February 2, 2008
Houston We Have a Problem: One Laptop Per Child Founder Creates Commercial Start-up with Tax Exempt Technology
We previously blogged the saga of Intel vs. One Laptop Per Child (OLPC). OLPC is a 501(c)(3) whose charitable goal was to develop and distribute very low cost laptop computers to children in poor and developing countries. After Intel pulled out, a move that an L.A. Times editorial likened to a virtual knife in the back, it seemed as though OLPC would fold its tent and go home. In fact, in a recorded interview, Nicholas Negroponte (one of the founders of OLPC) seemed to throw in the towel, saying that the idea of marketing low cost laptops to children in poor countries "just didn't work." A recent Boston Globe article, though states that one of the co-founders of the technology had founded a commercial start-up to do that which OLPC could not do:
The scientist who designed a notebook computer for poor children that is being produced and sold by a nonprofit foundation has set up a company to commercialize the technology with a goal of producing a $75 laptop computer. Mary Lou Jepsen, who left her post as chief technology officer of the One Laptop Per Child Foundation at the end of last year, said on a website for her company, Pixel Qi, that her firm is "a spin-out" from the nonprofit group. Jepsen invented a low-cost, low-power, sun-readable screen while at the foundation from 2005 to 2007. She also co-invented its power-management system.
Did you catch those last two sentences? That's public technology she will be marketing. The inventor -- apparently acting as an employee or agent of a 501(c)(3) when doing the inventing -- has acquired the technology (or the use thereof) and will now use it to open her own commercial [i.e., profit-paying] enterprise. Granted, the goal is very laudable but the tax lawyer in me wonders whether this is proper under IRC 501(c)(3). Let's boil this scenario down to a nice law school hypothetical, shall we? Organization applies for and receives tax exempt status as a "scientific" or "charitable" organization. It develops ground-breaking technology that does nobody any good unless that technology is transferred to public benefit. See generally Treas. Reg. 1.501(c)(3)-1(d)(5) (stating, inter alia, that science is in the public good only if knowledge acquired is somehow transferred to the market place). All fine and good. So after a few years, the tax supported entity discovers new technology. For whatever reason, its first efforts at technology transfer fail. Can an insider -- assuming Jepsen is an insider -- take the technology developed by the tax subsidized entity and use it for profit-making purposes? It would be analogous, it seems to me, for a nonprofit old folks transportation company to give away its vans and trucks to an employee who plans to start a commercial delivery company. Even if the insider paid market rates for the technology developed within the 501(c)(3) organization, there still seems to be problems with allowing the insider exclusive or free rights to that technology. The new commercial venture, by the way, states on its dot.com [not "dot.org" mind you] web site that it "will give OLPC products at cost, while also selling sub-systems and devices at a profit for commercial use." Hmmmmmm. Technology transfer is perfectly consistent with tax exempt status under 1.501(c)(3)-1(d)(5), but the individual or company exploiting tax exempt subsidized technology must pay market rates (usually via a royalty to the tax exempt organization). In addition, a 501(c)(3) that intends to fold can't just divide its assets up amongst its employees. I sure hope OLPC and Dr. Jepsen consulted a tax lawyer.
The broader point here relates to the current rush to "commercialize" charitable activities. I'm fine with that too. But there is a public subsidy that must be dealt with whenever a tax subsidized entity intends to go commerical in whole or in part.
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OK. Slow day at the office and I feel like stirring the pot a bit.
There is no problem with letting an insider commercialize technology developed by an exempt organization as long as the insider pays full fair market value for the right to do so.
As you note, the primary issue here is private inurement/excess benefit. But if the insider pays full fair market value to the charity for the right to exploit the technology, why should anyone care? Would you feel better if the charity sold the technology to Microsoft who then buried it as a threat to their hegemony? Or would you feel better if we prohibited them from selling it at all? Forced the charity to open its own factory to commercialize the technology even if it has no expertise in doing so? As long as the charity gets maximum economic benefit from the arrangement, which it can then use to further its charitable purpose, then let 'em go for it. I'm assuming you would not be in favor of a rule that shackles charities from selling or redeploying assets as they see fit to maximize their charitable impact. If selling technology makes a charity a ton of money that it can reinvest in its charitable purpose, I don't think we ought to interfere. Of course, the problem is establishing what "full fair market value" is in transactions with insiders. This harkens back to the days of hospital conversion transactions, where I always thought that we should require an open bidding process to establish FMV, before letting insiders buy (and if memory serves me, I think some states passed conversion laws that required something like this). Perhaps the same is true here: maybe we should prohibit a nonprofit from transferring valuable rights to an insider without some sort of public auction, which ought to be pretty easy to do in these internet-enabled days. But if the insider really does pay FMV for the rights, I see no problem with this - and standard economic analysis would note that sometimes exclusive contracts are the best way to maximize economic value to the rights holder.
Posted by: John Colombo | Feb 2, 2008 4:48:50 PM