Church of Scientology of California v. C.I.R.

Decision Date28 July 1987
Docket NumberNo. 85-7324,85-7324
Citation823 F.2d 1310
Parties, 60 A.F.T.R.2d 87-5386, 87-2 USTC P 9446 CHURCH OF SCIENTOLOGY OF CALIFORNIA, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
CourtU.S. Court of Appeals — Ninth Circuit

Christopher Cobb, Pasadena, Cal., Richard Riley, Washington, D.C. and Eric Lieberman, New York City, for petitioner-appellant.

Steven Frahm, Washington, D.C., for respondent-appellee.

Lee Boothby, Berrien Springs, Mich. and Gerald McNally, Jr., Glendale, Cal., for amicus-curiae.

Appeal from a Decision of the Tax Court of the United States.

Before TANG and BRUNETTI, Circuit Judges, and JAMESON, * District Judge.

TANG, Circuit Judge:

The Church of Scientology (Church) appeals a judgment of the Tax Court which affirmed the Commissioner's assessment of tax deficiencies and late filing penalties against the Church for the years 1970, 1971 and 1972. At issue is whether the Commissioner properly revoked the Church's tax exempt status.


The Church was incorporated as a nonprofit corporation in the State of California in 1954. In 1957, the Commissioner recognized it as a tax exempt organization under Sec. 501(c)(3) of the Internal Revenue Code of 1954. 1 The Commissioner revoked the Church's tax exempt status in 1967. The letter of revocation stated that the Church was "engaged in a business for profit," and was "operated in a manner whereby a portion of [its] earnings inure[d] to the benefit of a private individual," and was "serving a private, rather than a public interest." The letter instructed the Church to file federal income tax returns. The IRS subsequently published a notice of revocation in the Internal Revenue Service bulletin, and removed the Church from the Service's official roster of organizations eligible to receive tax deductible charitable donations. The Church did not file income tax returns for the years 1970 through 1972, instead, it submitted Form 990, information returns. On December 28, 1977, after auditing the Church's records, the IRS sent a Notice of Deficiency for the years 1970, 1971, and 1972. The IRS calculated the deficiency to be $1,150,458.87 and imposed an additional $287,614.71 in late filing penalties. 2

On March 28, 1978, the Church filed suit in United States Tax Court challenging the Commissioner's determination of tax deficiency. In an extensive opinion, the Tax Court substantially upheld the determination of the Commissioner. 83 T.C. 381 (1984). It held that the Church did not qualify for exemption from taxation under Secs. 501(a) & 501(c)(3) because: (1) the Church was operated for a substantial commercial purpose; (2) its earnings inured to the benefit of L. Ron Hubbard, his family, and OTC, a private non-charitable corporation controlled by key Scientology officials; and (3) it violated well defined standards of public policy by conspiring to prevent the IRS from assessing and collecting taxes owed by the Church. The Court also upheld the validity of the Notice of Deficiency. 3 Finally, the Court upheld the penalties for failure to file tax returns.


During the years in question, the Church of Scientology of California was the "Mother Church" of the many Scientology churches around the country. The Church propagated the Scientology faith, a religion founded by L. Ron Hubbard, through such means as the indoctrination of laity, training and ordination of ministers, creation of congregations, and provision of support to affiliated organizations.

Scientology teaches that the individual is a spiritual being having a mind and body. Part of the mind, called the "reactive mind" is unconscious and filled with mental images that are frequently the source of irrational behavior. Through the administration of a process known as "auditing" a parishioner, called a "pre-clear," is helped to erase his or her reactive mind and gain spiritual awareness. Auditing is administered individually by a trained "auditor." The auditor poses questions to the pre-clear and measures the latter's response with an electronic device call an "E-Meter" that is attached to the skin. The E-Meter assists in the identification of spiritual difficulty. Scientology teaches that spiritual awareness is achieved in stages. A disciple achieves different levels of awareness through additional auditing. The religion also offers courses to train auditors.

Scientology teaches that people should pay for whatever of value they receive. This is called the "Doctrine of Exchange." Toward the realization of this doctrine, branch churches exacted a "fixed donation" for training and auditing. Fixed donations were not based on ability to pay and with few exceptions, services were not given for free.

Scientology is an international religion with numerous churches around the world. In the 1970's, these churches were organized along hierarchical lines according to the level of services they were authorized to provide. Churches that delivered services at the lowest levels were called "franchises" and later "missions." "Class IV orgs" delivered auditing through "grade IV" and training through "level IV." "St. Hill organizations" and "advanced organizations" offered intermediate and higher level services. The branch known as "Flag" offered the highest level of training and auditing.

The California Church consisted of several divisions. The San Francisco Organization and the Los Angeles Organization were both class IV organizations. The American St. Hill Organization was located in Los Angeles and offered intermediate auditing and training. The Advanced Organization of Los Angeles provided high levels of auditing and training to persons who had completed services at a class IV organization. The Flag Operations Liaison Office, located in Los Angeles, was an administrative unit of the California Church.

In addition to auditing and training, the Church provided assistance to prisoners, ex-offenders, the elderly, the mentally ill and drug addicts. On occasion the Church assisted the poor and the sick. The Church performed christenings, funerals and wedding ceremonies free of charge, and conducted regular Sunday services. The Church's chaplain provided marriage and family counseling free of charge. The Church also provided free, a specialized form of auditing geared to help people in crisis.

Flag was the highest division of the California Church. It provided spiritual leadership. It also acted as the Church's administrative center. The Flag division was headquartered aboard the ship Apollo which cruised the Mediterranean Sea and docked in various countries along its shores. L. Ron Hubbard, his wife, Mary Sue, and their family lived aboard the Apollo with other members of the ship's crew and staff. Besides performing the highest levels of auditing and training, Flag staff members performed a variety of management functions. The Church's other divisions and other Scientology churches sent reports on a regular basis to Flag. These reports supplied information, often in statistical form, about the organization's operations. Flag staff, on the basis of the review of these reports, issued policy letters, directives, and other kinds of administrative advice geared to improving local church operations. Flag personnel also researched and developed programs for improving the administration of local churches. Flag sent teams of specialists to help other units or churches experiencing management difficulties.

The Church derived income from four sources: (1) auditing and training; (2) sales of Scientology literature, recordings and E-meters; (3) franchise operations; and (4) management services. Franchise operators were required to remit ten percent of gross income to the Church. The Church offered its managerial services to branch organizations around the world for a fixed fee.

One of the policy directives of the Church was to "MAKE MONEY". The Church frequently engaged in aggressive promotion of its products and services. This promotion included market surveys and advertisements. In addition, the Church trained staff members in salesmanship techniques.

L. Ron Hubbard officially resigned his position as executive head of the California and other Scientology churches in 1966. Despite his official resignation, the Tax Court found that he continued to exert significant control over the Church by making policy statements, directives, and orders. In addition, his approval was required for all financial planning. He was the sole trustee of a major Scientology trust fund into which the Church made substantial payments. He or Mary Sue Hubbard were signatories on many Church bank accounts.

During the tax years at issue, L. Ron Hubbard and Mary Sue Hubbard received salaries from the California Church and its affiliate, the United Kingdom Church, in the following amounts:

                                        1970     1971      1972
                California Church
                L. Ron Hubbard         $ 4,932  $ 9,368  $ 35,000
                Mary Sue Hubbard       $ 3,017  $ 2,430  $ 25,000
                United Kingdom Church
                L. Ron & Mary Sue
                  Hubbard Combined     $12,300  $37,850  $ 55,680
                TOTAL                  $20,249  $49,648  $115,680

During these years, L. Ron Hubbard, Mary Sue Hubbard and their four children resided for the most part aboard the Apollo. While aboard ship, the Church provided the Hubbards with free lodging, food, laundry, medical services and vitamins.

The Church made royalty payments to L. Ron Hubbard for sales of his books, tapes and E-meters. The royalties amounted to ten percent of the retail price. The Church, for example, made $104,618.27 in royalty payments to Hubbard in 1972. Additionally, Church policy required that all work pertaining to Scientology and Dianetics be copyrighted to L. Ron Hubbard. As the result of this policy, a number of publications copyrighted by L. Ron Hubbard were actually written...

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