M E M O R A N D U M TO: FROM: Board of Directors of Ingrid Mittermaier DATE: RE: Nonprofit and Tax-Exempt Status of ( Foundation ) As the Foundation s nonprofit and tax-exempt organization counsel, you have asked us to clarify the Foundation s nonprofit status and the basis on which the Foundation is expected to qualify as a tax-exempt organization under Section 501(c)(3) of the Internal Revenue Code (the Code ). 1 Our analysis is based on a review of the facts as the Foundation has presented them to us in written documents, published sources and oral conversations. I. NONPROFIT STATUS AND TAX EXEMPTION APPLICATION A. The Foundation is a Nonprofit Nonstock Corporation. The Foundation is incorporated under the laws of Delaware as a nonprofit nonstock corporation. 2 The term nonprofit or not-for-profit generally refers to the type or form of entity of an organization, which is a separate issue from its tax status. As a nonprofit corporation, whether taxable or tax-exempt, the Foundation is legally structured so that it has no shareholders and cannot issue stock, no person owns the corporation, and no person is entitled to receive Foundation profits. In other words, the term nonprofit or not-for-profit is not a tax designation given by the IRS, but rather a corporate form in which entities may choose to incorporate. Thus, the Foundation has accurately described itself as a not-for-profit organization to the public. 1 Unless otherwise indicated, all Section references are to the Internal Revenue Code of 1986, as amended. 2 A copy of the Foundation s current Certificate of Incorporation is available on its Website, https://www.stellar.org/wp-content/uploads/2014/07/filed-stellar-development-foundation- 00594674.pdf.
Page 2 B. The Foundation s Tax Exemption Application. The Foundation has not yet filed its application for recognition of exemption from federal income taxes as a charity on Internal Revenue Service ( IRS ) Form 1023. As the Foundation s nonprofit and tax-exempt organization counsel, we have been actively working with the Foundation s officers to complete the application materials. The IRS allows an organization 27 months from the date of incorporation to file its tax exemption application and have the exemption, once granted, be effective retroactively to the date of incorporation. The Foundation is well within this IRS deadline. Further, it is not uncommon for an organization with varied, complex, and novel activities to take time to carefully prepare its application materials. The Foundation has informed us that once the application is submitted, it will make its application materials available on its website. 3 II. FOUNDATION OPERATIONS As an entity formed as a not-for-profit corporation and in the process of applying for tax-exempt status as a charity, the Foundation s operations must comply with rules enforced both by the IRS and Delaware charitable trust regulations. Among other things, you have asked us to review four Foundation activities to ensure they are operated in a manner consistent with those rules: a transaction with Stripe, incentive compensation, distribution of stellars in a direct access program, and a stellar grant program. 4 Each of these is addressed in turn below. A. Relationship with Stripe. As you know, Stripe, Inc., a for-profit company founded by one of the Foundation s directors, Patrick Collison, made a loan to the Foundation at a below-market interest rate in order to help the Foundation with its initial operating costs. In addition to being a director of the Foundation, Mr. Collison also owns a significant interest in Stripe. Accordingly, the Foundation took steps to ensure that the loan would not represent an excess benefit transaction with either Mr. Collison or Stripe under Section 4958 of the Code. Federal tax law addresses conflicts of interest in Section 4958, which prohibits excess benefit transactions between insiders in a charity (such as its directors and certain 3 The Foundation currently maintains a page with all its governance policies. https://www.stellar.org/about/governance/#employee_compensation. 4 In furtherance of its mission to increase worldwide financial access and financial literacy, the Foundation s operations include, among other things, creating and maintaining open source software ( OSS ). We recognize that the IRS has denied OSS entities Section 501(c)(3) exemption on the grounds that promoting OSS is not in and of itself a charitable purpose, and because the IRS has concluded that specific OSS organizations served private interests more than incidentally or were too commercial. We are working with the Foundation to address these concerns and to distinguish the Foundation and its activities from those OSS organizations.
Page 3 officers) and the charity. Conflicts of interest do not always, or even often, arise from improper motives. In some circumstances, a charity may be better off dealing with an insider than dealing with an outsider, even though there may be a potential conflict of interest for the insider. For this reason, federal tax law does not absolutely prohibit transactions with insiders (the prohibition is only on transactions that result in excess benefits to the insider), but prescribes procedures through which the directors with no financial interest in the transaction may review and approve a transaction with an insider if, upon inquiry, the transaction is in the charity s best interest. Although the Foundation has not yet been recognized by the IRS as tax-exempt, Section 4958 already applies to its operations, since the Foundation will seek tax exemption retroactive to its incorporation. Thus, the Foundation must conduct its operations in full compliance with federal tax law applicable to charities during this period. When a charity engages in a transaction with an insider, the charity may not provide an excess benefit to the insider. Under the Regulations to Section 4958, a transfer of property between a charity and an insider will be presumed to be at fair market value, and thus not provide an excess benefit to the insider, if the terms are approved in advance by the charity s governing body, the governing body obtained and relied upon appropriate data as to comparability before making its decision, and the governing body adequately documented the basis for its decision concurrently with making that decision. We advised the Foundation regarding the appropriate procedures for documenting and approving the loan with Stripe. Following that guidance, the Foundation took reasonable steps to avoid an excess benefit transaction between Stripe and the Foundation. In addition, the loan was approved in accordance with Delaware state corporate law governing conflicts of interests. Moreover, during the course of our dealings with the Foundation, we have not seen any evidence to suggest that the Foundation intends to use stellars or other Foundation resources to provide an impermissible benefit to Stripe or Mr. Collison, or leverage Stripe s or Mr. Collison s relationships with any traditional banking service. B. Stellars as Compensation for Officers and Employees. The Foundation is using stellars to provide incentive compensation to its employees and consultants. The Foundation has been forthcoming with the amount of stellars held by insiders and/or employees by making this information publicly available on its launch day, July 31, 2014. We understand that the Foundation has not provided stellars to insiders and/or employees outside of its incentive compensation plan. The Foundation has published the amount of stellars currently set aside for its employee compensation plan on its website, which
Page 4 states, [a]s of July 31, 2014, approximately 2.5% of the stellars have been granted to employees and consultants of the Foundation under a 4-year vesting schedule.... 5 It is well established that a charity is entitled to pay reasonable compensation for services without endangering its exemption. 6 It is also well established that a charity may, in appropriate circumstances, provide incentive-based compensation, 7 so long as the total compensation is reasonable in light of the services received by the charity in return, and is not measured as a share of the charity s net earnings. What is considered reasonable is based on what organizations in similar circumstances would provide to their staff as compensation, i.e., appropriate comparability data. We have advised the Foundation on the procedure for adopting compensation arrangements in accordance with the rules surrounding Section 4958 and excess benefit transactions, discussed above. In addition, we understand that the compensation plan was developed by the employment law group at Orrick, Herrington & Sutcliffe LLP, and that the compensation plan is structured consistent with industry standards. 8 It is also our understanding that the Foundation has implemented the incentive compensation plan using the procedures discussed above to meet the presumption of reasonableness under Section 4958 and its corresponding Regulations. C. Direct Access Program. 1. Charitable Purpose. As will be detailed more thoroughly in its exemption application, the Foundation plans to further its charitable and educational purposes within the meaning of Section 501(c)(3) by engaging in general financial literacy education, education about digital financial services, and in other ways facilitating financial services for the poor and/or unbanked. The Foundation maintains that a key goal is to allow individuals all over the world to be educated about and have access to the digital financial services, especially people living in poverty or who otherwise do not have access, and who desperately need such access to improve their lives. 9 In addition, 5 Published, July 31, 2014,, About, Governance, Employee Compensation, https://www.stellar.org/about/governance/#employee_compensation. 6 World Family Corp. v. Comm r, 81 T.C. 958, 968 (1983). See also, Saint Germain Found. v. Comm r, 26 T.C. 648, 658-659 (1956). 7 See I.R.S. Information Letter 2002-0021. 8 A copy of the Foundation s compensation policy is available on its website, https://www.stellar.org/wpcontent/uploads/2014/07/stellar-compensation-policy.pdf. 9 See, for example, a report by the World Bank which finds that financial inclusion is crucial for reducing poverty and boosting shared prosperity. http://econ.worldbank.org/wbsite/external/extdec/extglobalfinreport/0,,menupk:8816192~pag epk:64168176~pipk:64168140~thesitepk:8816097,00.html. See, also, a recent annual letter from the Bill and
Page 5 research reviewed by the Foundation has indicated that pairing financial access with financial education produces the greatest impact. 10 What has attracted some attention to the Foundation to date is one aspect of its activities, a direct access program. As part of its educational program, as we understand it, the Foundation is permitting any individual around the world to sign up and claim a small amount of stellars (up to approximately US $10 in value). It is anticipated that providing such broad access to a small amount of stellars will encourage individuals to become familiar and comfortable with interacting with digital financial services which for many individuals, particularly with little technological or financial literacy, is itself an educational process. The Foundation also plans to provide educational tools to those who are making the connection to the Foundation in this way. For example, individuals will be encouraged to complete a particular tutorial on learning to create an account, securing their account, and sending and receiving currency, and, once completed, qualify for small amounts of stellars, typically valued at about $0.10 for each new educational segment completed, up to a total limit of stellars worth approximately US $10 per person. The final educational program will require participants to complete many educational steps over a particular time frame to ensure maximum familiarity with concepts. It is important to understand that distributing stellars is not the end goal; the most important step is for individuals to learn about and become comfortable with the idea of digital financial services. The Foundation s platform is a technology gateway to give participants experience with technology they are otherwise unfamiliar with. The distribution of stellars is part of the gamification of the learning process, a common tool in educational programs to incentivize learning. 11 The Foundation is spearheading the creation of this infrastructure on an open source basis. The Foundation will not charge anything to participants of the educational program for its role in providing access to the platform. To the contrary, using stellars, the Foundation will actually pay people to learn. Also, the infrastructure can be used by others for a variety of different currencies, not just for stellars. Melinda Gates Foundation, discussing why the Gates Foundation believes that mobile banking will help the poor transform their lives. http://www.gatesnotes.com/2015-annualletter?wt.mc_id=01_21_2015_do_com_domain_0_00&page=0&lang=en. 10 See, for example, a report from Women s World Banking. http://www.fgda.org/dati/contentmanager/files/documenti_microfinanza/from-access-to-inclusion-educating- Clients.pdf. See, also, the Center for Financial Inclusion s Roadmap to Financial Inclusion. http://www.centerforfinancialinclusion.org/fi2020/roadmap-to-inclusion/financial-capability. 11 The use of games and gamification in learning tools is widely discussed in the education space, including this MIT research paper, Moving Learning Games Forward. http://education.mit.edu/papers/movinglearninggamesforward_edarcade.pdf.
Page 6 Plans are in the works for significant targeted outreach to the types of populations in greatest need of financial education and access to financial services. The Foundation intends to work with non-governmental organizations and other collaborators all around the world to find ways to identify and connect with populations that are currently excluded and provide them with financial inclusion. First steps are already being taken. In the end, the Foundation believes that providing the small private benefit that any individual receives, in the form of the small number of stellars valued at approximately $10 that he or she can claim, will further the Foundation s achievement of its charitable and educational goals for the direct access program, and is incidental to that end. 2. Method of Introducing Stellars to the Public. The Foundation determined that the most effective and efficient way to start the process of allowing global access and introduce the public to the Foundation was through the use of Facebook, a website with over one billion active users. We understand that four of Facebook s top five countries (by number of users) are countries representing huge populations of the unbanked (India, Brazil, Indonesia and Mexico). In addition, Facebook, in pursuit of its own business purposes, has a focused program, Internet.org, aimed at providing Internet access to billions more in the developing world. 12 Thus, Facebook is working to provide Internet access to the same underserved communities that the Foundation is targeting for its charitable reasons. The Foundation also plans to use forms of access other than Facebook geared towards reaching populations that are not on Facebook. 3. Registration Issues. We understand that there are reports of fake Facebook accounts used to claim stellars during the Foundation s initial launch. The Foundation has been forthcoming regarding its security issues. 13 The issues experienced by the Foundation with improper use of Facebook accounts to register with the Foundation and claim stellars do not detract from its charitable purposes. The mere fact that certain individuals are finding ways to register more than one account in the system does not undercut the Foundation s mission or its charitable purposes. The Foundation cannot control, and should not be held accountable for, the actions of individuals who try to subvert the Foundation s registration system. The Foundation is not supporting or taking part in any way in the creation of fraudulent accounts. Like many Internet-based services, and a number of high-profile security breaches come to mind, the Foundation experienced 12 https://fbcdn-dragon-a.akamaihd.net/hphotos-ak-ash3/851575_228794233937224_51579300_n.pdf. 13 The Foundation has blogged about its security issues and steps it has taken to mitigate security threats. See https://medium.com/a-stellar-journey/what-happens-when-you-try-to-sign-up-the-world-f2d15159a012.
Page 7 security threats and has taken steps to address and enhance its registration methods and overall security in an effort to maintain its commitment to open access to the world. D. Grants Program. As part of its charitable activities, the Foundation is developing a grants program. The goal of the program is to allow the Foundation to reach, indirectly, underserved populations that do not have access to the online or mobile channels required to access the Foundation s platform as part of the direct access program described above. Because the Foundation does not have the infrastructure or local knowledge to reach individuals in developing countries, the Foundation will rely on existing experienced charitable organizations that actively engage in activities in these regions to help build the infrastructure needed to reach these populations. Since July 31, 2014, the Foundation has publicly stated that it will require a grant application process for participation in the grant program. 14 It is typical for grantmaking charities, particularly for overseas grants, to require an application and a commitment from the grantee, in the form of a written grant agreement, to use the grant funds in furtherance of the charity s exempt purposes. In fact, these steps constitute best grantmaking practices in the nonprofit sector, and are required in some circumstances to protect and responsibly steward the Foundation s charitable assets. The Foundation is exercising typical practices and processes, consistent with Section 501(c)(3) status, by requiring organizations to apply for funding and enter into grant agreements. III. CONCLUSION The Foundation has accurately maintained that it is a nonprofit corporation and that it is currently in the process of preparing its application for tax exemption. The Foundation has not indicated to the public or potential funding sources that it is already exempt under Section 501(c)(3). The Foundation has properly documented its transactions with insiders and employees, and has taken steps to ensure that these transactions are fair and reasonable to the Foundation. Further, the Foundation has been forthcoming with its employee compensation plan and the terms of its relationship with Stripe. Although the Foundation experienced registration issues during its initial launch, the specific security breaches cannot be attributed to the Foundation and do not detract from the Foundation s charitable purposes. Based on what we know about the Foundation s activities discussed in this memorandum, we believe the Foundation s structure and these activities have been consistent with the Foundation s desire to qualify for exemption under Section 501(c)(3) of the Code. 14 https://www.stellar.org/about/mandate/#increased_access_program.