EFTA00598083.pdf

USTC Cases, New Dynamics Foundation, Plaintiff v. The United States, Defendant., U.S. Court of Federal Claims, 2006-1 U.S.T.C. ¶50,286, (Apr. 24, 2006) New Dynamics Foundation, Plaintiff v. The United States, Defendant. U.S. Court of Federal Claims; 99-197T, April 24, 2006, 70 FedCl 782. Code Sec. 501I Exempt organhations: Exempt status: Charitable purpose.— The IRS properly determined that a California corporation that administered a donor advised fund did not qualify for tax-exempt status under Code Sec. 501(c)(3). The corporation's operations. in particular its supervision of donor foundations, was characterized at least by willful neglect and. more than likely. an active willingness to participate in a scheme designed to produce inappropriate tax benefits. The corporation and its board strained the concept of charity in approving personal expenditures. Further. its operations always were motivated by an intent to facilitate the abuse of the internal revenue laws. From the start, the fund's promotional materials revealed that it was designed to "warehouse wealth." that is, to allow donors to "contribute" property and cash to their foundations, control the investment of those resources and then assertedly have the income and appreciation on that corpus accrue or be realized tax free. Back reference: 122,609.411. Code Sec. 74281 Declaratory judgment: Procedures: Exempt organizations.— A corporation was not entitled to declaratory relief under Code Sec. 7428 because it was not operated exclusively for charitable purposes. In an initial qualification for tax-exempt status. the court held that de nova was the correct standard—is was for the court to determine whether the organization was entitled to exemption. This standard nxre closely tracts the statutory language and legislative history. Thus. the court was not required to review the IRS's determination directly. but rather compelled it to make a declaration as to the qualification itself. The court also held that it may determine that the corporation qualified for an exemption as of some date other than when its application for tax-exempt status was filed. Reg. §601.20 (O3)(i) clearly envisions that an application for exemption can be granted effective a date later than the date of the application. Where the IRS must account for changes made by the application in deciding whether an organization is exempt. so too must a reviewing court. Back references: 141,723.14 and 141,723.18. R. Todd Luoma, for plaintiff. Eileen J. O'Connor, W.C. Rapp, Department of Justice, for defendant. OPINION "[C]harity begins at home, and justice begins next door." 1 ALLEGRA, Judge:New Dynamics Foundation (plaintiff or NDF) brings this declaratory judgment action under 26 U.S.C. §7428(a), seeking a declaration that it is exempt from taxation under sections 501(a) and 501(c)(3) of the Internal Revenue Code of 1986 (the Code). After careful consideration of the parties' briefs and other submissions, review of the certified administrative record, and oral argument, the court finds plaintiff is not entitled to the relief it requests for the reasons set forth below. I. FACTS Based upon the administrative record in this case, the court finds as follows: O2011 Wolters Kluwer. All rights reserved. 1 of 19 7/28/2011 7:37 AM EFTA00598083  A. Background On or about May 11, 1996, NDF filed its initial application with the Internal Revenue Service (IRS) seeking tax-exempt status. It resubmitted its application following its formal incorporation as a California corporation. On October 2, 1996, the IRS indicated that it was disinclined to grant plaintiff's application based upon the information it had received to date, and requested additional information. On October 16, 1996, plaintiff responded to the request. Ultimately, on January 29, 1998, the IRS sent plaintiff a proposed final adverse determination letter in which it denied plaintiff's application for tax-exempt status. Following a protest, the IRS issued a final ruling denying the application on January 20, 1999. The final ruling stated that NDF did not qualify as an exempt entity because it failed to establish: (i) that it was operated exclusively for purposes described in section 501(c)(3) of the Code; (ii) that its net earnings would not inure to the benefit of private individuals; and (iii) that more than an insubstantial part of its activities would further private purposes rather than purposes described in section 501(c)(3). On April 5, 1999, plaintiff filed suit in this court seeking a declaratory judgment that it is exempt from federal income taxation under section 501(a) of the Code, as an organization described in section 501(c)(3) of the Code. B. New Dynamics Foundation: Its Origins and Operations Plaintiff was formed on or about May 11, 1996, and initially operated as a "sub-account- under a tax-exempt organization, the National Heritage Foundation (National Heritage). Plaintiff eventually was spun off from National Heritage, by its account, as a West Coast version of the latter organization. As noted, plaintiff filed its application for tax-exempt status on or about May 11, 1996. The application was returned because plaintiff was not yet an incorporated entity under state law. 1. Basic Governance On June 17, 1996, plaintiff incorporated as a California nonprofit public benefit corporation. Its incorporator and founder was Robert HenkeII (HenkeII), who was also NDF's first president and chairman of the board. Plaintiffs initial board of directors included HenkeII, Allen Sainsbury, William L. Sefton, and four other individuals, each of whom had previous business relationships with Henkel]. Article II of NDF's articles of incorporation sets forth the purposes of the corporation, among which was "[t]o promote and or contribute to charitable causes which serve the public good ... as defined in Section 170(c) of the Internal Revenue Code," adding that "(sJuch objectives may be met independently and by working with other tax exempt organizations since many 501(c)(3) organizations have similar objectives as ours under Section 501(c)(3) of the Internal Revenue Code." The Articles, in terms later echoed by NDF's bylaws, further provided that "no part of the net income or assets of the organization shall ever inure to the benefit of any director, officer, or member thereof or to the benefit of any private person." They concluded by indicating that "[t]he property of this corporation is irrevocably dedicated to charitable purposes," indicating that upon dissolution, the corporation's remaining assets would be distributed to a tax-exempt organization. According to an August 25, 1996, letter submitted to the IRS, the Board of Directors of NDF initially identified "as areas of activity and focus" during its first year of operation: (i) -promot[ing) the education of students in computers" and in "entrepreneurship;" (a) "provid(ing) support to prison ministries" and to -groups that provide drug and alcohol abuse education;" and (iii) providing support to -animal rights organizations" and "groups and organizations that work for the conservation and preservation of forest lands and wildlife management." Other documents indicate that NDF planned to work with financial and tax professionals to establish accounts for individuals, who, over time, could direct the use of those funds for alleged charitable purposes. In various promotional materials, plaintiff touted that ©2011 Wolters Kluwer. All rights reserved. 2 of 19 7/28/2011 7:37 AM EFTA00598084  "Imioney, investments and other property within a public charity grow tax-free, not tax deferred,' and that "[Once growth within a public charity is tax FREE, not tax deferred, effort should be made to earn a fair return within prudent risk parameters." On September 17, 1996, the State of California granted plaintiff tax-exempt status. Plaintiff's October 16, 1996, letter responding to an IRS information request, which was accompanied by promotional literature, described the operation of the donor accounts in the following terms - When a person wishes to contribute to NDF they simply make a contribution in the normal manner of writing a check or donating property. NDF will use this money on any of the many projects NDF is involved in itself. However, if the donor wishes to direct the funds for a specific purpose or project, the following steps occur: A A separate account is set up using the donor's contribution. B. An Advisory Committee is established over that account. The NDF Board of Directors establishes each Advisory Committee with at least three members of legal age. The Advisory Committee for each separate donor-directed sub-account reports to the NDF Board of Directors and must obtain Board approval for all actions. The donor is welcome to suggest two members of the Committee, including the donor, if desired.[ NDF will always appoint at least one of the Committee members. The committee does not control funds. They make recommendations to the main Board of Directors....[ _I) C. The Committee will make recommendations to the Board of Directors as to the use of the funds. The Board will pay special attention to be sure the Committee recommendations are in compliance with IRC 501(c)(3). Any recommendation must be accompanied by sufficient details to allow the Board adequate review.... All new recommendations or other changes must have NDF Board approval. Since only the Board of Directors of NDF controls the "purse string& the project cannot get started without Board approval. Donors do not control actual monies once monies have been gifted to NDF. The Committee can only make suggestions to the Board of Directors The letter indicated that, as of that date, $307,539.76 had been donated to NDF through 43 donor-directed sub-accounts, of which $20,258 had been used directly in Board-approved charitable activities. According to the protest, as well as accompanying materials, plaintiff charged several "fee& for creating and managing the sub-accounts. There was an initial "set-up fee" of S2,500, which was paid on a sliding scale out of the first $7,000 of each donation and a "management fee" of 0.625 percent of the account balance per quarter purportedly to cover NDF's general operating expenses and overhead. 4 When initially established, plaintiff entered into oral agreements with two "financial marketing companies" - Estate Preservation Services (EPS) and Washington Financial, Inc. (WFI) - to solicit contributions from potential donors. In exchange for those solicitations, plaintiff paid a percentage of each $2,500 set-up fee to the referring marketing company as a commission - 40 percent (or S1,000) to EPS, and 34 percent (or $850) to WFI. As between the two companies, the vast majority of commissions apparently went to EPS, which received $17,529.20 from the first 43 donors, compared to S375.70 received by WFI. The record reflects that HenkeII founded EPS and was the original incorporator. In its October 16, 1996, letter, however, plaintiff asserted that neither HenkeII nor any member of his family currently owned any interest in EPS. Other documents in the record suggest that EPS, at some point, was sold to another company, The Wealth Protectors, Inc. (TWP). The nature of Henkell's relationship with TWP is disputed. § Various documents explained how individual foundation assets could be expended. As described in greater detail below, under the specified process, the advisory committee of the individual foundations made recommendations to the NDF Board. Regarding this process, the "Operation Manual" (the Manual) supplied to donors emphasized that ©2011 Wolters Kluwer. All rights reserved. 3 of 19 7/28/2011 7:37 AM EFTA00598085  "fflunds donated to a specific donor-advised foundation are to be used in that end." The Manual listed, as examples of charitable uses, a range of religious, educational and general welfare projects. But, it noted that "it is just as important to realize that charitable use which is normally non-taxable, can also benefit the Donor or the Donor's family." By way of example, it stated that "if the Donor's child did volunteer work at a local hospital, the foundation could pay that child a reasonable 'wage' for participating in the 'volunteer activity.- In this regard, it observed la) direct charitable expense usually carries no income tax consequences to those involved or to the recipients," adding that IsJure, 'wages' for a charitable act are taxable but grants and fellowships usually are not." At a later point, it reemphasized - laJgain, just because a use of foundation assets is for a charitable purpose does not mean that the Donor, the Donor's family [or) any other designated person can't also benefit and be paid for participation." The Manual provided extensive directions as to how donors might use funds for what were termed "administrative expenses." Thus, it stated that "NDF understands that the operation of any charitable endeavor requires administrative expenses," noting that "[t)o that end, each donor-directed foundation's Advisory Committee will have the opportunity to recommend administrative expenditures as well as charitable expenditures." Later, the Manual opined that "[r)easonable administrative expenses are always an acceptable use of foundation money." For example, a donor could seek - reimbursement of expenses ranging from "office supplies" for foundation operation to gas mileage costs for travel in support of foundation goals or activities. Requests can be made in advance to "fund" a foundation meeting, including airfare and lodging, or to simply repair or improve a foundation-held asset. It later indicated that "Neasonable administrative expenses might include paying the Donor or a member of the Donor's family a fee or wage to attend a meeting or to 'research' an investment or to provide advice and direction - be a consultant." At several seminars that he conducted in April 1996, HenkeII indicated that "ninety-five percent" of the money contributed to a charity could be used for administration, noting, in particular, that such foundations could be used to pass "ninety-five percent" of life insurance proceeds to children. HenkeII highlighted the other supposed advantages of having a charitable foundation as compared to an individual retirement account (IRA): (i) no minimum age for taking money out and no requirement that money be taken out at age 70 'A; (ii) "easier to direct where your investments go;" (iii) a charitable foundation is never a part of an estate and its assets are unlikely to be seized, particularly by the IRS; and (iv) "zero" tax rate on the charitable foundation which can be taken over by family members. Consistent with these claims, an EPS newsletter, dated June 1996, emphasized that the foundations were "a very powerful long range planning device to establish, tax-free, a nest-egg that can provide retirement benefits and some great opportunities for charitable projects." NDF's promotional materials provided further insights into its operations. One brochure, entitled "Warehousing Wealth!," listed the following "potential uses of a public charity!" - 1. INCOME REDUCTION: Use an NDF public charity account to warehouse income for long range planning and wealth accumulation. Remember, a Trust can donate, and deduct, up to 100% of Trust income to a public charity. 2 CAPITAL GAINS AVOIDANCE: Use an NDF public charity account directly, or indirectly through a Charitable Remainder Trust, to receive an asset prior to sale to avoid any capital gains taxes. This can also eliminate a "mortgage over basis" or debt forgiveness problem. 3. ESTATE SIZE REDUCTION: Use an NDF public charity account to reduce the size of an estate prior to estate taxation. This can eliminate estate taxes (or have the Government donate up to 55% to your family foundation). ©2011 Wolters Kluwer. All rights reserved. 4 of 19 7/28/2011 7:37 AM EFTA00598086  4. CHARITABLE PROJECTS: Use an NDF public charity account to build wealth for a special project. This includes scientific grants, religious projects and educational scholarships. 5. LIABILITY PROTECTION: Use an NDF public charity account to provide liability protection for an asset. This can protect an asset from seizure by most creditors in most debt or lawsuit situations. This can also include some level of protection prior to a bankruptcy. 6. MEDICAID PAYDOWN RELIEF: Use an NDF public charity account to receive assets prior to a long term care situation and a potential Medicaid paydown. 7. TRANSFER OF QUALIFIED RETIREMENT PLANS: Use an NDF public charity account to receive withdrawals from a qualified plan. This includes 401(k), SEP, SARSEP, KEOGH, TSA's or 403(b), and IRA plans. A client can withdraw (even avoiding a 10% penalty if done regularly over at least 5 years) funds (taxable income) and make a charitable contribution to the family NDF account (charitable writeoff). Up to 50% of the adjusted income can be written off in the year given. (Keep planned withdrawals equal to net income and it can all be written off when placed in the NDF account). Summing up these perceived advantages, Henkel] indicated at one of his seminars that "[w]ith a charity, wealth goes tax-free and contributions are tax deductible." 2. Donor Investment and Expenditure Requests The advisory committee for each individual foundation was authorized to make recommendations to NDF's Board of Directors for investment of donated funds (or the sale of donated property and reinvestment of the proceeds). In fact, expenditure requests under $25,000 were ordinarily acted upon by only one member of the NDF Board, sometimes HenkeII himself. Despite indicating in its brochure that "(i]t is not proper for a public foundation to hold property or assets that ... do not generate income," the NDF Board approved requests authorizing certain foundations to receive or purchase non-income assets. For example, it approved the purchase of over $150,000 in collectible coins (some of which were apparently sent directly to the donor), authorized another donor to transfer a Mexican vacation time-share to his foundation, and allowed various other foundations to purchase life insurance or annuity contracts that did not generate income streams. In some instances, these assets were virtually the only asset held by the respective foundation. NDF approved a variety of expenditures to what appear to be recognized section 501(c)(3) organizations. Plaintiff claims that in its first year of operation, it distributed $97,313 to such organizations, corresponding roughly to 4.2 percent of the $2,249,089 that had been contributed as of January 1997. Some details regarding the approval of expenditure requests may be found in a June 5, 1997, letter from HenkeII to the IRS. In response to the IRS' question - "Do you have meetings concerning requests from donors?," HenkeII responded - Each donor request must be approved. This constitutes the "record" and action of the directors. For amounts over S25,000, at least 4 directors were involved. A summary of requests were presented and reviewed at the January Board of Directors meeting and another summary will be presented at the July Board of Directors meeting. Henkel] further stated that "NDF does not allow distributions of charitable funds to any donor, even if requested," but later indicated that "NDF does accept requests for donor-involved charitable activities" and that "(njo NDF donor who has an NDF sub-account can ever receive pay unless actual charitable functions are served." Asked whether ©2011 Wolters Kluwer. All rights reserved. 5 of 19 7/28/2011 7:37 AM EFTA00598087  NDF had ever turned down a donor's request to make a distribution, HenkeII listed four such instances - a couple that wanted to use charitable funds for a trip to Hawaii; an individual who wanted reimbursement for a trip to Napa Valley to study winery stock as an investment for charitable funds; an individual that wanted to use charitable funds for her child's education; and a donor that asked for checks to be made out to a school and delivered directly to him. Over time, NDF denied other requests for various reasons, such as a lack of charitable purpose or a failure to document needed expenditures. In some situations, however, it appears that checks for the same activity instead were later sent directly to a charity or non-profit institution, begging the question whether the payments were viewed by the recipient as a donation or as paying for specified services for the individuals previously named in the request. Tending toward the latter view, on several occasions, instructions were given to have checks issued with references to the donor or particular members of the donor's family, making it appear that the expenditure were for personal purposes. In other instances, requests that were denied were only slightly revised and then approved - for example, in several instances, requests were modified to have checks sent directly to the sellers of specified products rather than to the donors; in another, a request for home schooling expenses was denied, but over $2,900 was later paid to the "Home Church" for home-schooling materials. § Other requests that were approved bore the distinct mark of personal expenditures. In one of his promotional lectures, HenkeII provided the following telling example - Mr. Henckle: 7 I have one person right now with a charity who truly does some inner - inner-city free medical work. I have a - a doctor who's seventythree years old, lives down in Arizona. We've been working with him as a charity for a number [of] years. We got him in a private charity a long time ago. He's chunked away a lot of money in his charity. Now he travels around the Southwest and works especially with the Indians, and he does some free medical work. And basically he just likes going around visiting with the Indians. He doesn't do anything real heavy medically, but he had to have a motor home to do it. Paid a hundred and forty-seven thousand dollars for a motor home. This is the most beautiful executive motor home out of Inglewood that I've ever seen in my life. It has everything. (lit's 43 feet long. I mean this sucker - this sucker is superb. Who bought the motor home? Voices: Charity. Mr. Henckle: The charity. Is that taxable income to him? Voice: No. Mr. Henckle: Who buys the gas? Charity. At another lecture, Henkel] listed among the purposes to which money donated to a foundation could be directed - taking money for "an emergency in your life," to educate someone, and to fund a scientific study by the donor, such as "studying the canal systems of Peru." In another such lecture, he suggested that donors could go to a college financial aid office and ask whether the college would assist the donor's child if a donation were made to the college, noting that NDF would take a "[d]on't ask, don't tell" approach to such requests. Various promotional materials reinforced these claims. Thus, the Manual indicated that "if the Donor's child did volunteer work at a local hospital, the foundation could pay that child a reasonable 'wage' for participating in the 'volunteer activity.- A June 1996, EPS newsletter assured, in similar vein, that "[w]hen, and if, money is needed, the public charity can 'hire' the donor for management or consulting purposes" and that It]his warehoused wealth can also provide scholarships and grants." And other promotional materials indicated that suggested benefits also included, but were not limited to scholarships for the benefit of family members, avoiding estate taxes, avoiding capital gains taxes, and "paid" volunteer work. Still other promotional material stated that donors could "build a large charitable foundation to provide continued income during retirement years." ©2011 Wolters Kluwer. All rights reserved. 6 of 19 7/28/2011 7:37 AM EFTA00598088  Consistent with these representations, the record includes documentation of various questionable expenditures that NDF approved, involving such things as: (i) $4,130 to allow two members of an advisory committee to attend a religious retreat; (ii) approximately $1,600 to cover the travel, lodging and food expenses of two members of an advisory committee who attended a world conference on evangelism and a marriage seminar; (iii) approximately $3,470 to allow donors to attend an "elder conference; (iv) over S300 to provide salary to foundation members' children working at an AIDS center; (v) various requests to cover the costs of donors attending seminars taught by Henkell, as well as "training classes" provided by EPS and NDF; (vi) approximately S1,200 for expenses associated with providing meals, entertainment and gifts to individuals of Chinese descent, purportedly in support of evangelization efforts, with some of these expenses relating to dinners held at the advisory board member's house; and (vii) S216 to cover a rental car and other expenses of advisory committee members seeking to provide support to a nephew who had bipolar depression and a recently-divorced niece, as well as to visit a student at a college who had "stalking problems" with a fellow student. Records reveal that NDF also approved, virtually with no documentation, thousands of dollars of expenditures for "administrative expenses and "fundraising." 3. The Role of Henkell The parties dispute most of the details relating to Henkell's past and current association with plaintiff and the roles of other entities owned or controlled by him and his family. Plaintiff does not contest - and the record confirms - that early in NDF's life, Henkell dominated its operations. Various documents suggest that Henkell and his wife resigned from their respective positions at NDF on or around June 30, 1997. Initially, Henkell was replaced by Scott Grace. On September 15, 1997, Allen Sainsbury then became the Chairman of NDF's Board of Directors and its President. In a letter to the IRS, dated November 21, 1997, Sainsbury emphasized that la] clear distinction needs to be recognized between NDF and Mr. Robert Henkell." Referring to many of the materials quoted above, Sainsbury noted that "[m]uch of this material was written or spoken by Mr. Henkell in the capacity of a marketer with a definite sales spin," and emphasized that, following Henkell's resignation, significant modifications had been made "to the written material that is currently being used with the general public." Sainsbury attached the revised materials to the letter and, indeed, the revised brochures (dated September 26, 1997) excluded much of the language that had previously suggested that Foundation moneys could be used to fund personal expenses and activities. Nothing in the record, however, indicates whether and when plaintiff communicated these changes to its preexisting donors. a When asked by the IRS for hard evidence that new officers and a board of directors had been appointed ( e.g., letters of resignation, minutes, or resolutions), neither Sainsbury nor any other representative of NDF were forthcoming. At least several of the new board members were former agents of EPS and the newly-formed board met at Henkell's house after his resignation. NDF attempted to demonstrate that it was no longer affiliated with Henkell by providing the IRS with a list of the entities paid for fundraising/field support that reflected no NDF payments to any of Henkell's entities. But, the record reveals that NDF made payments to American Legal Services, an entity related to Henkell, in August, October and November of 1997, and at various points during 1998. Further, the record suggests that, even after Henkell's alleged departure, NDF continued to use, at least at times, the original versions of its promotional material, and not the revised versions that had been provided to the IRS. Still other evidence, particularly testimony given by Sainsbury in a case involving EPS and OES, indicates that he often was a figurehead for entities that were actually controlled by Henkell. On June 30, 1997, defendant filed a complaint for permanent injunctive relief against EPS (both as a trust and corporation), Henkell and others, seeking to enjoin them from participating in organizing, selling or assisting in the promotion of establishing charities based upon the false representation that individual taxpayers could essentially shelter income in such charities, characterizing this as among several -abusive tax shelters, plans or arrangements" in which the were involved. See United States v. Estate Preservation Services 2000-1 usrc ¶50,202], CIV-S- 97-1166 (M. Cal.). The complaint averred that Henkell had, during seminars, falsely claimed that -individual taxpayers can set up their own charities to improperly amass assets tax free and to hide money from the Internal Revenue Service." In an order, see United States v. Estate Preservation Services [ 2000-1 USTC ¶50,202], 38 ©2011 Wolters Kluwer. All rights reserved. 7 of 19 7/28/2011 7:37 AM EFTA00598089  F.Supp.2d 846 (E. Cal. 1998),M 2000-1 USTC ¶50,203), 202 F.3d 1093 (9 th Cir. 2000), the district court noted that the NDF promotional materials had made "false" statements "that an individual can use a charitable foundation to disburse funds back to the donor or the donor's family," noting that such statements were "not supportable under the Internal Revenue Code. Id at 854.9 Ultimately, the district court enjoined Henkell, EPS, and several former officers and board members of NDF, including Sefton and Grace, from promoting abusive tax avoidance transactions. That injunction, however, did not extend to NDF. Nonetheless, the order clearly referred to NDF's role in Henkell's promotion of "a tax scheme that contradicted fundamental tax principles and specifically advocated the use of deductions not allowable under the Internal Revenue Code." Id. at 856. ID C. The IRS Rulings On January 29, 1998, the IRS issued a proposed final adverse determination letter denying plaintiffs application for tax-exempt status. The extensive ruling began with a summary of what the IRS believed were the facts surrounding NDF's formation and operation, highlighting some of the same materials quoted above. The ruling made various findings, among them that - - While your Articles of Incorporation provide that you are organized for charitable purposes, your activities have demonstrated that you are not operated exclusively for charitable purposes .... You aggressively market, and have permitted others to aggressively market, your services as part of a classic tax scheme. You have provided information to your -contributors" which clearly misstates settled principles of tax law. In particular, you have advised your "contributor& that money placed in one of your subaccounts can and should be used for the -contributors" personal benefit. You have gone beyond mere advice, you have set up the subaccounts in a way that provides the donor with control over the funds. While you stated to the Service that all funds belong to you and that you have control over their use for charitable purposes, in operation this is not the case. Your -contributors" control their individual accounts.... In many cases, such as expenditures for personal medical costs, for entertainment expenses, for personal educational expenses, your "contributors" directions have not resulted in a bona fide charitable contribution. - The information submitted in the file indicates that you are operating for the private benefit of your donors, your directors and the agents of the for-profit organizations aggressively marketing your services. Evidence that you are operating for your donors' private interests is based upon the aggressive marketing of your subaccounts. The for-profit organizations induce owners to establish subaccounts by presenting benefits of an income tax deduction, a lower estate for determination of estate tax, the right to retain control over their contribution by being able to recommend how funds are to be invested, and the right to "appoint" who will be able to make advisory decisions in the event of a donor's death. - Based on the information in the file you are organized and operated for the benefit of your directors, and in particular Mr. Henkell. Evidence showing that you are operating for the benefit of Mr. Henkell is that you were created by Mr. Henkell, and all fees are passed to organizations controlled by him (EPS, OES).... [Y]our net earnings are inuring for the benefit of Mr. Henkell, donors, and agents of the for-profit companies. Mr. Henkell receives a percentage of the set up fees through his for-profit companies without a capped amount. Some earnings inure to the benefit of the agents through the open ended commission agreements, whereby each agent receives a yearly fee for their life and their heirs for each account established. Your earnings inure to the benefit of your donors because several donors establish accounts through their own contributions and receive some of their contributions back in the form of reimbursements. Finally, this ruling rejected the notion that plaintiff was operating differently after Henkell resigned, finding - "You have not provided sufficient information to show that you are now operating for exempt purposes within the meaning of section 501(c)(3). In fact, other than providing names of new directors, you have not indicated any change in your method of operation. You have not renounced any of your methods or tactics or provided new information for us to consider." The IRS concluded: "[a]ccordingly, you do not qualify for exemption as an ©2011 Wolters Kluwer. All rights reserved. 8 of 19 7/28/2011 7:37 AM EFTA00598090  organization described in section 501(c)(3) of the Code ...." On February 12, 1998, counsel for NDF requested additional time to protest the preliminary denial. He indicated that he believed that "many of the difficulties the Foundation is currently facing in connection with this filing are attributable to bad advice and counseling by other professionals and that the New Dynamics program and operations can be conducted in a manner that clearly falls within the requirements and constraints of a section 501(c)(3) organization." On March 27, 1998, plaintiff provided additional documentation to the IRS ( e.g., resignation letters from some of the prior board members and minutes of several board meetings), but refused to provide other documents that had been requested ( e.g., certain declarations under penalty of perjury). This response also emphasized various changes that plaintiff had made in its operations following the filing of its application and the severance of its relationship with HenkeII and his web of organizations. Plaintiff requested a conference to discuss the matter, which meeting apparently occurred on July 24, 1998. On October 13, 1998, plaintiffs counsel wrote the IRS, summarizing resolutions adopted by NDF's Board of Directors (copies of which were attached to the letter) that eliminated both the use of third-party marketers paid by commission and of advisory committees for sub-accounts. The resolutions indicated that in the future donors would make requests for investment or expenditure of funds directly to NDF's Board of Directors. The letter also suggests that plaintiff had eliminated the use of separate checking accounts to hold and disburse funds for each individual foundation. On January 15, 1999, counsel for plaintiff provided the IRS with additional information, commenting, in particular, on testimony that had been given by several individuals, including HenkeII, in the district court injunction proceeding. As noted, on January 20, 1999, the IRS issued a final adverse ruling denying NDF's application for tax-exempt status. This ruling succinctly concluded that - You have not shown that you are operated exclusively for one or more exempt purposes. You have not shown that you are not more than incidentally serving private rather than public interests. You have not shown that your earnings do not inure to private shareholders or individuals. It noted that NDF could contest the IRS' decision under the declaratory judgment provisions of section 7428 of the Code. D. The Proceedings to Date On April 5, 1999, plaintiff, indeed, filed a complaint in this court seeking a declaratory judgment under section 7428 that it is tax-exempt under section 501(a) of the Code by virtue of its compliance with section 501(c)(3) of the Code. On October 25, 2000, the court issued an order staying the case to allow for settlement discussions. For several years the parties urged the court to continue the stay. Ultimately, when a settlement did not materialize, the court restored the case to its active docket. Per order, defendant filed the administrative record in this case on May 17, 2004. Following a round of motions addressing plaintiffs objections to the inclusion of certain items in the record, revisions to the record were filed, with the last corrected volume filed on September 8, 2004. On August 12, 2004, plaintiff filed its motion for declaratory judgment. On January 10, 2005, defendant filed its cross-motion for judgment. On March 3, 2005, plaintiff filed its response brief, and on March 18, 2005, defendant filed its reply. Oral argument on the cross-motions occurred on June 6, 2005. Thereafter, the court received supplemental briefing on two key issues: (i) what standard of review is to be applied in determining whether a declaratory judgment is appropriate in an action filed pursuant to section 7428 of the Code, and (ii) whether the court, acting under section 7428, could issue a declaratory judgment that plaintiff was tax-exempt as of a specified initial qualification date other than the date of plaintiff's initial application for tax exemption. II. DISCUSSION ©2011 Wolters Kluwer. All rights reserved. 9419 7/28/2011 7:37 AM EFTA00598091  Plaintiff seeks a declaration that the IRS wrongly denied its initial application for exempt status, arguing that the facts do not support the refusal to grant it tax-exempt status. It asserts that defendant is carrying out a "vendetta" against Henkell. Defendant replies that the IRS' decision to refuse tax-exempt status to plaintiff was valid, both because plaintiff failed to meet the "operational" requirements of section 501(c)(3), and because plaintiff is "part of a larger abuse tax avoidance scheme" that has produced private inurements. A. Preliminaries Section 7428(a) of the Code provides that "10 a case of actual controversy involving" a determination by the Secretary "with respect to the initial qualification ... of an organization as an organization described in section 501(c)(3) which is exempt from tax under section 501(a) or as an organization described in section 170(c)(2)," this court may "make a declaration with respect to such initial qualification." 11 Notably, there is a difference of opinion as to the standard of review to be applied in such cases. The Circuit, as well as this court, have held that de novo review applies, 1I2 while the Fifth Circuit has employed something akin to arbitrary and capricious review. L The Tax Court, at various times, has appeared to weigh in on both sides of this debate. 14 Upon analysis, this court concludes that, at least in the case of an initial qualification, de novo is the correct standard - that is, it is for the court, ab inftio, to determine whether the organization in question is entitled to exemption. This view more closely tracks the statutory language, which does not require the court to review the Secretary's determination directly, but rather compels the court to make a declaration as to the qualification itself. Further evidence that the court is not reviewing the agency decision may be found in the legislative history of section 7428, which indicates that "[title court is to base its determination upon the reasons provided by the Internal Revenue Service in its notice to the party making the request for a determination, or based upon any new argument which the Service may wish to introduce at the time of the trial." S. Rep. No. 94-938(1), at 588 (1976) (emphasis added); see also H.R. Rep. No. 94-658, at 285 (1976). That defendant can raise new arguments before this court is itself indication that de novo review is required, as it can hardly be the case that a new theory in support of denial would be subject to arbitrary and capricious review. And defendant does not claim otherwise. Thus, both the statute and its legislative history indicate that the court is not to review the administrative decision made by the IRS and, concomitantly, suggest that de novo review is thus appropriate. As defendant notes, this view is cemented by contrasting the language of section 7428 with that of since-repealed section 7477 of the Code. The latter section provided for Tax Court review where the Commissioner had, inter a/ia, determined "that an exchange described in section 367(a)(1) is in pursuance of a" tax avoidance plan. See 26 U.S.C. 7477, enacted as §1042(d)(1) of the Tax Reform Act of 1976, Pub. L.