or facility in exempt functions does
not, by itself, make the income from the commercial endeavor gross income from
related trade or business. The test, instead, is whether the activities productive of the
income in question contribute importantly to the accomplishment of exempt purposes.

Rev. Rul. 65-1, 1965-1 C.B. 226, concerns an organization, the primary purpose of
which is to foster the development and design of labor saving agricultural machinery,
including the development of new labor saving ideas and methods, and to conduct
pertinent research. In carrying out its purposes, the organization undertakes to
determine the need for the development of agricultural machinery which can plant,
cultivate, or harvest crops of the type which are normally planted, cultivated, or
harvested manually by agricultural laborers. Upon selecting a project to be developed,
the organization consults with various public institutions, agricultural colleges, and
engineers to ascertain if any similar projects are in process. If not, a grant is made by
the organization to an appropriate public agency or firm to develop the necessary
machinery. A committee then follows up the development under actual field conditions
during the agricultural season. If a machine proves successful, a patent is sought in the
organization’s name and a manufacturer is licensed to build and sell the machine or
device on an exclusive or non-exclusive basis. The successful development of such
machinery is expected to ultimately result in reducing the cost of the particular crops to
the public. The ruling concludes that the development or designing of machinery under
these circumstances is incident to commercial or industrial operations and does not
constitute “scientific research” within the meaning of § 1.501(c)(3)-1(d)(5). Furthermore,
TAM-109518-15 7

the development of a new machine, the patents of which may be licensed on a
restrictive basis to selected manufacturers, is directed toward benefiting those particular
manufacturers. Under these circumstances the organization cannot be considered as
operating for a public purpose. Accordingly, it is held that the organization is not
organized and operated for scientific or any other purpose described in § 501(c)(3).

Rev. Rul. 66-179, 1966-1 C.B. 139, concerns a nonprofit organization organized for the
purposes of instructing the public on horticultural subjects and stimulating interest in the
beautification of the geographic areas. In furtherance of these purposes, the
organization (1) maintains and operates a free library of materials on horticulture and
allied subjects; (2) instructs the public on correct gardening procedures and
conservation of trees and plants by means of radio, television, and lecture programs; (3)
holds public flower shows of a noncommercial nature at which new varieties of plants
are exhibited; (4) makes awards to children for achievements in gardening; (5)
encourages roadside beautification and civic planting; and (6) makes awards for civic
achievement in conservation and horticulture. It is concluded that the organization is
organized and, in carrying out its purposes in the manner described above, is operated
exclusively for charitable and educational purposes. Accordingly, the organization
qualifies for exemption under § 501(c)(3).

Rev. Rul. 73-104, 1973-1 C.B. 263, concerns an organization, exempt from federal
income tax under § 501(c)(3), that maintains and operates an art museum devoted to
the exhibition of modern art. The museum offers for sale to the general public greeting
cards that display printed reproductions of selected works from the museum’s collection.
Each card is imprinted with the name of the artist, the title or subject matter of the work,
the date or period of its creation, and the museum’s name. The organization sells the
cards in the shop it operates in the museum. It also publishes a catalog in which it
solicits mail orders for the greeting cards. In addition, the shop sells the cards at
quantity discounts to retail stores. It is concluded that the sale of the greeting cards
displaying printed reproductions of art works contributes importantly to the achievement
of the museum’s exempt educational purposes by stimulating and enhancing public
awareness, interest, and appreciation of art. Moreover, a broader segment of the public
may be encouraged to visit the museum itself to share in its educational functions and
programs as a result of seeing the cards. The fact that the cards are promoted and sold
in a clearly commercial manner at a profit does not alter the fact of the activity’s
relatedness to the museum’s exempt purpose. Accordingly, it is held that these sales
activities do not constitute unrelated trade or business under § 513.

Rev. Rul. 76-204, 1976-1 C.B. 152, concerns an organization formed for the purpose of
preserving the natural environment. The organization accomplishes this purpose by
acquiring and maintaining ecologically significant and undeveloped land such as
swamps, marshes, forests, wilderness tracts, and other natural areas. The organization
works closely with Federal, state, and local government agencies, and private
organizations that are also concerned with environmental conservation. Through
TAM-109518-15 8

preserving "ecologically significant undeveloped land, the organization is enhancing the
accomplishment of express national policy of conserving the nation's unique natural
resources." Thus, it is concluded that the "organization is advancing education and
science and is benefiting the public in a manner that the law regards as charitable."

Rev. Rul. 78-145, 1978-1 C.B. 169, concerns a blood bank, exempt from income tax
under § 501(c)(3), that collects and maintains inventories of human blood and blood
products which are furnished to hospitals for immediate patient use. The whole blood
collected by the blood bank is separated into components to meet demands for red
blood cell transfusion. The blood bank is left with a large supply of plasma after removal
of the red blood cells. Since only a small part of this supply of plasma is needed by the
hospitals served by the blood bank, most of it is sold to commercial laboratories. The
blood bank also obtains plasma from donors through a procedure called
plasmapheresis, in which whole blood is drawn from a donor (typically a donor with rare
antigens, reagents, and antibodies in his or her plasma), the red cells are separated and
replaced in the donor, and plasma is collected. The plasma obtained through
plasmapheresis is sold to commercial laboratories for processing into its various
components. The blood bank also sells plasma to commercial laboratories that is
salvaged from unused whole blood in the blood bank’s inventory that is near the end of
its shelf life. Finally, the blood bank purchases some plasma from other blood banks
that it sells to commercial laboratories. The ruling states that although the sale of
plasma to commercial laboratories does not bear a causal relationship to the blood
bank’s exempt functions, where the blood bank is merely disposing of products which
result from the performance of its exempt functions, it will not be considered to be
engaging in unrelated trade or business under § 1.513-1(d)(4)(ii). Since providing blood
and blood products to hospitals is one of the organization’s exempt functions, its sale of
by-product plasma after the red blood cells are removed for use by the hospitals is not
unrelated trade or business. Similarly, since the maintenance of an inventory of whole
blood is one of the organization’s exempt functions, its sale of plasma salvaged from
blood in its inventory that is nearing the end of its shelf life is not unrelated trade or
business, assuming that the amount of whole blood maintained in inventory is not
excessive in view of the expected needs of the hospitals that the organization serves.
On the other hand, plasma derived from donors through the process of plasmapheresis
is not a product resulting from the performance of exempt functions, but is obtained for
resale. Similarly, the plasma purchase from other blood banks and resold to
commercial laboratories is not a result of the performance of an exempt function. In
both of these cases, the sale of the plasma constitutes unrelated trade or business.

Rev. Rul. 78-384, 1978-2 C.B. 174, concerns an organization that owns farm land. It
restricts the use of its farm land to farming or such other uses as the organization
deems ecologically suitable for the land. Although the organization claims to benefit the
public by restricting its land to uses compatible with the ecology of the area, it is not
preserving land that has any distinctive ecological significance with the meaning of Rev.
Rul. 76-204. In addition, any benefit to the public from this organization’s self-imposed
TAM-109518-15 9

restriction on its own land is too indirect and insignificant to establish that the
organization serves a charitable purpose within the meaning of § 1.501(c)(3)-1(d)(2).
Accordingly, because the organization does not preserve ecologically significant land
and has not otherwise established that it serves a charitable purpose, it is not operated
exclusively for charitable purposes and does not qualify for exemption from federal
income tax under § 501(c)(3).

California Thoroughbred Breeders Assoc. v. Comm’r, T.C. Memo 1989-342, concerns a
nonprofit corporation (“CTBA”, or “the petitioner”) organized “to encourage, assist,
regulate, and protect the raising and breeding of Thoroughbred horses; to disseminate
information to members of the corporation and to others who are breeders of
Thoroughbred horses within the State of California, and to give support, financially an
otherwise, to the development and general welfare of the breeding of Thoroughbred
horses by breeders within the State of California….” CTBA’s bylaws limit membership
to owners of one or more thoroughbred brood mares maintained for breeding in
California. The Service recognizes CTBA as tax exempt as an organization described
under the predecessor statute to § 501(c)(5). CTBA entered into a joint venture with a
for-profit auction company, and later formed wholly owned corporation, to conduct
thoroughbred horse auction sales in California. The Service sought to tax CTBA’s
distributive share of the profits of the joint venture as unrelated business taxable income
under § 511, relying on § 1.513-1(d)(2) to assert that the auction sales bear no causal
relationship to the advancement of CTBA’s exempt purpose. The Tax Court looked to §
1.501(c)(5)-1(a)(2) to define the exempt purposes of a § 501(c)(5) organization as “the
betterment of the conditions of those engaged in [labor, agricultural, or horticultural]
pursuits, as well as the improvement of their products.” The court concluded that
CTBA’s objectives of encouraging, assisting, regulating and protecting the breeding of
thoroughbreds in California is an exempt purpose under § 501(c)(5), and that the
auction sales were substantially related to those purposes, saying that “the size of the
state, the scattering of breeders throughout the state, the history of unreliable auction
sales conducted by private commercial operations, the inherent importance of
petitioner’s auctions to the operation of the industry, and the benefits achieved by the
industry because of the auctions, all establish that the auction sales are indeed
substantially related to CTBA’s objectives.” The court noted that “petitioner itself is not
buying and selling the product, but providing an outlet for its members to do so. Of
particular interest is that the industry had no comparable commercial outlet available for
such services. Had petitioner not organized such sales, the industry as a whole would
undoubtedly have floundered [sic], with the result that the California horses would have
remained undermarketed and underpriced.”

As an organization described in § 501(c)(3), Organization is subject to the tax imposed
by § 511 on its unrelated business taxable income (as defined in § 512). Generally,
gross income of an exempt organization is includible in the computation of unrelated
business taxable income if: (1) is it income from trade or business; (2) such trade or
business is regularly carried on; and (3) the conduct of such trade or business is not
TAM-109518-15 10

substantially related (other than through the production of funds) to the organization’s
performance of its exempt functions. See § 1.513-1(a).

Organization derives gross income from the sale of ------------------------------------------------

to the public (the “--------sales”). These ------- sales are conducted continuously through
print and web-based catalogs and from ----------------located at ----------------------------------
-------------------------------------------------------------------------------------------------------------------,
and other retail locations in a manner, and with regularity, similar to that of non-exempt -
------- suppliers. Organization does not dispute that its ------- sales are a trade or
business or that they are regularly carried on. Therefore, the gross income from
Organization’s ------- sales will not be excluded from unrelated business taxable income
unless such sales are substantially related to Organization’s exempt purpose within the
meaning of § 1.513-1(d). Also see § 1.513-1(b).

Organization is organized for the purpose of ---------------------------------------------------------

----------------------. To find that the ------- sales are substantially related to Organization’s
exempt purpose within the meaning of § 513, the sales activities must contribute
importantly to the accomplishment of that purpose. See § 1.513-1(d)(2). Organization
maintains that its ------- sales contribute importantly to its exempt purposes by serving
educational, charitable, and scientific functions.

Even though Organization’s research and educational activities are substantially related
to Organization’s exempt purposes, the fact that the ------- sales are conducted in
conjunction with, or (in the case of its online catalog) through the same vehicles (e.g.,
the website) as, Organization’s exempt activities does not compel a conclusion that the
------- sales, too, are substantially related. The --------sales do not lose their separate
identity as a trade or business merely because they are carried on within the larger
context of ---------------------------------------------------------------as part of Organization’s ------
----------------------------------------functions. See § 1.513-1(b). Therefore, to determine
whether the ------- sales are substantially related (other than through the production of
funds) to the purposes for which exemption was granted to Organization, it is necessary
to examine the relationship between those sales, as a separate trade or business, and
the accomplishment of Organization’s exempt purposes. See § 1.513-1(d)(1).

Organization posits that the ------- sales contribute importantly to its educational function
in that they may encourage buyers to visit its visitor center or the educational pages of
its website. Organization points specifically to a reference, printed ------------------ of
each ------- package, to its website and, furthermore, notes that customers who order
online and provide their email addresses during checkout will subsequently receive
periodic educational newsletters via email. In Rev. Rul. 73-104, an art museum sold
greeting cards that display reproductions of art work and that are imprinted with the
name of the artist, the title or subject matter of the work, the date and period of its
TAM-109518-15 11

creation, and the name of the museum. The Service concluded that the sales of
greeting cards contribute importantly to the achievement of the museum’s educational
purposes by stimulating and enhancing public awareness, interest, and appreciation of
art, and by encouraging a broader segment of the public to visit the museum. The mere
reference on a ------- package to another, separate activity or function of the
Organization, in this case, the educational portion of its website does not render the------
--------package itself “educational” or cause the ------- sales, as a separate trade or
business, to “contribute importantly” to the accomplishment of Organization’s
educational purpose within the meaning of § 1.513-1(d)(2). Likewise, the fact that a
piece of information, such as a customer’s e-mail address, is acquired in the course of a
commercial endeavor and used in the conduct of exempt educational functions such as
to include in the e-newsletter mailing list does not, by itself, make the
commercial endeavor of --------sales substantially related to exempt functions; this is
because visitors to Organization’s website can sign up online to receive Organization’s
e-newsletters without purchasing ---------. The test, instead, is whether the activity of
selling ---------, in and of itself, contributes importantly to the accomplishment of
Organization’s educational purposes. See § 1.513-1(d)(4)(iii).

The greeting cards described in Rev. Rul. 73-104 are different from the --------- offered
for sale by Organization. In the case of Rev. Rul. 73-104, the thing sold – i.e., the
greeting card – bears a reproduction of an original work of art. A person looking at the
greeting card sees an image of the work itself, and is thus exposed to all of the
“information” conveyed by the original. In addition, since the greeting card reproduces a
unique work in the possession of one museum, a person looking at the card is more
likely to be encouraged to visit that museum to see the original and other work in the
museum’s collection.

In the case of the ------- sales, on the other hand, the thing sold – i.e., the --------- – do
not impart any information at all, while the ------- package, with its instructions on how to
---------------------------------------------------as well as a sentence or two concerning ------------
-----------------------------------, imparts little that could not also be found on ------- packages
offered by commercial -------- ------------. Significantly, there are no instructions or other
information on the package about how to ------------- --------- or how to ----------------- -------
------------------. Therefore, we conclude that Organization’s ------- sales do not contribute
importantly to the educational purpose of preserving -----------------------------------------------
-----------------------------------------------and conserving ------------------------------------------------
-------------.

Organization states that the ------- sales further its charitable purpose of preserving and
protecting the environment for the benefit of the public, similar to Rev. Rul. 76-204
(holding that an organization that acquires and preserves ecologically significant
undeveloped land is operated exclusively for charitable purposes). However, the facts
here are more similar to those described in Rev. Rul. 78-384 (holding that an
organization that operates a farm and merely restricts the land to uses that do not
TAM-109518-15 12

change the environment is not preserving land that has any distinctive ecological
significance within the meaning of Rev. Rul. 76-204). Organization does not claim that
its ------ occupies ecologically significant land, nor, more importantly, that the --------------
-----------------------------------and selling the --------- serve in any way to preserve land that
has ecological significance.

We recognize that Organization’s purpose to conserve --------------------------------------------

-----------------------------------------------------------------------------------------------------------------is
charitable and educational. See, e.g., Rev. Rul. 66-179, supra. We also recognize that
many of Organization’s conservation “strategies” — developing --------------------------------

----------------------------------------------------------------------------------------------------, teaching
and inspiring ----------------------------------, and facilitating the sharing of ------------------------
------------------------ – are in furtherance of that exempt purpose. However, Organization
has not shown that selling large quantities of----------is necessary to preserve --------------
------------.

Organization states that another of its conservation strategies of encouraging -------
companies to sell ---------------------is also in furtherance of the same exempt purposes,
and that its ------- sales are necessary to effectuating that strategy. Specifically,
Organization maintains that the establishment of a successful ------- catalog ----------------

------------ is an example of a market-driven conservation model, which anticipates that
the for-profit ----------------------industry will supply more --------------------------------, thus
making ------- less scarce, if another institution can demonstrate a demand for the
resource. Organization reasons that its --------sales contribute importantly to its
scientific and charitable purpose of conserving ------------------------------- by establishing
market demand and thus incentivizing other ------- companies to carry ------------------------
----------------------------------------------------------------------------------------------------------------.
However, there are already commercial---------companies selling ---------------------.

Further, the development of a product in connection with a commercial operation does
not necessarily further scientific purposes under § 501(c)(3). See, e.g., Rev. Rul. 65-1
(holding that an organization which promotes and fosters the development and design
of machinery incident to commercial operations does not qualify for exemption under §
501(c)(3)). Organization compares its ------- sales to the horse auctions conducted by
the petitioner (“CTBA”) in California Thoroughbred Breeders Ass’n v. Comm’r, T.C.
Memo 1989-342. Organization maintains that both it and CTBA are “-------------------------

----------------------,” and that both seek “to provide a superior product to the public.”
However, California Thoroughbred Breeders Ass’n involved an organization exempt
under § 501(c)(5), not one exempt under § 501(c)(3). Section 1.501(c)(5)-1(a)(2)
TAM-109518-15 13

provides that an organization described in § 501(c)(5) has as its object the betterment of
the conditions of those engaged in labor, agricultural, and horticultural pursuits, the
improvement of the grade of their products, and the development of a higher degree of
efficiency in their respective occupations. In finding that “had petitioner not organized
such sales, the industry as a whole would undoubtedly have floundered [sic], with the
result that the California horses would have remained under-marketed and
underpriced,” the Tax Court concluded that the auction sales bettered the conditions of
thoroughbred breeders and improved the grade of their products, and heightened the
efficiency of their occupations consistent with § 501(c)(5). Furthermore, the Tax Court
discerned a difference between selling a product directly and conducting an auction. In
explaining its reasons for concluding that CTBA’s activities “better the conditions of
those engaged in [thoroughbred breeding] pursuits” the court noted that “[CTBA] itself
was not buying and selling the product but providing an outlet for its members to do so.”
Conversely, Organization’s ------- sales go beyond “providing an outlet” for its members
to share ---------, but entail direct sales to the public. In determining whether
Organization’s ------- sales are substantially related to § 501(c)(3) purposes, the
question is not whether the --------sales better conditions in, or improve the grade of
products of a particular industry; It is whether they contribute importantly to
Organization’s charitable and scientific purpose of --------------------------------------------------
---------------------------------. Organization has failed to demonstrate that they do.

The ------- sales are not aimed at ------------interested in working to preserve, multiply,
and spread unique and threatened --------------------------, nor to people wishing to start or
participate in ----------------------------------------------------------------------------------. Rather
the --------- are marketed and sold to the public in a manner similar to that of other
purveyors of -----------------------, and, thus, are likely to be used for the same purpose as
--------- sold by other purveyors – i.e., to ----------------------------------------------, not
preservation. Therefore, we conclude that there is no substantial causal relationship
between the ------- sales and Organization’s exempt purposes of conserving and
preserving-------------------------.

Finally, the ----------sold to the public through the catalog and ----------------are not
“products which result from the performance of exempt functions” as described in §
1.513-1(d)(4)(ii).

Rev. Rul. 78-145 holds that blood bank sales of by-product plasma (which is what
remains of whole blood after the red cells have been extracted to meet the demands of
hospitals for red blood cell transfusion) and salvage plasma (which is plasma extracted
from units of whole blood which are no longer fresh enough for transfusions because
their shelf-life has expired) to commercial laboratories does not give rise to unrelated
trade or business income, assuming that the amount of whole blood maintained in
inventory is not excessive in view of the expected needs of the hospitals served by the
blood bank. On the other hand, gross income derived from the sale to commercial
TAM-109518-15 14

laboratories of plasma obtained from other blood banks or drawn from individual donors
does give rise to unrelated business taxable income.

By analogy, if the----------sold through the ------- catalog are merely the “by-products” or
the “remains” of -------------------------------------in the course of the performance of
Organization’s preservation functions in furtherance of exempt purposes (assuming that
the amount of ---------------------------------is not excessive in view of the expected
requirements of such functions), gross income from the sale of such by-product or -------
-----------------------would not be gross income from the conduct of unrelated trade or
business. On the other hand, if the----------sold are not products that result from the
performance of Organization’s preservation functions, as would be the case if the --------

were ---------------specifically for sale, the ------- sales would constitute unrelated trade or
business.

Organization needs to -----------------------------------------------to effectuate its preservation
strategies in furtherance of its exempt function of preserving ------------------------------------
--------------. Specifically, Organization needs to -------------------------------to maintain its ---
--------------------------------, stock its -----------------, and provision its members, volunteers
and other persons who are interested in preserving -------------------------through
Organization’s preservation and conservation projects, -------------------------------------------
----------------------------------------------. Where the quantity of ---------------------------------------

--------------, is reasonable in relation to the requirements of Organization’s conservation
strategies, income from the disposition of the ----------------------- does not constitute
unrelated trade or business. However, where the --------------------------------------------------
--------- is conducted on a larger scale than is reasonably necessary to effectuate such
strategies, the gross income attributable to the ----------------------------in excess of the
needs of exempt functions constitutes gross income from the conduct of unrelated trade
or business. See § 1.501(c)(3)-1(d)(3).

The facts show that the --------- offered for sale through the catalog and ----------------------
-----------------------------------------------------------------------------------------------------------are not
the mere “by-products” or “remains” of -------------------------------------in the course of the
performance of Organization’s conservation functions, but, instead, are the product of --
--------- produced in a business venture which sees Organization ------------------------------
------------------------------------------------------------ the quantity of --------- necessary to have
sufficient stock on hand to sustain a commercially viable and profitable---------business.
This quantity of --------- is in excess of the quantity of --------- necessary to effectuate the
Organization’s preservation strategies in furtherance of its exempt function of preserving
---------------------------------------------. Therefore, because the --------------------------------------
---------------------------------------------------------------------------------------------------------------is
conducted on a larger scale than is reasonably necessary for performance of
Organization’s exempt functions, the ------------------------for sale are not considered
TAM-109518-15 15

products which result from the performance of exempt functions under § 1.513-
1(d)(4)(ii). Consequently, the gross income attributable to the --------sales constitutes
gross income from the conduct of unrelated trade or business.

CAVEAT(S):

A copy of this technical advice memorandum is to be given to the taxpayer(s). Section
6110(k)(3) of the Code provides that it may not be used or cited as precedent.