OpenAI’s Tax Exemption: It’s All Over But The Profiteering
It’s becoming increasingly clear that the joint venture involving OpenAI and Microsoft is doomed to fail. Not as a matter of profit making — there is plenty of that — but as a matter of tax exemption law. Elon Musk might have been right all along. Last week, he dismissed his suit alleging that Sam Altman and OpenAI breached a contract by morphing into a for-profit entity. Not because he was wrong about the profiteering going on. Its just that there never was a contract between those parties. OpenAI’s contract is with the rest of us. It promised to remain charitable. Instead, it’s looking like a company on the verge of an IPO. Maybe Musk thinks OpenAI is proving the allegations without the need for judicial intervention.
We have followed OpenAI since it first announced a “whole hospital joint venture” with Microsoft. A joint venture that explicitly allows an ROI for Microsoft and other private investors capped at 100 times capital investment. Given that it takes gazillions to pursue OpenAI’s scientific research, and that the market is valuing the JV at nearly $100 billion as of last week, the return to investors from the tax-exempt venture promises to be very handsome. The Wall Street Journal reports that Microsoft’s capital account is about $13 billion. That means Microsoft could walk away with as much as $1.3 trillion from its partnership with OpenAI. Seemingly too much to justify tax exemption though I have tried each time some new profit-making happens. In my pathetic defense, I started out saying it could never work.
The first sign of profiteering came when the JV granted stock options to many of its employees. That seemed a literal violation of the prohibition against private inurement, though the uncertainty regarding revenue sharing gives OpenAI the ability to justify the move. The employees aren’t necessarily insiders either. But even then, revenue sharing creates private benefit concerns.
Then the Board fired CEO Sam Altman because he was not adhering to the Board’s conception of charity. It seems he was too quick to monetize the very profitable technology. The joint venture follows the prescription in Revenue Ruling 98-15, but Microsoft nevertheless engineered a reverse coup that purged charitably minded board members and reinstalled Altman. Even the CIA must have envied Microsoft’s skill. Despite what the governing structure looked like on paper, it was beginning to seem like Microsoft was running the show. In hindsight, this thing has been for-profit as a practical matter for more than just a minute.
And then news broke early last week that OpenAI has entered into some sort of agreement, presumably on an exclusive basis, with Apple:
Apple is integrating ChatGPT into experiences within iOS, iPadOS, and macOS, allowing users to access ChatGPT’s capabilities—including image and document understanding—without needing to jump between tools. Siri can also tap into ChatGPT’s intelligence when helpful. Apple users are asked before any questions are sent to ChatGPT, along with any documents or photos, and Siri then presents the answer directly. Additionally, ChatGPT will be available in Apple’s systemwide Writing Tools, to help users generate content for anything they are writing about. Users can also tap into ChatGPT image tools to generate images in a wide variety of styles to complement what they are writing.
Look, I hate to be a scrooge about all this, but an exempt scientific research organization is not supposed to grant exclusive license to its work product unless that is the only “practicable” way to get the research into public use. Treas. Reg. 1.501(c)(3)-1(d)(5)(iv)(b). “Open” in OpenAI means open source not exclusive license to the highest bidder. OpenAI didn’t say a word about partnering with Samsung, by the way. The license gives Apple a competitive advantage, meaning private benefit. I swear these guys don’t know when to stop pushing envelopes.
And then late last Friday, The Information – an IT industry newspaper – reported overhearing Sam Altman talking about converting OpenAI to a B corporation. Apparently, OpenAI needs even greater access to capital and is fending off stiff competition from Anthropic and xAI, two B corporations. None of that sounds like justification for tax exemption anymore. Here are excerpts from one of the better subscription free reports:
OpenAI CEO Sam Altman has informed some shareholders that the company is evaluating a shift in its governance model, according to a report by The Information on Friday. Sam Altman says OpenAI could become a for-profit corporation to increase its financial flexibility. Altman mentioned that the nonprofit board may relinquish control to a for-profit business structure. One option under consideration is transitioning to a for-profit benefit corporation, similar to competitors Anthropic and xAI, as reported by an insider. This change is part of ongoing discussions, which are still in a fluid state. OpenAI’s leadership, including Altman, might eventually decide on a different path.
OpenAI’s potential shift from a nonprofit to a for-profit structure raises important questions about the balance between profit and purpose. On one hand, transitioning to a for-profit benefit corporation could provide greater access to capital, allowing OpenAI to scale its operations, invest in advanced research, and compete with other leading AI companies like Anthropic and xAI. This structure might also offer flexibility in attracting top talent through competitive salaries and stock options.
However, this move could spark concerns about the company’s commitment to its original mission of developing AI that benefits everyone. A for-profit model might prioritize shareholder returns, which could lead to decisions that compromise ethical considerations and societal impact. The core values that have guided OpenAI’s work might be challenged if financial pressures take precedence.
The important difference between a B corporation and a nonprofit/for-profit joint venture is that a B corporation may elevate charity to the same or higher level of importance as profit-making. A joint venture must elevate charity to a higher level than profit. It appears, then, that OpenAI is succumbing to inexorable market forces. The market doesn’t care about charity and OpenAI’s consideration of B corporation status might be its way of saying “uncle.” The joint venture is all but dead for tax exemption purposes.
A conversion won’t be cheap though. OpenAI’s know-how and other intellectual properties are owned by an exempt organization that can’t just give that stuff to a for-profit entity. OpenAI would have to sell the company for its fair market value and then utilize all that tax-exempt gain for charitable purposes. That’s not nickels and dimes; remember, the JV is worth nearly $100 billion, most of which is probably attributable to OpenAI’s contributions. Google, Microsoft, Apple or some other big tech money bags would have to be the purchaser. In hindsight, that might have been what was intended all along. The silver lining in this failing experiment is that OpenAI can endow an institute to study the ethical deployment and use of artificial intelligence. Maybe at a law school. Maybe at my law school. Maybe with me as the well-paid tax guy in residence.
darryll k. jones