Tuesday, October 25, 2005

Hacking the tax code.

Mitchell Baker posted a good article to her blog recently about the relationship between Mozilla Corporation (of which she is president) and the Mozilla Foundation (of which she is a board member). I want to write about that relationship here, because it's a great example of the old-school hacker ethic.

If you don't know the Mozilla Foundation, think Firefox and Thunderbird. These code lines are descendants of the Netscape browser released under an open source license in the late 1990s. The Firefox browser in particular is enormously popular -- Slashdot reports that more than 100 million copies have been downloaded. Firefox is an excellent web browser with plenty of great features and lots of useful plug-ins. It's very fast at rendering pages. If you're still seeing advertisements on the web pages you visit, well, all us Firefox users are over here laughing at you.

The Foundation is unabashedly about programming in the public interest. It exists to create, maintain and enhance Firefox and Thunderbird, because the world deserves a decent browser. Mozilla is the sort of open source project that gets economists scratching their heads: Talented engineers donate their time to do hard work for no money and build great software that you can have for free. Magic!

Mozilla Corporation was created by the Foundation on August 3rd of this year. The Corporation exists to productize and distribute the open source packages. So why bother having a Corporation, if it's just shipping what the Foundation builds?

Well, US tax law makes it hard for the Mozilla Foundation to be dynamic and agile. In technology, you often need to strike partnerships, build up funding, make investments, enter into business deals and pay for work from consultants and contributors. The Foundation is a not-for-profit organization established under section 501(c)(3) of the US tax code. The details of the code are complicated, but the effect is reasonably simple: The Foundation isn't allowed to earn a profit from its operation. In exchange, it never has to pay taxes.

Paying taxes in the US, especially for a corporation, is a lot of trouble. It's expensive to do -- you generally can't fill in the forms yourself, but need to hire a professional accountant to do it for you.

The Foundation, focused on building software, neither needs nor wants the hassle of quarterly tax filings. On the other hand, in order to make the Mozilla project really successful, the Foundation needs to be agile. It needs money. It needs the freedom to use that money in complicated and interesting ways, without worrying about whether it has transgressed some piece of the tax code limiting the activities of non-profits.

And that's where the interesting old-school hack comes in.

By hack, here, I mean a really clever and novel solution to a problem. The term has lost its meaning lately in the popular press -- what we used to call pirates and crackers and script kiddies are sometimes referred to as hackers, now. When I use the term, I mean the same thing that Steven Levy did. Self-modifying code on early generations of computing hardware? Sweet hack. Woz's floppy disk controller design for the Apple II? Unbelievably cool hack. Building a golf course in Scott McNealy's office on April Fool's Day? Hack!

What Baker and the other Foundation board members did by setting up the Corporation was a really neat hack. Corporations exist to create value for their shareholders. They work hard to make money and invest it in ways that maximize that value. The only shareholder in the Mozilla Corporation is the Mozilla Foundation. The Foundation's mission is to serve the public good by promoting the development and adoption of the Mozilla code base. There's just one way for the Corporation to create value for its sole shareholder: Invest to support the mission. Fund Mozilla's programming in the public interest!

The Corporation has much more freedom to earn and manage capital than the Foundation has. It can sell boxed sets of software. It can negotiate partnerships and development agreements with big platform vendors who want to distribute the Firefox browser on their computers. It can enter into service agreements. Granted, the Corporation has to pay taxes, but it presumably earns enough from its various activities to do that. The Foundation is insulated from the hassles of corporate tax law, and is free to focus on collaborative development of great software.

This adaptation of corporate behavior to serve the interests of a non-profit, by creating a combination that mixes them, but which allows each to behave exactly as it normally would, is really clever. Corporations sometimes create foundations in order to channel their charitable activities and shelter them from tax law. Foundations creating corporations -- well, that's much less common. It's a pretty good hack.


Blogger Mike Olson said...

An astute reader wrote to correct a couple of inaccuracies in my article. Any remaining errors are my responsibility, of course!

First, there are plenty of filing requirements for not-for-profit organizations, so the mechanics of filing taxes really aren't much additional burden. That's right; I used tax filings as a stand-in for the work required to manage a commercial organization, but it's not the reason that the Foundation needed the Corporation.

A not-for-profit is allowed to collect more than it distributes, and to lay money aside for leaner years. Nevertheless, the tax code does impose real restrictions on where that money comes from, and (in some cases) how it can be used. The Mozilla Corporation has more latitude than does the Foundation, on the basis of tax law, to generate and manage money in interesting ways.

I believe my big picture is correct: The combination of the Foundation and Corporation is good for both. I absolutely believe that this was a great and innovative way to solve an operational problem for the Foundation!

12:03 PM  

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