While, to the best of my knowledge, this statutory construction for Sec. 513(a)(3) has never been advanced before the Internal Revenue Service or the courts, I believe that this construction of the term "merchandise" is not at all at odds with the law of personal property; and an individual's name is personal property. Brown Chemical Company v. Meyer, 139 U.S. 540 (1891). H.R. 1773 serves to end any ambiguity in this area by achieving a clear and certain result and, in the interests of avoiding late administrative appeals and/or litigation, we would like to express our support for the clarifying amendment.

One other reason supporting enactment of the bill is that it affirms an administrative interpretation of the unrelated business income tax as now incorporated Regs. § 1.513-1(d)(4)(ii), Disposition of Product of Exempt Function. The regulation cited above exempts from tax the profitable sale of the "natural by-product" of an exempt function. As exemplified, the sale of articles made by the handicapped is not taxable to a rehabilitation center since the articles sold to the general public result directly from the conduct of a charitable or educational function, i.e., teaching the disadvantaged how to become productive through manufacture of repair of goods. If the rehabilitation center scrapped the manufactured or repaired goods, or gave them away, the training function would continue but would be impaired because the trainees would not have a concrete measure of the quality and value of their training when they move on to a commercially productive employment. In our case, the names and addresses of donors are a natural by-product of our fund raising function which is as charitable as the charitable programs we support with the funds we raise. See, e.g., Trinidad v. Sagrada Orden, 263 U.S. 578 (1924). When, and if, our charities choose to dispose of the names of their donors, they are merely doing something incidental to their exempt function by profiting from an article of property available to it arising as a by-product form the performance of an exempt function.

Although the Internal Revenue service has administratively approved this byproduct doctrine even where there is a pervasiveness commercial presence, and probable anti-competitive impact of such "by-product" sales, we would be reluctant to put forward such an argument in the United States Claims Court in light of the sweeping nature of Judge Merow's opinion in the DAV case.

The position of the Internal Revenue service in recent years has been to view as unrelated income any revenues from activities which resemble activities of commercial corporations, no matter how close the nexus between that activity and the exempt purposes of the organization. For example, the Service recently argued unsuccessflly that no medical society journal advertising can be substantially related to the society's exempt function, because the advertising resembles commercial advertising. The American College of Physicians v. United States, Fed. Cir. No. 84-715, decided September 17, 1984. Similarly, in a recent case our office handled, the Service unsuccessfully argued that religious book publishing was nonexempt because it resembled commercial publishing, even though the 1909 legislative history of the predecessor of Section 501(c)(3) stated the contrary. However, litigation proving one's point in this unevenly administered area is lengthy, and very expensive, and does not provide a uniform, nationwide rule for interested or affected organizations.

F. REASONS FOR ENACTMENT OF H.R. 1773

In last year's testimony, the Deputy Secretary for Tax Policy, on a similar Senate bill, conceded the social utility of donor mailing list exchanges.5 Mr. McKee acknowledged that the maintenance of current donor lists is necessary for a charitable organization, and that the exchange and sale of membership lists between charities is routinely associated with that process.

The main reason for Treasury's opposition to legislation such as this was to preserve the purportedly clear policy line between exempt and commercial activities. As our discussion of current law indicates, however, the mere fact that an exempt organization engages in activities which resemble activities of commercial companies does not automatically subject the activity to tax under current law. Many

3 An agricultural college can sell milk tax free from its dairy herd maintained to teach students. Regs. § 1.513-1(d)(4)(ii).

4 See Presbyterian & Reformed Publishing Co. v. United States, 54 A.F.T.R.2d 5730 (3d Cir. Aug. 29, 1984).

5 Supra note 1, at 25-26.

6 See generally, "Dealing with Investors and Other Methods of Generating Income: Tax Aspects of Revenue Producting Activities", 42nd Annual N.Y.U. Inst. on Fed. Tax., ch. 26 (1983).

other factors need to be considered; and IRS conceded, in 1973, that a truly related enterprise can be as commercial as the market requires. Rev. Rul. 73–104, 1973-1 C.B. 263, dealing with the sale of Christmans cards by, for example, the Smithsonian Institution bookstore. The current bill will simply provide a clear exemption where it is admittedly needed, and very likely available under current law, while forestalling years of litigation and uncertainty on the question.

In closing, let me raise one issue yet undiscussed-the possible revenue loss from this exemption. The tax revenues at stake here are very modest, probably less than $500,000 per year. Since its inception, the unrelated business income tax has not paid the Treasury any real substantial sums of money (see chart to our 1983 testimony) and never lived up to the revenue raising estimates published by the Congress in 1950 (see Aug. 30, 1950 Cong., Rec., p. 13951), even adjusted for inflation. The amount of tax foresworn by enacting this bill will be more than offset by the increased vigor of charitable solicitations which, in turn, will lessen the burdens of government relating to health, welfare and veterans' services. If AKF and AMVETS save $20,000 in federal taxes that sum is spent directly on charitable services and the federal fisc suffers no real loss due to our re-investment of the tax savings in the welfare of victims of kidney disease or needy veterans.

Chairman STARK. Thank you.

I guess I am uncertain as to whether the objection in this just comes on tax policy out of the IRS or whether there really are commercial fundraisers or mailing lists maintainers or whatever you refer to them as, who don't want you all competing against them on a tax-exempt basis.

Are there commercial operations that have objected?

Mr. HEILMAN. Mr. Chairman, during the DAV's court litigation, we had representatives from commercial mail order houses testify that the fact that the DAV was renting and exchanging its list, either with nonprofits, as we do mainly, or even with commercial groups, to the limited degree we do that, does not impact on them in any way, does not compete with them, does not affect their profit margin.

This type of activity is unique in that a list will either work for an organization or it won't. If its presence is there, you will use it, rent it, or exchange it; if it is not, you won't.

So they were not objecting at all to the fact that the DAV or other nonprofits rent and exchange their lists. And the court conceded this point in our case. But nonetheless, the court said it looks like a commercial activity, therefore, it is UBTI.

But the private industries did not object whatsoever.

Chairman STARK. I often wonder what would happen if they started to look into the practice of Members of Congress exchanging lists of fund contributors, either with their own political party or with other Members of Congress.

Ms. HATCH. You would have to start paying taxes.
Chairman STARK. That is a horrible thought, isn't it?

Mr. ALEXANDER. Mr. Chairman, the Treasury seems to be hung up on the reasoning that, No. 1, despite what Mr. Heilman said, that a charity that exchanges with another charity a limited right to mail to a name on its unique list is somehow engaging in a competitive activity.

Now, having reached that conclusion, then they discover that unless that competitive activity is taxed there is a competitive advantage to the charity, despite what Mr. Heilman said, and, therefore, one must eliminate the advantage by imposing a tax.

The problem with their reasoning is it is fallacious on points 1 and 2, and, therefore, on point 3.

Chairman STARK. Mr. Duncan.

Mr. DUNCAN. Thank you, Mr. Chairman. I want to thank all of you for appearing.

It is obvious that the Internal Revenue Service is inconsistent in their interpretation of this issue. I am hopeful that we will be able to help you sometime early in the next Congress, because you certainly have a lot of friends here who are in sympathy with you.

There has been some concern expressed that this legislation results in an increase in mailing lists and in direct mail solicitations. How do you respond to this concern?

Mr. HEILMAN. Quite frankly, Mr. Duncan, I don't follow the logic that that question assumes-why it would result in an increase in the number of the lists. If the DAV is required to pay these taxes, we will continue in operation-if we can improve or expand our list, we will do so irrespective of the fact that we have to pay tax on our income or if we don't—and I imagine other charities will continue to try to improve their donor lists for their purpose of administering their programs-whether or not IRS is able to tax or

not.

Certainly if this bill were not enacted and IRS really collects this money, I think it will definitely inhibit the ability of organizations, especially smaller ones, to maintain their lists and to improve their lists.

Mr. DUNCAN. Do you use your revenues from selling your mailing lists for any purpose not related to your tax-exempt purposes? Mr. HEILMAN. No, sir. We certainly do not. As I indicated, the revenues that we do get from renting our lists are far and away offset by what we spend to identify and mail to those 900,000 potential donors to replace the ones we lose.

Mr. DUNCAN. Would you have to reduce your service to the disabled veterans and their widows and families without this revenue?

Mr. HEILMAN. Well-

Mr. DUNCAN. If you had to pay the taxes.

Mr. HEILMAN. Let me put it this way. If we didn't have to pay the tax, we certainly could increase our services to veterans. The DAV is very fortunate in that the general public has been most generous in contributing to our organization.

But as far as the smaller organization is concerned, and I am sure perhaps one of the other witnesses will attest to this, if they have to pay taxes, they very well might have to fold up shop. Mr. DUNCAN. Mr. Lehrfeld, would you care to respond?

Mr. LEHRFELD. I think Ms. Hatch could probably respond best. Ms. HATCH. Mr. Duncan, your question is a very good one, because the American Kidney Fund would definitely be affected by these taxes in that we would have to cut back on our programs and it wouldn't be us that would be suffering, it would be the kidney patients who are depending on our financial assistance that would suffer.

And it could eventually lead to the demise of the American Kidney Fund, and we are currently providing a supplement to the Federal and State programs for kidney patients.

Mr. DUNCAN. If you did not supply it, then the Federal Government would have to supply it, I suppose.

Ms. HATCH. They would not, I don't think so.

Mr. DUNCAN. You are at least giving a service and I think an excellent service. Thank you.

Thank you, Mr. Chairman.

Chairman STARK. We thank the panel.

Walter Stults, president of the National Association of Small Business Investment Companies, NASBIC.

STATEMENT OF WALTER B. STULTS, PRESIDENT, NATIONAL ASSOCIATION OF SMALL BUSINESS INVESTMENT COMPANIES Mr. STULTS. Thank you, Mr. Chairman.

Chairman STARK. You have a pass from the Treasury and with broad bipartisan support for your bill, you are doing as well as the Chicago Cubs.

Mr. STULTS. I will let you go to lunch then.

Chairman STARK. Your entire statement will appear in the record.

If you would like to summarize it, proceed.

Mr. STULTS. Fine. Thank you very much for this opportunity to allow me to give this testimony in support of H.R. 2686. Members of my association are small business investment companies licensed by SBA and business development companies which are venture capital companies.

These firms provide funds for new and growing small businesses and often provide significant managerial assistance.

We were delighted, obviously, by Treasury's OK for our legislation. We point out only that the problem addressed by this legislation was created when Congress enacted the Small Business Investment Incentive Act of 1980.

This set up a new regulatory framework under the SEC for certain publicly held venture capital companies. And the one problem was that we did not get the Internal Revenue Code amended at the same time we amended the Investment Company Act of 1940.

I would point out that this is a revenue neutral measure. The Treasury Department has no objection.

The Senate has passed the measure, incidentally, twice, in 1981 and 1982, by unanimous vote.

Page 3 in my statement, Mr. Chairman, right in the middle, I made a mistake and said that "otherwise would have to register under the 1980 act.” It should be the 1940 act.”

To summarize, H.R. 2686 would provide necessary and deserved relief from a technical oversight. It would permit the full implementation of the Small Business Investment Incentive Act of 1980 and would not extend the special tax treatment provided in subchapter M of the code to any type of company that could not now claim the benefit of that treatment.

The amendments that this bill would make are important to a part of the venture capital industry, the industry that provides money and management assistance to new and growing businesses. We urge Congress to enact H.R. 2686 at the earliest possible opportunity.

Thank you.

Chairman STARK. Thank you very much, Walter. I hope we can.

[The prepared statement follows:]

STATEMENT OF WALTER B. STULTS, PRESIDENT, NATIONAL ASSOCIATION OF SMALL

BUSINESS INVESTMENT COS.

Good morning Mr. Chairman and Members of the Subcommittee, my name is Walter B. Stults and I am President of the National Association of Small Business Investment Companies (NASBIC). I am here today to express NASBIC's support for H.R. 26×6, which would amend subchapter M of the Internal Revenue Code to bring it into conformity with amendments to the Investment Company Act of 1940 made by the Small Business Investment Incentive Act of 1980.

The members of NASBIC are small business investment companies (SBICs), which are venture capital companies licensed by the Small Business Administration under the Small Business Investment Act of 1958. SBICs provide funds for new growing small businesses and also often provide significant managerial assistance.

Several SBICs and non-SBIC venture capital companies are publicly-owned companies whose shareholders are able to obtain a professionally managed and diversified portfolio of investments. Because these companies have characteristics similar to mutual funds, they are registered under the Investment Company Act of 1940 and are subject to the same SEC regulation as mutual funds. Also, like mutual funds, these SBICs are accorded special tax treatment under subchapter M of the Internal Revenue Code. Under subchapter M, a “regulated investment company,” which is generally defined as a corporation registered under the Investment Company Act of 1940, can pass through to its shareholders its investment income without having to first pay Federal income taxes on those earnings at the corporate level. This allows small investors to diversify their investments and obtain professional investment management without having their investment earnings subjected to a second level of tax at the corporate level. This puts small investors on an equal footing with wealthy individuals who can avoid the second level of tax by making direct investments and directly hiring professional investment managers.

The problem addressed by H.R. 2686 was created when Congress enacted the Small Business Investment Incentive Act of 1980, amending the Investment Company Act of 1940. Under the 1980 Act, a new regulatory framework was established for certain public venture capital companies. To help make capital available for new, developing businesses, public venture capital companies that invest in and provide substantial management assistance to small, growing companies were allowed to claim exemption from the registration requirements of the 1940 Act and instead elect simplified regulation by the SEC as "business development companies." The only companies that can elect to be regulated as business development companies under the 1980 Act are investment management companies that otherwise would have to register under the 1980 Act. Unfortunately, this law has not been utilized by the majority of publicly-owned SBICs and venture capital companies because subchapter M of the Code allows pass-through tax treatment only to investment companies registered under the 1940 Act. The limitation of pass-through tax treatment to companies registered and regulated under the 1940 Act has also been a major deterrent to the formation of new publicly-owned SBICS and venture capital companies. The only publicly-owned SBICs and venture capital companies that have elected to give up registration under the 1940 Act are those companies that are not paying dividends and would currently gain no benefit from subchapter M.

H.R. 2686 would amend subchapter M of the Code to provide, in effect, that any business development company regulated under the 1980 Act will be treated as if it were registered under the 1940 Act. We understand the intention of H.R. 2686 is to remove any difference in tax treatment between a business development company and a company registered under the 1940 Act. Thus, any business development company that meets all other requirements of subchapter M of the Code would be treatd as a regulated investment company for all purposes of the Code, including the passthrough tax treatment under subchapter M. Also, under section 851(a)(1) of the Code, in determining whether a company has been at all times during the taxable year registered under the 1940 Act, a company that is a business development company under the 1980 Act for a part of a year would be treated under H.R. 2686 as if it were registered under the 1940 Act for that part of the year. Further, under section 851(e), relating to special portfolio diversity requirements for "registered management companies" (a sub-type of regulated investment company), a business development company under the 1980 Act would be treated under H.R. 2686 as a “registered management company." This is appropriate because if any business development company had not elected to be regulated under the 1980 Act it would have been a registered management company under the 1940 Act.