Tax Exemption On Blood Business Challenged

Posted: September 27, 1989

As owner of Chapin Medical Co. in Anaheim, Calif., Mark Johnson does considerable business with the American Red Cross.

For one thing, his company serves as a national distributor of Red Cross plasma medicines, delivering them to hospitals wherever the Red Cross has contracts. Chapin Medical and a number of other national distributors are paid a fee for these services.

But Johnson also buys plasma medicines from the Red Cross outright, marks them up and sells them to hospitals on his own.

"If I call up a hospital that has no relationship with Red Cross, then I'll sell at any price I can get," Johnson said. "It's a substantial business to us."

In other words, the Red Cross, a nonprofit organization that gets its blood free from donors, sells some of the medicines it makes to Johnson's for-profit company for resale.

That is one example of the Red Cross' involvement in the commercial plasma business, in which it earned an estimated $75 million last year. The Red Cross has about a 15 percent share of the plasma market.

In this market, the Red Cross competes head-to-head with for-profit companies - but pays no state or federal taxes on this business.

Competitors argue it should.

Commercial plasma companies say that the Red Cross has an unfair business advantage - that its blood operations have become so extensive that those

revenues are no longer substantially related to the charitable mission for which the tax exemption was originally granted.

"I'm all for competition, but it has to be on a level playing field. To the extent that Red Cross has this incredible advantage of not paying taxes, it is unfair," said Jack J. Luchese, former vice president of Armour Pharmaceutical Co. in Blue Bell, Pa., one of the largest makers of plasma medicines in the United States.

Red Cross officials defend their tax-exempt status by citing the charitable nature of their work and the fact that profits remain within the organization and are not distributed to shareholders.

As for the Red Cross' aggressive entry into the plasma business, officials assert that they are acting as a "steward" of the plasma that is part of the blood collected by the Red Cross from unpaid donors.

Dr. Lewellys F. Barker, Red Cross senior vice president for blood services, acknowledged in testimony before a U. S. House subcommittee in 1987 that the lines between the Red Cross and for-profit companies have blurred. But he rejected the idea that the Red Cross should pay taxes.

"A great strength of the American system is that it has room for private enterprise and for the nonprofit provision of human services," he said. ''Sometimes, the lines between these functions become blurred. This, however, seems a small price to pay for the opportunity for private citizens to organize to help their neighbors without constant recourse to government."

H. Edward Matveld, vice president of Alpha Therapeutic Corp., a commercial manufacturer of plasma products based in Los Angeles, offered a different view during the 1987 hearings, which looked into the question of whether charitable organizations should be taxed on certain of their operations.

Matveld estimated that the Red Cross earned $51 in net profit on every liter of plasma it processed into medicines - compared with $11 a liter earned by for-profit companies.

"The results, therefore, allow (the Red Cross) to substantially influence the market price," Matveld said.

The oversight subcommittee of the House Ways and Means Committee is still looking into the activities of nonprofit organizations.

In 1978, the Internal Revenue Service was asked for an advisory opinion on whether the income from the sale of plasma by a tax-exempt blood bank to a commercial firm was taxable. Such IRS opinions are called revenue rulings.

The IRS said the issue turned on whether the trade or business was ''substantially related" to the exempt purposes of the organization. When tax-exempt blood banks sell plasma that is the byproduct of their routine blood collections (plasma separated from whole blood they have collected), the revenue should be considered exempt from taxation - since blood collection is an exempt purpose, the IRS said.

However, when blood banks purchase plasma from other blood centers to resell, or begin to collect plasma by a separate procedure known as plasmapheresis (in which a donor gives blood, the plasma is separated out from the whole blood and the red cells are recycled back into the donor), then they are involved in "unrelated trade" and the income from those sales is taxable, the IRS ruled.

The IRS has not been asked to rule on whether nonprofit blood banks retain their tax-exempt status when they sell plasma medicines to for-profit companies, as in the case of Chapin Medical.

"We pay (taxes) where we have been asked (by the IRS)," Barker said. ''But I don't believe this is an area. . . . There are few areas where we do."

Barker could think of only two businesses on which the Red Cross reports taxable income: revenue from parking lots it operates and income from office space it leases.

A Red Cross spokesperson, Pat Davis, said: "We have a very limited amount of unrelated income. It is mostly property and rental income. However, after applying the allowable deductions against the income, there is no tax liability."

At least three other large nonprofit blood organizations have started paying taxes on their plasma businesses in recent years. In each instance, the organization formed a separate for-profit corporation, which it uses to buy and sell plasma.

The three are Blood Systems Inc. of Scottsdale, Ariz.; Gulf Coast Regional Blood Center of Houston, and Blood Centers of America Inc., a corporation based in Providence, R. I., that was created by eight nonprofit blood centers.

"What we want to avoid is someone saying: 'You guys have an unfair competitive advantage because you don't pay taxes,' " said Bill T. Teague, president and chief executive officer of Gulf Coast.

"We want to keep things clear so there is absolutely no problem with the IRS," Teague said. He has good reason to be concerned: "The IRS has audited us on an average every three years," he said.

Barker said most of the Red Cross' plasma business involved the distribution of medicines to hospitals. In some cases, these products are sold directly to the hospitals by the Red Cross' 56 blood centers. In other cases, they are distributed by companies such as Chapin Medical.

In addition, distributors such as Chapin buy medicines directly from the Red Cross. Barker said he could not say how much blood the Red Cross sells to for-profit firms but said the amount was small.

Is selling plasma medicines to commercial companies in keeping with the Red Cross' nonprofit mission?

"Well, we do have a board of governors' policy for disposition of excess materials," Barker said. "That is to say, we really have two choices in some situations. One is to destroy them and the other is to turn them over to an entity that has a need for them and try to get compensated."

Johnson, however, said the medicines he buys from the Red Cross are no different from the medicines the Red Cross sells to hospitals.

"It's all the same," he said. "Look, there's a minimum of three to five years' (effectiveness) and it's always sold within three to five years."

Johnson would not say how much he buys from the Red Cross, only that it was a "substantial" part of his $25 million business. He said he buys both from national headquarters and regional blood centers.

The bulk of the Red Cross' plasma is manufactured under contract by the Hyland Division of Baxter Healthcare Inc., a $6 billion diversified corporation. Hyland, in Glendale, Calif., processes about 900,000 of the 1.1 million liters of plasma collected by the Red Cross each year, according to documents and interviews.

Hyland is paid a fixed fee for each processed liter, based on the number and mix of plasma medicines, estimated at $25 a liter, or about $22.5 million annually.

In 1986, the Red Cross-Baxter relationship was expanded when they signed a contract under which the Red Cross agreed to purchase all the plastic blood- collection bags it uses from Fenwal Labs Inc., another subsidiary of Baxter Healthcare. According to the Red Cross' 1987 tax return, it also paid Fenwal $2.3 million for "consulting/research & development."

A company that suffered as a result of the agreement was Cutter Biologicals Inc., one of the largest manufacturers of plasma derivatives and maker of one brand of the plastic bags used to collect blood.

"As a result of that (agreement) . . . the Red Cross use of blood bags became closed to us in one fell swoop," said Cutter attorney and spokesman R. J. Modersbach.

Modersbach said the Red Cross accounts for half of the estimated $80 million U. S. market for blood bags.

The Los Angeles Red Cross center was one of those that had to switch.

"We didn't like it," said administrator Norman R. Kear. "We already had a good supplier - Cutter."

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