C. Overview of Inurement/Private Benefit Issues in IRC 501(c)(3)/est of Hawaii




 * 6. Problems Involving Multiple Entities
 * C. More Complex Cases
 * 2. est of Hawaii

est of Hawaii v. Commissioner, 71 T.C. 1067 (1979), aff'd , 647 F.2d 170 (9th Cir. 1981), involved the marketing of a self realization program developed by Werner Erhard and known as "Erhard Seminar Training." Rights to commercially exploit the program were held by EST, Inc., a for profit corporation. In 1973 a franchise system was created whereby EST, Inc., would relinquish its operations in a particular geographic area to a local tax-exempt corporation. EST, Inc., through one or more intervening corporations, would supply qualified personnel to staff the organization, furnish materials needed to conduct the organization's activities, and assure that the organization conducted its activities in conformity with the standards of EST, Inc.

est of Hawaii was a corporation formed in Hawaii to act as a local provider of est services. It conducted training programs for fees and out of the fees it paid its operating expenses and a franchise fee which entitled it to use the EST methods, name, and materials.

est of Hawaii applied for recognition of exemption under IRC 501(c)(3). The Service ruled that the organization was not operated exclusively for exempt purposes because it served private commercial interests. The organization sought a declaratory judgment in the Tax Court.

est argued that it had no commercial purpose itself. Payments for its franchise were ordinary and necessary expenses. It was entirely independent from its franchiser.

The Tax Court disagreed. Since the franchise arrangements controlled the tuition fees the Hawaii organization could charge, set the minimum number of students it must serve, supplied the programs it would use, and provided the personnel to manage the organization, est of Hawaii was left with no function

except to present to the public for a fee ideas that are owned by International [one of the intervening corporations] with materials and trainers that are supplied and controlled by EST, Inc. Under these circumstances it cannot be said that petitioner has made payments to a corporation with which it had no connection whatsoever. Supra, at 1080.

Since the existence and operation of the direct customer service corporations was an essential element in the generation of income for the for-profit corporations, the Court concluded that est of Hawaii was itself engaged in commercial activity for the benefit of the for-profit corporations.