This month's featured cases:

The High Court of Madras has held that, where a trust was established to impart knowledge and education primarily in a particular language (in this case Gujarati), exemption from income tax cannot be denied under section 13 (1) (b) Income Tax Act 1961 on the grounds that the trust is established to promote the interest of a particular religion or caste. (CIT v Sri Gujarathi Mandal, [1998] 101 Taxman 647 (Mad.))

CIT v Nagi Reddi Charity

WESTERN EUROPE

France

The Supreme Administrative Court (Conseil d"Etat) has held that the Church of Scientology, which derived most of its income from the sale of publications and the organisation of courses promoting scientology, mainly used commercial methods, in particular various forms of marketing, with a view to generating surplus revenues and is therefore engaged in commercial activities and is liable to tax accordingly. (Conseil d'Etat, 8th & 9th district, 8 July 1998, case nos. 149736 & 159135, Association Eglise de Scientologie)

Albert & others v Association club du chien-guide d'aveugles d'Ile de France

Varsani v Jesani [1998] 3 All E.R. 273

In a case involving a dispute betwen rival factions of a religious charity, the majority sought to remove the trustees of the charity who were in the minority. The High Court held that the exercise of the court's jurisdiction to order a scheme for the administration of the charity under section 13 Charities Act 1993 was not limited to cases where the objects of the charity had become impossible or impracticable. The original purpose of the charitable gift had ceased to provide a suitable and effective method of using the property given, and the spirit of the gift supported an order for a scheme dividing the property between the two factions.

Singh v Bhasin, The Times 21 August 1998

In a case where a trustee of a religious charity was sued in a representative capacity by a member of the charity challenging the validity of a resolution of the general meeting of members to suspend his membership for 10 years, the High Court held that a trustee who chose to defend an action against him without first obtaining the protection of an order authorising the payment of his costs out of trust funds proceeded at his own risk. The court will not allow trust funds to be used to pay costs unless it would have authorised the defence of the suit at the charity's expense.

The Zoological Society of London v Customs & Excise, VAT Tribunal 8 July 1998; Dean & Canons of Windsor v Customs & Excise, VAT Tribunal 7 September 1998

The 6th EC Council Directive on VAT, Directive 77/388, permits member states to impose conditions on the exemption from VAT of cultural services provided by non-public bodies. Two recent tribunal cases concerned the liability to VAT of admission charges imposed by a zoo and a chapel. The tribunal in the second case accepted that the chapel's features were similar to those of a museum for this purpose. The critical issue in each case was whether the charity was managed and administered on an essentially voluntary basis. So far as the zoo was concerned, the tribunal accepted that this was true on the basis that the governing body, who exercised effective control over the paid management staff, were not remunerated. In the case of the chapel, the trustees were paid a stipend; the tribunal held that these payments were consideration for their temporal as well as their spiritual duties, so that the trustees could not be said to be acting in an essentially voluntary capacity.

National Trust v Hoare, Court of Appeal, 13 October 1998

A recent case in the Court of Appeal concerned the liabilty to business rates (a tax on the ownership or occupation of real property) of a charity owning a historic building open to the public. Charities are exempt from 80% of their liability to business rates; this case concerned the valuation of the property for the purposes of determining the remaining 20% liability, based on the estimated rent that could be obtained if the property was on the open market. The court rejected the finding of the Lands Tribunal that a valuation based on 3% of the gross receipts from the property was the correct method and held that, where there is no commercial market for the property (which is normally the cae with historic buildings because the costs of maintenance and repair would deter any potential tenant), the Lands Tribunal must consider reducing the assessment to nil.

United Cancer Council v. Commissioner

The United States Court of Appeals for the Seventh Circuit recently rejected an IRS claim that an arms-length contract between a nonprofit organization and a professional fundraiser that resulted in a high ratio of fundraising expenses to net fundraising proceeds constituted private inurement to the fundraiser, justifying revocation of the nonprofit’s charitable tax exemption under 26 U.S.C. § 501(c)(3). In United Cancer Council v. Commissioner, (7^th Cir., Feb. 10, 1999), the Seventh Circuit held that the Internal Revenue Service improperly revoked an organization’s charitable tax exemption on the grounds that the organization’s net earnings had inured to the benefit of a professional fund raising company it hired. The Seventh Circuit’s decision overturned a ruling of the United States Tax Court.

United Cancer Council ("UCC"), a small, nearly bankrupt charity supporting preventive approaches to cancer with an annual operating budget of $35,000, contracted with Watson and Hughey Company ("W&H"), a professional fundraising firm, to organize a fundraising campaign. Under the terms of the contract, W&H served as UCC’s exclusive fundraiser for a five-year term, and obtained co-ownership of UCC’s prospective donor list. UCC agreed to refrain from selling or leasing the list, while W&H ‘s use was subject to no restrictions. W&H fronted fundraising expenses until the campaign yielded sufficient proceeds to allow UCC to reimburse W&H. W&H conducted a mail solicitation that included educational materials about cancer prevention as well as a request for donations and a sweepstakes entry form. The campaign yielded $28.8 million in net proceeds, of which $26.5 million, over 90%, was paid to W&H as fundraising expenses.

The IRS claimed that UCC did not qualify for the section 501(c)(3) exemption from federal income tax. Section 501(c)(3) exempts from taxation organizations that are "organized and operated exclusively for [charitable] purposes . . ." where "no part of the net earnings of the charity may inure [ ] to the benefit of any private shareholder or individual." 26 U.S.C. § 501(c)(3). The purpose of the restriction of private inurement is intended to prevent "siphoning of charitable receipts to insiders of the charity." United Cancer Council.

The Court rejected the IRS’ contention that the arrangement was so advantageous to W&H that it effectively rendered W&H in control of UCC and an insider of the charity, triggering the private inurement provision of the code. The Court found, inter alia, that the high ratio of fundraising expenses to net charitable receipts was unrelated to the issue of private inurement.

The investigation began in 1997 shortly after Lokelani Lindsey, one of the estate’s trustees, became involved in a dispute between Michael Chun, the principal of the Kamehameha Schools, and Kamani Kuala’au, the school’s student body president. The investigation led to the indictment of Henry Peters, another trustee, and the discovery of an independent inquiry by the IRS. Furthermore, it has recently been determined by a court-appointed master that between fiscal years 1993 and 1996, the trust lost $242 million and that the trust would have been better off investing its money in a simple savings account rather than with the investments made by the trustees.