Group of Franchisees of Single Organization Did Not Qualify as §501(c)(6) Organization

The organization in LTR 201649017 was found to be pursuing too narrow of a business interest to qualify as an exempt business league under IRC §501(c)(6), thus its request for exemption was denied.

IRC §501(c) contains a list of exempt organizations.  IRC §501(c)(6) provides that one of those exempt organizations is:

(6) Business leagues, chambers of commerce, real-estate boards, boards of trade, or professional football leagues (whether or not administering a pension fund for football players), not organized for profit and no part of the net earnings of which inures to the benefit of any private shareholder or individual.

In this case the organization consisted of a group of franchisees of the same organization.  The group described its exempt purpose as:

  • Educating and helping franchisee members with the N's current and new policies;
  • Communicating and finding resolution of member owners issues to N's executives;
  • Presenting and communicating the unresolved and disputed issues of franchisees to the O president group;
  • ·       Hosting trade shows with the vendors for the mutual benefit of franchisees and vendors. This provides franchisees the opportunity to build one-to-one relationships with the vendors and vice-versa.

The organization’s position was that its operations should qualify it as a business league.

The IRC’s definition is somewhat skeletal, but the IRS has provided more detail regarding what type of organization qualifies for this exemption in the regulations, specifically at Reg. §1.501(c)(6)-1 which provides:

A business league is an association of persons having some common business interest, the purpose of which is to promote such common interest and not to engage in a regular business of a kind ordinarily carried on for profit. It is an organization of the same general class as a chamber of commerce or board of trade. Thus, its activities should be directed to the improvement of business conditions of one or more lines of business as distinguished from the performance of particular services for individual persons. An organization whose purpose is to engage in a regular business of a kind ordinarily carried on for profit, even though the business is conducted on a cooperative basis or produces only sufficient income to be self-sustaining, is not a business league. An association engaged in furnishing information to prospective investors, to enable them to make sound investments, is not a business league, since its activities do not further any common business interest, even though all of its income is devoted to the purpose stated. A stock or commodity exchange is not a business league, a chamber of commerce, or a board of trade within the meaning of section 501(c)(6) and is not exempt from tax. Organizations otherwise exempt from tax under this section are taxable upon their unrelated business taxable income. See part II (section 511 and following), subchapter F, chapter 1 of the Code, and the regulations thereunder.

In its letter denying exempt status the IRS cited the following to justify its position that this organization’s purpose was too narrow to meet the above definition:

  • Revenue Ruling 58-394 which found that an association of licensed dealers in a certain type of patented product.  In that ruling, “[t]he association in this ruling owned the controlling interest in the corporation that held the basic patent of the product, it engaged mainly in furthering the business interests of its member dealers, and it did not benefit businesses that manufactured competing product of the same type covered by the patent.”
  • Revenue Ruling 68-182, where the IRS announced it would not follow the Seventh Circuit’s decision in the case of Pepsi-Cola Bottler’s Association, Inc. v. United States.  In that ruling the IRS stated “[i]t is the position of the Service that organizations promoting a single brand or product within a line of business do not qualify for exemption under Section 501(c)(6) of the Code.”
  • Revenue Ruling 68-338 that “an organization that was formed to promote the interests of a particular retail trade and is not exempt from federal income tax under Section 501(c)(6) of the Code because it advises its members in the operation of their individual businesses and sells supplies and equipment to them.”
  • National Muffler Dealers Association, Inc. v. United States, 440 U.S. 472, Ct. D. 1997, 1979-1 C.B. 198 (1979) which “held that an organization of muffler dealers franchised by Midas International Corporation did not qualify for exemption from federal income tax as a business league under Section 501(c)(6) of the Code. The organization's purpose was too narrow to satisfy the line of business test of Treasury Regulation Section 1.501(c)(6)-1.”

The IRS in this case found that the organization operated similarly to those described in the above citations, finding that the organization’s “activities are not directed to the improvement of business conditions of one or more lines of business” and the organization was “formed to provide particular services to your members.”  Thus, the IRS ruled it was not an organization described in Reg. §1.501(c)(6)-1.

The organization replied that they had plans to enroll businesses that were not N franchisees.  But the IRS was not impressed, finding:

You have not explained how you educate and help franchisees with convenience store policies. You have not proven that you have access to the business policies of stores other than those of N in order to be in a position to educate and help.

You have not demonstrated how you communicate and find resolutions between various convenience store owners and their respective franchisor executives.

You have not provided evidence that you present and communicate unresolved and disputed issues of non-N franchisees to national non-N franchisor groups.

You have not provided convincing evidence that you represent the interests of convenience store franchisees owners industry-wide apart from N franchisee owners; therefore, you are not an organization described in Section 501(c)(6) of the Code.