

The problem with the IRS and open source: logic, not discrimination - malbiniak
http://blog.cashmusic.org/post/54699615496/the-problem-with-the-irs-and-open-source-logic-not

======
zaroth
TL;DR; Apparently there's a long and consistent history of administrative
rulings and judgements demonstrating that you can't offer something like a
commercial SaaS platform, even if it's open source, and call yourself a
501(c)(3). Fundamentally you are providing a service which is "ordinarily
carried on as an incident to commercial or industrial operations" and as such
doesn't fall under the "scientific" qualification.

\-------------------

At first read, this seemed like a serious affront to non-profit open source
development, but reading the rejection letter in full, I'm swayed by an
apparent long history of rejecting applications of this type.

> I.R.C. § 501(c)(3) exempts from taxation any corporation organized and
> operated exclusively for religious, charitable, scientific, testing for
> public safety, literary, or educational purposes,... The key term here I
> think is 'scientific purposes'.

> Treas. Reg. § 1.501 (c)(3)-1 (d)(5)(i) provides that a scientific
> organization must be organized and operated in the public interest.
> Therefore, the term scientific, as used in I.R.C. § 501(c)(3),includes the
> carrying on of scientific research in the public interest. "Research," when
> taken alone, is a word with various meanings; it is not synonymous with
> scientific; and the nature of particular research depends upon the purpose
> which it serves. For research to be scientific, within the meaning of I.R.C.
> § 501 (c)(3), it must be carried on in furtherance of a scientific purpose.
> The determination as to whether research is scientific does not depend on
> whether such research is classified as fundamental or basic as contrasted
> with applied or practical.

Now here's where I think it starts to go _downhill_ for CASH Music:

> Treas. Reg. § 1.501 (c)(3)-1 (d)(5)(ii) provides that 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.

The IRS, I think rightfully, is claiming that the service CASH Music provides
(SaaS platform for selling and promoting music) is carried on as an incident
to commercial operations.

> The following are examples of scientific research which will be considered
> as directed toward benefiting the public, and, therefore, which will be
> regarded as carried on in the public interest: (1) scientific research
> carried on for the purpose of aiding in the scientific education of college
> or university students; (2) scientific research carried on for the purpose
> of obtaining scientific information, which is published in a treatise,
> thesis, trade publication, or in any other form that is available to the
> interested public; (3) scientific research carried on for the purpose of
> discovering a cure for a disease; or (4) scientific research carried on for
> the purpose of aiding a community or geographical area by attracting new
> industry to the community or area or by encouraging the development of, or
> retention of, an industry in the community or area.

There are two examples in the case law that are cited by the IRS letter where
applications for 501(c)(3) was denied which seem quite relevant:

> Rev. Rul. 65-1, 1965-1 C.B. 226, describes an organization which promoted
> and fostered the development and design of machinery in connection with
> commercial operation, and in connection therewith had the power to sell,
> assign, and grant licenses with respect to its copyrights, trademarks, trade
> names, or patent rights, that did not qualify for exemption from Federal
> income tax under l.R.C. § 501(c)(3). The primary purposes of the
> organization were 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 related to this purpose. The
> organization was engaging in development activities of a type incident to
> commercial activities and was not exempt under I.R.C. § 501(c)(3).

> Rev. Rul. 68-373, 1968-2 C.B. 206, described an organization whose principal
> activity was clinically testing drugs for commercial pharmaceutical
> companies. These tests were required in order to comply with Food and Drug
> Administration requirements that drugs be tested for safety and efficacy
> before they can be marketed. The pharmaceutical companies selected the drugs
> to be tested and used the results of the tests in their marketing
> applications to the Food and Drug Administration. In addition, the results
> of the tests were freely available for publication in various scientific and
> medical journals. Clinical testing is an activity ordinarily carried on as
> an incident to a pharmaceutical company’s commercial operations. The fact
> that the testing must be done by highly qualified professionals does not
> change its basic nature. Therefore, such testing did not constitute
> scientific research within the meaning of Treas. Reg. §
> 1.501(c)(3)-1(d)(5)(i). The organization failed to qualify for exemption
> from Federal income tax under I.R.C. § 501(c)(3).

It goes on an on... all seemingly very consistent in establishing what is
considered 'scientific' and that how creating a SaaS platform falls squarely
outside the definition:

> In lIT Research Institute v. United States, 9 Cl. Ct. 13, (1985), ... The
> Court held that "in the context of this litigation, ’science’ will be
> defined as the process by which knowledge is systematized or classified
> through the use of observation, experimentation, or reasoning." The Court
> further held that as scientific research _does not include activities of a
> type ordinary carried on as incident to commercial or industrial operations_
> , the organization was found not to be involved "in the commercialization of
> the products or processes developed as a result of its research," as it _"
> would only develop a project to the point where the research principles were
> established."_ (emphasis added).

\--------------

And so the knife goes in:

> Based upon the above law, you do not meet the first and second elements for
> recognition as a scientific research organization under I.R.C. § 501(c)(3)
> because you do not engage in scientific research and your development
> activities are of a type incident to commercial or industrial operations.
> Unlike the organizations described above, you are not utilizing objective
> scientific methods to formulate or verify facts or natural laws, or to
> search for a demonstrable truth. You do not propose a hypothesis pertaining
> to the verification of facts or natural laws. You do not utilize scientific
> methods to test this hypothesis and objectively record the results of your
> experimentation. Finally, you do not objectively evaluate your research
> results and publish the findings for the public to utilize. Instead, you
> describe your scientific research activities as developing open source
> software. These activities can best be described as routine product
> development, which are a type incident to commercial operations. Under
> Treas. Reg. §1.501 (c)(3)-1 (d)(5)(ii), scientific research does not include
> activities carried on as an incident to commercial or industrial operations,
> such as the design or improvement of goods or services.

...

> Finally, you do not meet the third element for a scientific research
> organization, which requires that scientific research to be directed toward
> benefiting the public. Treas. Reg. § 1.501 (c)(3) - I (d)(5)(iii). Your
> research does not benefit the public. First, you do not publish the results
> of your research. See Treas. Reg. § 1.501 (c)(3)-1 (d)(5)(iii)(a). Rather,
> you make X and I software’s source code and documentation, not the results
> of your research, available to the public. The release of X and Y software’s
> source code is akin to the release of a commercial product, not the
> publication of scientific research.

