Quality Auditing Company, Inc. v. Commissioner

114 T.C. No. 31UNITED STATES TAX COURT
QUALITY AUDITING COMPANY, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 8794-99X. Filed June 19, 2000.
P is a nonprofit corporation organized to audit
structural steel fabricators pursuant to a quality
certification program administered by the American Institute
of Steel Construction, Inc. (AISC). AISC is likewise a
nonprofit organization and is exempt from Federal taxation
under sec. 501(c)(6), I.R.C. As its primary activity, P
inspects the quality control procedures used in facilities
of fabricators applying to AISC for certification. P
evaluates whether such procedures are in compliance with the
standards set forth in the AISC program. The certification
program was established by AISC at the request of public and
private owners and developers who desired a reliable method
for selecting competent fabricators from among those who
submit bids for the steel work component of a construction
project.
P seeks tax-exempt status as an organization described
in sec. 501(c)(3), I.R.C., on the grounds that P is operated
exclusively for the charitable purposes of lessening the
burdens of Government and encouraging safe construction for
the benefit of the general public.
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Held: P furthers private interests and therefore is
not operated exclusively for exempt charitable purposes.
Consequently, P is not entitled to exemption from income
taxation under sec. 501(a), I.R.C., as an organization
described in sec. 501(c)(3), I.R.C.
James A. Nitsche, for petitioner.
Joan Ronder Domike, for respondent.
OPINION
NIMS, Judge: Respondent determined that petitioner Quality
Auditing Company, Inc., does not qualify for exemption from
Federal income taxation under section 501(a) as an organization
meeting the requirements of section 501(c)(3). Having exhausted
its administrative remedies, petitioner challenged respondent’s
determination by timely invoking the jurisdiction of this Court
for a declaratory judgment pursuant to section 7428(a). The case
was submitted for decision under Rule 122 upon the stipulated
administrative record. For purposes of this proceeding, the
facts and representations contained in the administrative record
are accepted as true, see Rule 217(b), and are incorporated
herein by this reference. The issue for decision is whether
petitioner is operated exclusively for charitable purposes within
the meaning of section 501(c)(3).
Unless otherwise indicated, all section references are to
sections of the Internal Revenue Code, and all Rule references
are to the Tax Court Rules of Practice and Procedure.
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Background
Petitioner, a nonprofit corporation with a principal place
of business in Bristol, Virginia, at the time of filing its
petition, was formed under the laws of Virginia on April 7, 1995.
Developments and concerns within the structural steel fabrication
industry, and particularly the response thereto by the American
Institute of Steel Construction, Inc. (AISC), led to petitioner’s
genesis. AISC is a nonprofit organization exempt from Federal
income taxation pursuant to section 501(c)(6). Since its
founding in 1921, AISC has been engaged primarily in the creation
of standardized engineering codes and specifications for use in
the fabrication and construction of steel-framed buildings and
bridges.
During the 1960's, a number of governmental agencies and
private industrial owners and developers approached AISC and
requested that it develop a certification program for structural
steel fabricators. As technological advances had increased both
the predominance and the complexity of steel’s role in commercial
and residential structures, a growing concern over potential
differences in quality had arisen among entities attempting to
select contractors for this component of a building project. Yet
few owners and developers had sufficient expertise, time, or
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funds to adequately investigate the fabricators submitting
project bids. AISC undertook to create a program which would
afford the requested quality assurances.
Working in collaboration with engineers, architects,
contractors, and other industry participants (including
governmental agencies), AISC developed and trademarked the AISC
Quality Certification Program. This certification program
incorporates codes, standards, and specifications for particular
aspects of the fabricating process developed by, among others,
the American Welding Society, the Steel Structures Painting
Council, the American Society for Testing Materials, the Bolting
Council, and AISC. The program is designed to verify that
fabricators have in place a quality control system that will
assure compliance with such construction standards, as well as
with contract requirements. Ongoing revision and upgrading of
the program track changes and advancements within the industry.
The certification program operates in the following manner.
Fabricators desiring certification, often because the owner or
developer of a project conditions bid awards thereon, submit an
application and appropriate fee to AISC. The fees so charged are
determined in accordance with a schedule set by AISC and are
based upon the fabricator’s status as a member or nonmember of
AISC, the type of certification sought, and the number of
employees at the facility. The program is open to all
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fabricators, regardless of AISC membership, but the fee is less
for members also responsible for AISC dues. The following four
types or categories of certification are available: Conventional
steel building structures, simple steel bridges, complex steel
building structures, and major steel bridges. A paint
endorsement is also offered. Fees for a first-time audit range
from $3,200 to $6,900.
AISC then contracts with and pays for an independent entity
to perform the actual audit investigation of the fabricator’s
facility. The auditor evaluates the fabricator’s quality control
procedures to determine whether such procedures adequately test
for and ensure compliance with the industry specifications
incorporated in the AISC program. No particular structure,
project, or product is certified; rather, the construction
process itself is examined. Following the audit, the auditor
communicates his or her findings to the fabricator and recommends
to AISC whether certification should be awarded. Upon receipt of
a positive recommendation from the auditor, AISC forwards to the
fabricator documentation reflecting AISC certified status. If
the auditor does not believe certification warranted, the
fabricator may choose to be reevaluated after corrective actions
have been implemented. The specific report pertaining to a given
audit is not disseminated to the public, but AISC publishes the
names of certified companies.
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In so administering the certification program, AISC
initially contracted with Abstect, a private, for-profit company,
to conduct the facility audits. Problems with this arrangement
developed, however, because a profit-driven enterprise was
unwilling to reinvest a sufficient portion of the fees charged to
achieve the level of auditor training and audit consistency
necessary for a uniform, reliable certification program. AISC
therefore provided the startup capital to establish petitioner as
an independent, nonprofit corporation. Petitioner’s articles of
incorporation state that its purpose is “To conduct quality
certification and inspection programs which meet the requirements
of private and public standards setting bodies and governmental
agencies”. Substantially all of petitioner’s time and resources
are dedicated to performing the quality audit function, and no
other entities presently furnish this service.
Petitioner is governed by a board of directors consisting of
the sitting chairman of AISC; the sitting chairman of AISC’s
Committee on Fabricating Operations and Standards; petitioner’s
president and CEO; and two elected members. Petitioner operates
by hiring and training independent contractors to inspect and
audit the facilities of fabricators applying to AISC for
certification. These auditors are paid by petitioner $400 per
audit day plus expenses, which include airfare, lodging,
transportation, and telecommunications. Petitioner also pays
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royalties to AISC for use of its trademarked certification
program. Petitioner’s income is derived solely from the fees
charged AISC for conducting the quality audits. These fees are
determined annually by petitioner’s board based upon an estimate
of the costs, expenses, and overhead associated with providing
the auditing service. Petitioner’s stated intent is to set fees
at a level which approximates actual cost. The request for tax-
exemption submitted by petitioner to respondent estimated an
excess (loss) of revenue over expenses for the years 1995, 1996,
and 1997 of ($28,350), $25,500, and $103,300, respectively.
The majority of steel structures in the United States are
built without imposing a certification prerequisite on
fabricators. However, the AISC certification program has
increasingly become recognized as furthering structural integrity
and quality within the steel fabrication industry. Numerous
private and public owners, developers, and contractors, including
the Army Corps of Engineers and 38 to 40 State highway
departments, now require AISC certification for bridges and other
metal work. To promote such use of the program, AISC solicits
owners and developers to require certification of fabricators
submitting bids. The following is representative of a
communication sent by AISC for this purpose:
Congratulations on reaching the bid stage of the new
Cleveland Stadium. We understand this is a complex
project, requiring skilled and experienced construction
contractors. AISC, the non-profit association
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responsible for the Specification for Design and
Fabrication of Structural Steel for Buildings for over
75 years, offers a quality certification intended to
make the task of selecting qualified bidders more
reliable. The AISC Quality Certification Program is
internationally recognized as a leader in ensuring that
steel fabricators have the equipment, personnel and
procedures to handle specific types of projects. By
requiring an AISC Quality Certified fabricator, you
will join a growing list of designers and owners who
have elected to use the program, including the U.S.
Army Corps of Engineers, the Navy Facilities Command
and 40 states. Currently, more than 390 shops,
representing 327 companies in the United States,
Canada, Japan and Korea are certified--with more being
added each month.
Though some specifiers have expressed concern that
requiring a Quality Certified fabricator will raise
project costs, rest assured that this is not the case.
The Program is administered by fabricators, for
fabricators with an annual fee to a fabricator of
usually less than $5,000. This fee is much less than
comparable programs in other industries. The fee funds
the cost of administering the program and performing
audits. The Program relies on the use of prevailing
industry standards so there are no implementation costs
associated with the program and the audits often
provide a cost benefit for fabricators since they not
only review a company’s existing quality procedures,
but also help to inform a fabricator about the latest
industry issues and trends. Many program participants
have reported that their procedures and practices have
greatly improved under the impetus of Quality
Certification audits.
We therefore recommend that project specifications
require fabricators bidding on a project be certified
and that contracts be awarded to fabricators that are
certified prior to submitting their bid. The AISC
Quality Certification Program exists to provide
assurances to construction team members such as
yourself that suppliers are capable of performing
according to your specification. We hope you will let
us help you with your work by awarding the project to
currently certified fabricators.
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The Cleveland stadium is a highly complex and visible
project. We recommend the following language be
inserted n [sic] your structural steel specification:
“The structural steel fabricator shall be
certified at the time of bid in the AISC
Quality Certification Program in the Complex
Steel Structure Category with a Sophisticated
Paint Endorsement. A copy of the certificate
shall be submitted with the bid documents.”
If you’d like more information on the Certification
Program, please feel free to call * * *
Petitioner’s application for exemption under section
501(c)(3), for its role in the above-described quality
certification endeavor, was received by the Internal Revenue
Service on August 2, 1995. On February 11, 1999, respondent
issued the final adverse ruling which is the subject of this
litigation.
Discussion
I. General Rules
Section 501(a) exempts from Federal income taxation
organizations described in section 501(c). Among the
organizations so described are those set forth in section
501(c)(3):
Corporations * * * organized and operated
exclusively for religious, charitable, scientific,
testing for public safety, literary, or educational
purposes, or to foster national or international
amateur sports competition * * * , or for the
prevention of cruelty to children or animals, no part
of the net earnings of which inures to the benefit of
any private shareholder or individual * * *
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In order to be exempt under section 501(c)(3), an
organization must be both organized exclusively for one or more
of the exempt purposes specified in the section, known as the
organizational test, and operated exclusively for such purposes,
known as the operational test. See sec. 1.501(c)(3)-1(a)(1),
Income Tax Regs. Failure to satisfy either test forecloses a
section 501(c)(3) exemption. See id.In application of the organizational and operational tests,
“exclusively” does not mean “‘solely’” or “‘absolutely without
exception’”. Nationalist Movement v. Commissioner, 102 T.C. 558,
576 (1994) (quoting Church in Boston v. Commissioner, 71 T.C.
102, 107 (1978)), affd. 37 F.3d 216 (5th Cir. 1994); see also
Copyright Clearance Ctr., Inc. v. Commissioner, 79 T.C. 793, 803-
804 (1982). Nonetheless, the presence of a single nonexempt
purpose, if substantial in nature, precludes exempt status,
regardless of the number or importance of truly exempt purposes.
See Better Bus. Bureau v. United States, 326 U.S. 279, 283
(1945); Redlands Surgical Servs. v. Commissioner, 113 T.C. 47,
71-72 (1999); Nationalist Movement v. Commissioner, supra at 576;
American Campaign Academy v. Commissioner, 92 T.C. 1053, 1065
(1989).
To satisfy the exclusivity requirement as it pertains to the
organizational test, the entity’s articles of organization must
limit its purposes to those which are exempt and must not
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expressly empower it to engage, except in insubstantial part, in
activities not in furtherance of exempt purposes. See sec.
1.501(c)(3)-1(b)(1)(i)(a) and (b), Income Tax Regs.
With respect to the operational test:
An organization will be regarded as “operated
exclusively” for one or more exempt purposes only if it
engages primarily in activities which accomplish one or
more of such exempt purposes specified in section
501(c)(3). An organization will not be so regarded if
more than an insubstantial part of its activities is
not in furtherance of an exempt purpose. [Sec.
1.501(c)(3)-1(c)(1), Income Tax Regs.]
Additionally, although an organization may be engaged only in a
single activity directed toward multiple purposes, both exempt
and nonexempt, failure to satisfy the operational test will
result if any nonexempt purpose is substantial. See Redlands
Surgical Servs. v. Commissioner, supra at 71; Copyright Clearance
Ctr., Inc. v. Commissioner, supra at 803-804.
Exempt purposes, in turn, are those specified in section
501(c)(3), such as religious, charitable, scientific, and
educational. See sec. 1.501(c)(3)-1(d)(1)(i), Income Tax Regs.
Charitable is further defined as follows:
The term “charitable” is used in section 501(c)(3) in
its generally accepted legal sense and is, therefore,
not to be construed as limited by the separate
enumeration in section 501(c)(3) of other tax-exempt
purposes which may fall within the broad outlines of
“charity” as developed by judicial decisions. Such
terms include: Relief of the poor and distressed or of
the underprivileged; advancement of religion;
advancement of education or science; erection or
maintenance of public buildings, monuments, or works;
lessening of the burdens of Government; and promotion
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of social welfare by organizations designed to
accomplish any of the above purposes, or (i) to lessen
neighborhood tensions; (ii) to eliminate prejudice and
discrimination; (iii) to defend human and civil rights
secured by law; or (iv) to combat community
deterioration and juvenile delinquency. * * * [Sec.
1.501(c)(3)-1(d)(2), Income Tax Regs.]
However, regardless of the presence of what might otherwise
be proper exempt purposes, an explicit exception to section
501(c)(3) status exists in that:
An organization is not organized or operated
exclusively for one or more of the purposes specified
in * * * [section 501(c)(3)] unless it serves a public
rather than a private interest. Thus, * * * it is
necessary for an organization to establish that it is
not organized or operated for the benefit of private
interests * * * [Sec. 1.501(c)(3)-1(d)(1)(ii), Income
Tax Regs.]
Private interests within the meaning of this rule include not
only related persons and insiders but also unrelated and
disinterested private parties. See id.; American Campaign
Academy v. Commissioner, supra at 1068-1069. In other words, if
an organization benefits private interests, it will be deemed to
further a nonexempt purpose. See American Campaign Academy v.
Commissioner, supra at 1066. The organization will thereby be
prevented from operating primarily for exempt purposes “absent a
showing that no more than an insubstantial part of its activities
further the private interests or any other nonexempt purposes.”
Id.
The burden of proof rests on petitioner to demonstrate,
based on materials in the administrative record, that it is
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organized and operated exclusively for exempt purposes, not
benefiting private interests more than incidentally. See Rule
217(c)(4)(A); Redlands Surgical Servs. v. Commissioner, supra at
72; American Campaign Academy v. Commissioner, supra at 1063-
1064.
II. Contentions of the Parties
Petitioner contends that it satisfies the requirements of
section 501(c)(3) for exemption from Federal taxation as a
charitable organization. Petitioner maintains that it is
organized and operated exclusively for charitable purposes, that
no part of its net earnings inures to the benefit of private
individuals, and that it serves public rather than private
interests. According to petitioner, its purpose and activities
qualify as charitable in that quality auditing of steel
fabrication firms both lessens the burdens of Government and
encourages the safe construction of buildings and bridges for the
benefit of the general public.
Conversely, respondent asserts that petitioner is not
entitled to exemption from taxation under sections 501(a) and
(c)(3). Respondent concedes that petitioner is organized
exclusively for exempt purposes and that no part of its net
earnings inures to the benefit of proscribed private individuals.
However, it is respondent’s position that petitioner’s inspection
activity neither lessens the burdens of Government nor confers
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upon the general public any benefit which is not merely
incidental to petitioner’s furthering of the private interests of
AISC and firms within the steel industry.
We conclude, for the reasons explained below, that
petitioner has failed to establish that it qualifies for
exemption from tax as a charitable organization within the
meaning of section 501(c)(3).
III. Application
The question of whether petitioner is entitled to tax-exempt
status as a section 501(c)(3) organization turns here upon
whether petitioner is operated exclusively for exempt purposes.
Petitioner’s primary activity consists of performing audits of
steel fabricators who have applied to AISC for quality
certification. Petitioner contends that, in so functioning, it
operates exclusively for the charitable purposes of lessening the
burdens of Government and encouraging safe construction for the
benefit of the general public. We examine each of these
potential grounds for exemption.
A. Lessening the Burdens of Government
An organization can be classified as having the charitable
purpose of lessening the burdens of government only if two
criteria are satisfied. See Columbia Park & Recreation
Association v. Commissioner, 88 T.C. 1, 21 & n.45 (1987), affd.
without published opinion 838 F.2d 465 (4th Cir. 1988);
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University Med. Resident Servs., P.C. v. Commissioner, T.C. Memo.
1996-251; Public Indus., Inc. v. Commissioner, T.C. Memo. 1991-3.
First, the activities engaged in by the organization must be
those which a governmental unit considers to be its burden. See
Columbia Park & Recreation Association v. Commissioner, supra at
21 & n.45; University Med. Resident Servs., P.C. v. Commissioner,
supra; Public Indus., Inc. v. Commissioner, supra. In other
words, it must be shown that a governmental unit accepts as its
responsibility the activities conducted by the organization and
recognizes the organization as acting on the Government’s behalf.
See Columbia Park & Recreation Association v. Commissioner, supra
at 21. Second, the organization’s performance of the activities
must actually lessen the burdens of Government. See Columbia
Park & Recreation Association v. Commissioner, supra at 21 &
n.45; University Med. Resident Servs., P.C. v. Commissioner,
supra; Public Indus., Inc. v. Commissioner, supra. However, “The
mere fact that such activities might improve the general economic
well-being of the Nation or a State or reduce any adverse impact
from the failure of Government to carry out such activities is
not enough.” Public Indus., Inc. v. Commissioner, supra.
Applying these criteria to the case at bar, we conclude that
petitioner has failed to make the requisite showing for an
exemption on the basis of lessening Government burdens.
Petitioner’s primary activity consists of performing quality
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audits of steel fabricators. Yet there is no indication in the
record that governmental units consider it their burden to
inspect or certify the quality control procedures in place in the
facilities of private fabricators. The quality inspection and
certification activities here are not part of a legislated
governmental program, are not the result of an express
governmental delegation of function, and do not seek to enforce
governmentally established standards or guidelines. See Indiana
Crop Improvement Association v. Commissioner, 76 T.C. 394 (1981)
(relying on such factors to hold that a taxpayer’s testing and
certification of agricultural products lessened the burdens of
Government); see also Professional Standards Review Org. v.
Commissioner, 74 T.C. 240 (1980) (finding an entity authorized by
statute to review utilization of Government-subsidized programs
to lessen the burdens of Government).
Rather, the record reflects only that governmental agencies
were among those who initially requested that AISC develop a
certification program and who have since made use of the program
in awarding bids. Although such involvement shows a concern with
obtaining high-quality steel work in public projects, it falls
short of demonstrating that governmental units view a program for
auditing steel fabricators as a Government responsibility and
recognize petitioner as acting on their behalf. The record is
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likewise bereft of evidence that, in absence of the AISC program,
governmental entities would have undertaken to develop a similar
program or to conduct actual audit inspections.
Furthermore, to the extent that the existence of the AISC
program and petitioner’s role therein facilitate the Government
in selecting qualified fabricators, an equivalent benefit is
conferred upon private owners and developers. Private entities
joined with public in requesting the AISC program and likewise
utilize the program in awarding bids. If, as petitioner
contends, it is operated to lessen the burdens of Government, it
would follow that it is also operated to lessen the burdens on
private parties. While the former is a charitable purpose, the
latter is not, and the record offers no basis upon which to
determine that the latter is merely incidental to the former. We
thus cannot conclude that petitioner is operating exclusively for
the charitable purpose of lessening the burdens of Government.
B. Encouraging Safe Construction
We turn to the question of whether petitioner is operating
exclusively for the charitable purpose of encouraging safe
construction for the benefit of the general public. We
acknowledge that furthering public safety is indeed a charitable
objective. Moreover, we do not dispute that the AISC
certification program and petitioner’s audit activities promote
increased structural integrity and safety in steel buildings and
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bridges. Nonetheless, we find that petitioner’s activities also
further private interests to a degree that is more than
insubstantial. See Better Bus. Bureau v. United States, 326 U.S.
279, 283 (1945).
Petitioner performs quality audits at the request of AISC,
which in turn acts at the request of steel fabricators applying
for certification. Neither AISC nor the fabricators, however,
are public entities. As an organization exempt from taxation
under section 501(c)(6), AISC is a business league or board of
trade. Such entities are defined as follows:
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 * * * [Sec. 1.501(c)(6)-1, Income Tax
Regs.]
Hence, AISC is classified as an organization which seeks the
betterment of an industry, not the betterment of the general
public. Although AISC’s actions are not profit-motivated and may
have positive results for society at large, that does not
transform AISC’s purpose, and activities undertaken in
furtherance thereof, from private to public. As expressed by
this Court:
It is clear, however, that not all organizations which
incidentally enhance the public good will be classified
as “public” organizations within the meaning of section
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501(c)(3). One need only glance at the other types of
organizations described in section 501(c) for examples
of “nonpublic” organizations which often do much to
enhance the public good * * *
We think it is significant that Congress enacted
special exemption provisions for certain types of
organizations which would be unable to meet the
stricter section 501(c)(3) tests which require service
to public interests rather than to private ones. * * *
[American Campaign Academy v. Commissioner, 92 T.C.
1053, 1077-1078 (1989).]
Here, the development and administration of a quality
certification program, at the request of and for the structural
steel industry, would appear to be consistent with AISC’s mission
as a section 501(c)(6) organization. AISC, in its solicitations
to owners and developers, states that the program is “intended to
make the task of selecting qualified bidders more reliable” and
“exists to provide assurances to construction team members such
as yourself that suppliers are capable of performing according to
your specification.” The focus thus seems to be on aiding
industry participants, with any benefit to the general public
being merely secondary. We note that safety is never mentioned
in the solicitation, and having qualified bidders and suppliers
would address a host of concerns distinct from that of ending up
with a finished product that will not harm its users. Increased
nonconformities, delays, project cost overruns, reduced structure
longevity, and frequent repair expenditures are among the
problems that could flow from hiring fabricators with inadequate
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quality control. Therefore, to the extent that petitioner serves
AISC’s interests in carrying out its section 501(c)(6) role of
industry betterment, petitioner benefits a private interest.
The steel fabricators who request audits and whose
facilities petitioner inspects are likewise private entities.
Moreover, because these fabricators operate as commercial
enterprises, we are constrained to assume that they largely apply
for certification when to do so furthers their primary objective
of making a profit. We doubt that firms would seek and pay to
obtain certified status unless they believed the investment would
prove lucrative in the future. They likely wish to pursue
revenues from a contract requiring certification, or they see the
certification process as a vehicle to increased work through an
improved control process and reputation for quality. Thus, in
auditing these fabricators, petitioner is once again furthering
private interests.
Lastly, petitioner has failed to convince us that the
private interests discussed above are insubstantial in comparison
to the benefit reaped by the general public. The majority of
steel structures built in the United States do not require
certified fabricators. The certification process itself does not
result in petitioner’s inspecting or certifying the safety of any
finished structure or product with which the public might come in
contract. Rather, petitioner evaluates the internal quality
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control procedures of private, for-profit steel fabricators,
incident to a quality certification program administered by a
nonpublic section 501(c)(6) entity and implemented at the request
of steel industry participants. Accordingly, we conclude that
petitioner is operated to a substantial degree for the benefit of
private interests, including those of AISC and members of the
steel industry. As furthering private interests constitutes a
nonexempt purpose, petitioner has not established that it is
operated exclusively for exempt charitable purposes. We hold
that petitioner is not entitled to exemption from taxation as a
charitable organization described in section 501(c)(3).
To reflect the foregoing,
Decision will be entered
for respondent.