December 4, 2008
Australian High Court Reinstates Exempt Status for Feeder Corporation: VSP Revisited
Yesterday, we posted a comment regarding Vision Service Plan's petition before the U.S. Supreme Court. As you may recall, VSP is a nonprofit, contract model HMO whose 40 year old (c)(4) tax exemption was suddenly revoked when the Service decided that it impermissably operates for the private benefit of its subscribers. If we assume, as we must, that VSP funnels all of its "profit" into health care and that health care is indeed a charitable goal, then the revocation must ultimately rest on IRC 503 -- the "feeder" provision that codifies Mueller Macaroni. In essence, an organization that operates a non-charitable business is not entitled to tax exempt status merely because all of its operating surplus is devoted to an irrefutably charitable goal. If the Government is correct, VSP is not just a normal business operation but is, instead a feeder organization, since its operating surplus is not paid to investors but is instead devoted to the provision of charity by some other entity. I make this point because we, in the United States, think calling something a feeder organization settles the matter. And, in fact, it does as a matter of statutory law. But what about good policy? Not just a few commentators (I won't cite to any at the moment because I want to get to the broader point) have questioned the whole basis for the preclusion of tax exemption for feeder organizations. Is it really true that if we allow tax exemption for normal businesses, the owners of whom disdain profit-taking and instead devote all profits to supporting someone elses charitable activities, we will undercut the tax base by encouraging all business owners to declare themselves nonprofit and therefore tax exempt? In other words, does unrelated business really and truly threaten for-profit business with unfair competition. I think not and here's why. People will always want to get rich. And tax exempt status precludes people from getting rich, at least its supposed to, by way of the nondistribution constraint (aka, the prohibitions against private inurement and excess benefit). Let's set aside for the moment the argument that the prohibitions are enforced and therefore you can get rich operating a nonprofit. The fact that you cannot get rich legitimately via a nonprofit organization is proof enough that unrelated business and feeder organizations are not to be viewed as threats to the capitalist marketplace. It is just not true that without the unrelated business income tax or the prohibition against feeder organizations, nonprofits will take over the world.
Which brings me to Commissioner of Taxation of the Commonwealth of Australia v. Word Investment Limited. Yesterday, the High Court of Australia ruled that an organization that existed solely to conduct funerals for profit was entitled to tax exempt status because it paid all of its operating surplus (i.e., its profit) to a religous organization. In effect, the Australian High Court ruled that a feeder organization is indeed entitled to tax exemption under Australian law. Unless we really believe that unrelated business threatens the tax base or, as a macro-economic matter, actually results in a nonprofit competitive advantage over profit-seekers, we should be unimpressed by the holding. Indeed, we should not believe that a tax exempt VSP exists as a threat to the for-profit HMO world. So long as VSP and other feeders devote all their profits to a charitable goal, according to the Australian High Court, they ought to be tax exempt. Mind you, whether the fiduciaries of VSP are improperly enriching themselves at the expense of charity is a whole 'nother matter.
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