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Comment by rayiner | Hacker News Reader

Non-profit exemptions rest on the government's policy of forgoing tax revenues on specific favored activities. Non-profit entities have to take great care to avoid engaging in activities besides those favored ones. So the non-profit hospital likely couldn't fold the advertising activities into itself without jeopardizing their tax-exempt status.

The problem is not the acquisition of the for-profit entity by the non-profit entity. The problem is when those entities don't interact at arm's-length.

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I'm not sure if this is a valid comparison, but imagine that a group of doctors got together and founded a hospital, and decided that they would run the hospital as a co-op, where employees would buy into the co-op rather than receiving a normal salary. However, as they grow they realize that they actually need some corporate guidance, so they find a management company. The management company doesn't want an ownership stake in the co-op, and the co-op doesn't want to dilute it's members, so instead they mutually agree to pay the management company a fixed X million dollars for it's contracting services. In the meantime, the co-op grows 10-fold, but the contract with the management company doesn't change (somehow, let's just assume the co-op doesn't require active management, they just need guidance occasionally or something). Now, someone looks at this and says, hey, if you had the normal management structure you'd be paying 10 times what you pay for your current management since they would take home y% of the profit and that would be taxed, but instead your co-op gets better tax treatment.

This would clearly be absurd, the management company is happy with their fee, and the co-op members are happy. The fact that "normal" corporate structure would pay more in tax shouldn't really factor into the decision since the question should be, given your corporate structure, are you paying taxes.

Your analogy hits a snag here:

> In the meantime, the co-op grows 10-fold, but the contract with the management company doesn't change (somehow, let's just assume the co-op doesn't require active management, they just need guidance occasionally or something)

The question isn't what a "normal management structure" would cost. It's what the affiliated entity would normally charge in the market for the same service. Vanguard's sells its investment management services to the mutual fund at cost because it's owned by the mutual fund. It wouldn't do that otherwise.

So to make your example comparable, the co-op buys the management company, and makes it operate at zero profit. So the question is: would the management company be happy making zero profit if it weren't owned by the co-op? The answer is: probably not.

So, I'll admit that I don't understand the details of how vanguard is paying employees or the external people that actually manage the money, but presumably, they pay a fixed fee to someone to manage the money, and that fee is significant (but not a significant fraction of the money under investment). The fact that "normal" in investment funds is percentage of money under investment plus percentage of the profit shouldn't matter since they've found a way to run a company that doesn't need to pay those fees to get the money invested.

edit: I should add, that I'm fairly certain that the employees at vanguard are in fact getting paid.

edit2: So the question is should we look at whether the employees/contractors at vanguard are getting paid market rate, or whether vanguard as a whole is charging market rate to the investors. My comparison to the hospital co-op was that it's unfair to compare apples-to-orangutans.

But isn't one of the points of Vanguard that their investment management is cheaper by its very nature? Namely: passive, index-tracking funds are simpler and cheaper to manage than active ones?

I can see that they could have run afoul of some tax rules due to their structure, but it seems disingenuous to argue that they should charge management fees just as high as their active management competitors. (But sure, maybe they should charge more than they do now.)

Then again, as an owner of Vanguard index funds, maybe it's hard for me to be rational in this case. >:D

I feel like I'm missing something here... Is it not legal to run an investment management company as a non-profit? Likewise, is it not legal for the non-profit arm of Vanguard to mange its own investment as an integrated part of its organization?

At what point do these legal distinctions begin to take effect? If a friend and I pool resources and purchase some stock, then later sell it at a profit and split the trading fees, did we somehow owe unpaid tax?

It seems like this is a tax against vertical integration in financial services, which I'm not sure I understand the need for...

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