Federation Pharmacy Services, Inc. v. Commissioner

OPINION

Sterrett, Judge:

Respondent determined that petitioner does not qualify for exemption from Federal income tax under section 501(c)(3). Petitioner challenges respondent’s determination and has invoked the jurisdiction of this Court for a declaratory judgment pursuant to section 7428. The issue is whether petitioner is organized and operated exclusively for charitable purposes within the meaning of section 501(c)(3).

This case was submitted for decision on a stipulated administrative record under Rule 122, Tax Court Rules of Practice and Procedure. The stipulated record is incorporated herein by this reference.

Petitioner Federation Pharmacy Services, Inc., is a nonprofit Minnesota corporation with its principal place of business in St. Paul, Minn. Petitioner filed its application for exemption as an organization described in section 501(c)(3) on March 16,1977. On February 14, 1978, respondent issued a final ruling denying petitioner’s application. The request for exemption was denied on the ground that petitioner is not organized and operated exclusively for any charitable purpose.

Petitioner was organized in November of 1976 to provide prescription drugs at discount prices to the elderly and handicapped. It was organized primarily under the auspices of the Metropolitan Senior Federation. The Metropolitan Senior Federation is a Minnesota nonprofit corporation whose purpose is to enhance the well-being of senior citizens in the Minneapolis-St. Paul metropolitan area.

Prior to petitioner’s organization, the Metropolitan Senior Federation had arranged with Script Shoppes, Inc., a commercial pharmacy, to obtain a special discount of 10 percent off the lowest verifiable retail price in the Minneapolis-St. Paul area on drugs sold to Metropolitan’s elderly members. The arrangement also provided for delivery services to certain high-rise apartments occupied by senior citizens and to other senior citizens who were not ambulatory or were otherwise unable to obtain their drugs personally. Because of substantial losses, however, Script Shoppes, Inc., was forced to discontinue its operations. Faced with the loss of Script’s valuable services, Metropolitan negotiated the purchase of Script’s remaining inventory and operating assets. Petitioner was later formed to make the acquisition and to operate the pharmacy.

Initially, petitioner hoped to break even, where its predecessor previously had incurred losses, by using the services of volunteers (for mailing prescriptions, completing patient profiles, maintenance, etc.) instead of paid employees. In addition, local community leaders and charitable foundations had expressed an interest in the project, and it was believed that gifts could be obtained to help defray some of petitioner’s operating expenses. Petitioner decided later to apply all such gifts directly to benefit financially distressed senior citizens who, because of a catastrophic illness or accident, incurred large prescription drug bills. Moreover, petitioner decided upon its formation that the needs of handicapped persons paralleled those of the elderly and, therefore, made purchase discounts and delivery services available to handicapped persons, too.

Petitioner’s initial capital was raised by two loans, one from a bank for approximately $20,000 and another from Metropolitan for approximately $10,000. Petitioner intends to repay those loans with operating funds and to continue financing its operations with its sales revenues. In this respect, petitioner’s income statement for its first 2 months of operation reflects a net profit of $878.11. After repaying its debts, petitioner intends to apply any excess receipts over expenses to reduce its drug prices. Petitioner’s prices generally are set by a survey of local retail drug prices. It charges the lowest retail price available for each drug on the survey, reduced by a 5.-percent discount. Petitioner intends to return any excess receipts realized in the operation of its business to its elderly and handicapped patrons through further price reductions. However, there is no commitment to reduce the amount charged below cost.

Although petitioner is required by the Minnesota State Pharmaceutical Board to serve the general public, less than 2 percent of its sales at normal retail prices are in fact made to persons other than senior citizens and handicapped persons. Only members of petitioner are entitled to the 5 percent below retail price allowance on drugs. Petitioner’s members are all those persons holding VIP Buying Plan cards issued by the Metropolitan Senior Federation. Sales to the general public constitute an insubstantial part of its activities. Petitioner does not advertise and does not sell toiletry articles, magazines, cards, or other items normally sold for profit by pharmacies. All items sold qualify for Minnesota State sales tax exemption as “prescribed drugs and medicine intended for use, internal or external, in the cure, mitigation, treatment or prevention of illness or disease in human beings.” Minn. Stat. Ann. sec. 297A.25(b) (West Supp. 1979).

Petitioner’s organization and operations have been at the direction of various community leaders, and none of them has obtained any personal financial benefit from their participation. In the event of petitioner’s dissolution, its assets will be distributed to or for the benefit of such organizations, causes, or projects as in the judgment of the court supervising dissolution will accomplish petitioner’s general purposes. If court supervision of dissolution is not required or permitted under Minnesota law, then the assets will be distributed to or for the benefit of other section 501(c)(3) organizations or, in default thereof, to the State or local government for a public purpose.

In his final adverse ruling, respondent determined that petitioner is not organized and operated exclusively for a charitable purpose within the meaning of section 501(c)(3).¹ In this respect, respondent’s ruling states in pertinent part:

The sale of prescription drugs to senior citizens and handicapped persons is a trade or business normally carried on for profit. Sales of prescription drugs to the elderly and the handicapped even at a discount is not, without more, in furtherance of a charitable purpose.

Petitioner contends that the promotion of health and the relief of financial distress of a recognized charitable class, i.e., the aged and handicapped, are generally considered to be charitable purposes, and that petitioner is organized to and in fact does promote the health of and relieve the financial distress of its elderly and handicapped members.

Section 501(a) exempts from income tax, among others, organizations described in section 501(c)(3). Section 501(c)(3) provides in pertinent part:

SEC. 501(c). List of Exempt Organizations. — The following organizations are referred to in subsection (a):

* * * * * * *

(3) Corporations, * * * organized and operated exclusively for * * * charitable, * * * purposes, * * * no part of the net earnings of which inures to the benefit of any private shareholder or individual, * * *

The original burden is on petitioner herein to prove by a preponderance of the evidence that it falls within the intendment of the statute, i.e., that it is operated exclusively for charitable purposes. Hancock Academy of Savannah, Inc. v. Commissioner, 69 T.C. 488, 492 (1977); Rule 217(c)(2)(i), Tax Court Rules of Practice and Procedure. While the case before us is a rather close one, we hold that petitioner has failed, on the administrative record before us, to carry its burden.

In order to qualify as an organization operated exclusively for an exempt purpose, the organization must be engaged primarily in activities that accomplish one or more exempt purposes. Sec. 1.501(c)(3)-l(c)(l), Income Tax Regs. An organization will not qualify for exemption under section 501(c)(3), however, if more than an insubstantial part of its activities is not in furtherance of an exempt purpose. Sec. 1.501(c)(3)-l(c)(l), Income Tax Regs. In making the appropriate analysis, we must focus on the purpose rather than the nature of the organization’s activities. est of Hawaii v. Commissioner, 71 T.C. 1067 (1979); B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 (1978); Golden Rule Church Association v. Commissioner, 41 T.C. 719 (1964); see Trinidad v. Sagrada Orden de Predicadores, 263 U.S. 578 (1924); San Francisco Infant School v. Commissioner, 69 T.C. 957 (1978). Thus, an organization whose activities constitute a trade or business or generate a profit may still be exempt provided that those activities accomplish an exempt purpose. Sec. 1.501(c)(3)-1(e)(1), Income Tax Regs.; B.S. W. Group, Inc. v. Commissioner, supra. Compare Randall Foundation v. Riddell, 244 F.2d 803 (9th Cir. 1957), with Passaic United Hebrew Burial Association v. United States, 216 F. Supp. 500 (D. N.J. 1963). Petitioner must fail herein because, at least as presently constituted, it is operated for a substantial commercial purpose.

It is clear that petitioner’s exclusive purpose for being, its raison d’etre, is to sell drugs, an activity that is normally carried on by a commercial profitmaking enterprise. It does not serve as an adjunct to a larger exempt entity. It operates in the manner of an old-fashioned cooperative. We fail to see how the fact that it happens to deal in drugs can convert it to a section 501(c)(3) organization. If it could be so converted, then so could a store selling orthopedic shoes, crutches, health foods, or any other product beneficial to health. Virtually everything we buy has an effect, directly or indirectly, on our health. We do not believe that the law requires that any organization whose purpose is to benefit health, however remotely, is automatically entitled, without more, to the desired exemption. We have been cited no evidence that Congress intended to exercise its grace in such an expansive manner.

To support our finding of a substantial commercial purpose, we make several points. The selling of goods, health or otherwise, at a discount, is not, of itself, a charitable deed. Cf. Pulpit Resource v. Commissioner, 70 T.C. 594 (1978); Sonora Community Hospital v. Commissioner, 46 T.C. 519 (1966). Many profit-making organizations sell at a discount. Nor does the fact that the petitioner seeks to sell its drugs at cost alter the result; so does an old-fashioned cooperative, yet it is not entitled to classification as charitable.

Petitioner’s sole activity is in direct competition with profit-making drugstores which are obviously commercially oriented. The fact that the item sold bears a relationship to health care does not remove the commercial taint or make the competition with drugstores any less disabling. Certainly, its purpose of selling at a discount, as distinguished from below cost, smacks more of commercialism than of charity. An entirely different situation would pertain if the petitioner were required by its bylaws to provide drugs at no, or below, cost to some indigent elderly or handicapped. As it is, financial need is not a stated requirement for membership.

We further note that as soon as any member is unable to pay the full price charged by petitioner for its drugs, the member will cease to receive the benefits offered by membership. It is clear, therefore, that petitioner does not alleviate poverty and does not promote health, except to the same extent that any commercial cooperative or pharmacy would. We dealt with a similar issue in the case of B.S. W. Group, Inc. v. Commissioner, supra at 359-360, where we said:

although to some extent fees will reflect ability to pay, it does not appear that petitioner ever plans to charge a fee less than “cost.” To be sure, petitioner states that its fee is “nominal,” and it may in fact be lower than those charged by other firms. However, we think that this is not enough to prove that petitioner’s purposes are primarily exempt. In this respect, petitioner resembles certain health care organizations which have sought classification under section 501(c)(3) on the ground that they provide medical services which are of great social value. Despite the public benefit of the services provided, some degree of free or below-cost services to patients has generally been required to qualify these organizations as charitable before exemption has been granted under section 501(c)(3). See Hassett v. Associated Hospital Service Corp., 125 F.2d 611, 614-615 (1st Cir.); Sonora Community Hospital v. Commissioner, 46 T.C. 519, 525-526, affirmed per curiam 397 F.2d 814 (9th Cir.); Lorain Avenue Clinic v. Commissioner, 31 T.C. 141, 160-161. It has also been held that a policy of charging low, rather than high, prices does not render medical services charitable. See Lorain Avenue Clinic v. Commissioner, supra at 161. See also Medical Diagnostic Association v. Commissioner, 42 B.T.A. 610, 615-616.

See also Sound Health Association v. Commissioner, 71 T.C. 158, 172, 184-185 (1978).

For all the foregoing reasons we sustain respondent’s determination that petitioner does not qualify for exemption as an organization described in section 501(c)(3).

Decision will be entered for the respondent.

Reviewed by the Court.

1 On brief, respondent limits his arguments to petitioner’s operations. We shall likewise confine our discussion to petitioner’s operations. Nevertheless, we find that petitioner’s purposes for organizing are identical to those for which it operated. Compare sec. 1.501(c)(3)-l(b)(l), Income Tax Regs., with sec. 1.501(c)(3)-l(c)(l), Income Tax Regs.