Cleveland Athletic Club, Inc. v. U.S.
| Decision Date | 23 December 1985 |
| Docket Number | No. 84-3782,84-3782 |
| Citation | 779 F.2d 1160 |
| Parties | -471, 86-1 USTC P 9116 The CLEVELAND ATHLETIC CLUB, INC., Plaintiff-Appellant, v. The UNITED STATES of America, Defendant-Appellee. |
| Court | U.S. Court of Appeals — Sixth Circuit |
Frank R. Osborne, argued, Roudebush, Brown & Ulrich Co., L.P.A., Cleveland, Ohio, for plaintiff-appellant.
John M. Siegel, Asst. U.S. Atty., Cleveland, Ohio, Jonathan B. Forman, Robert Pomerance (argued), Trial Atty.--Tax Div., U.S. Dept. of Justice, Washington, D.C., Glenn L. Archer, Jr., Lead Counsel, Michael L. Paup, Ann Belanger Durney, for defendant-appellee.
Leonard J. Henzke, Lehrfeld & Henzke, argued, Washington, D.C., for amicus curiae--Nat. Club Ass'n.
Before KENNEDY and MILBURN, Circuit Judges; and WEICK, Senior Circuit Judge.
Plaintiff-Appellant The Cleveland Athletic Club ("the Club") appeals from an Order of the District Court for the Northern District of Ohio, Eastern Division, Aldrich, J., granting the Defendant-Appellee's Cross Motion for Summary Judgment, denying the Plaintiff-Appellant's Cross Motion for Summary Judgment, and dismissing Plaintiff's Complaint in this civil tax refund action.
The relevant facts are as follows. The Club is a tax-exempt social club pursuant to sections 501(a) and 501(c)(7) 1 of the Internal Revenue Code of 1954 ("the Code"), 26 U.S.C. Secs. 501(a), 501(c)(7). Under sections 501(b) and 511(a) 2 the Club is subject to income tax on its "unrelated business taxable income." A general definition of "unrelated business taxable income" appears in section 512(a)(1) of the Code. It is as follows:
(1) GENERAL RULE.--Except as otherwise provided in this subsection, the term "unrelated business taxable income" means the gross income derived by any organization from any unrelated trade or business (as defined in section 513) regularly carried on by it, less the deductions allowed by this chapter which are directly connected with the carrying on of such trade or business, both computed with the modifications provided in subsection (b).
For taxable years beginning before January 1, 1970 social clubs were not subject to federal income tax on their unrelated business income. However, for taxable years beginning after December 31, 1969 social clubs became subject to tax on their unrelated business income under a portion of the Tax Reform Act of 1969, Pub.L. 91-172, 83 Stat. 487. That act added section 512(a)(3)(A) which provides a special definition of "unrelated business taxable income" applicable, inter alia, to section 501(c)(7) social clubs. That subsection provides:
(A) GENERAL RULE.--In the case of an organization described in section 501(c)(7) or (9), the term "unrelated business taxable income" means the gross income (excluding any exempt function income), less the deductions allowed by this chapter which are directly connected with the production of the gross income (excluding exempt function income), both computed with the modifications provided in paragraphs (6), (10), (11) and (12) of subsection (b) ...
The Club provides entertainment, amusement, and athletic recreation to its members. During the years in question (fiscal years ending June 20, 1975, 1976, 1977, and 1978) the Club derived unrelated business income from two sources--investments, and sales of food and beverages to non-members who would eat and drink and be served at the Club--in addition to tax-exempt income primarily from membership dues.
In connection with the non-member sales of food and beverages the Club incurred direct expenses such as cost of goods sold, salaries, and other directly related expenses, and indirect or overhead and fixed expenses. The indirect or overhead expenses consisted of items such as rent, insurance, and depreciation. The fixed expenses would have been incurred whether the Club served non-members or not. An allocation formula based on the ratio that non-member sales bore to total sales was used to compute the proper amount of fixed expenses deductible from unrelated business income. The government concedes that these indirect expenses were reasonably allocated. The allocation is not an issue.
During each year in question gross non-member sales receipts exceeded the direct expenses or cost of sales attributable thereto. However, each year when the indirect expenses were allocated a net sales to non-members loss resulted. Each year the Club subtracted this loss from its net investment income to arrive at unrelated business taxable income or loss.
For the fiscal year ending June 30, 1975 the Club reported an unrelated business loss of $9,970.00. For the fiscal year ending June 30, 1976 the Club reported unrelated business income in the amount of $4,585.00. (There is a $500 variance between this figure and the figure shown in the chart in footnote 3, however, the difference is of no consequence to the result reached in this case.) In 1976-77 the Club reported a loss in the amount of $15,036.00. Finally, for the year ending June 30, 1978 the Club reported unrelated business taxable income in the amount of $5,043.00. The 1977 loss was first carried back to 1976, and then forward to 1978, pursuant to section 512(b)(6), thereby eliminating the taxable income reported for those years. 3
In sum, for the years in question, the Club realized net investment income in the total amount of $149,508.00 and unrelated net losses on sales to non-members in the total amount of $164,886.00 resulting in no unrelated business taxable income for the period.
The Commissioner disallowed all the losses claimed on the theory that each unrelated business activity must be considered separately and not aggregated; that the Club did not have a profit motive with respect to its sales of food and beverages to non-members; and, that the deductions attributable to sales of food and beverages could only be allowed to the extent they did not exceed food and beverage sales gross income.
On August 31, 1981 the Internal Revenue Service issued a Notice of Deficiency in income taxes paid for the four years in question for the total amount of $31,357.00. The Club paid the deficiency, with interest, and filed a Claim for Refund, which claim was disallowed on May 13, 1982. The Club then commenced the present suit in the District Court for a refund of the amount paid, plus statutory interest.
Pursuant to Fed.R.Civ.P. 56(c) the parties filed Cross-Motions for Summary Judgment. The trial judge, upon consideration of the pleadings, affidavits, and exhibits, denied the Club's Motion, granted the government's Motion, and dismissed the Complaint, primarily on the ground that the Club's primary motive with respect to the food and beverage activity was not to earn a profit, but rather to lessen the financial burden on its members. 4
There are basically two issues on appeal.
1) Whether the Club may net the excess expenses attributable to sales of food and beverages to non-members against the income from investments and thereby reduce or eliminate unrelated business taxable income for the years in question.
2) Whether the District Court properly granted summary judgment for the government on the first issue on the ground that the claimed deductions failed to meet the requirements of section 162(a) of the Code.
The result we reach concerning the first issue makes it unnecessary for us to fully address the second issue.
The Club argues that Code Section 512(a)(3)(A) does not have a profit motive requirement. Section 512(a)(1) () provides that "unrelated business taxable income" includes only the gross income derived from "any unrelated trade or business" and expressly authorizes subtraction from gross income of "deductions allowed by this chapter which are directly connected with the carrying on of such trade or business." 26 U.S.C. Section 512(c)(1). On the other hand, Section 512(a)(3)(A), applicable to Section 501(c)(7) organizations such as the club, expressly eliminates the "trade or business" language and defines the term "unrelated business taxable income" as "gross income (excluding any exempt function income) less the deductions allowed by this chapter which are directly connected with the production of gross income." 26 U.S.C. Section 512(a)(3)(A).
The Club contends the IRS ignored the distinction in issuing Revenue Ruling 81-69 which is based on a case involving an organization governed by section 512(a)(1) and not 512(a)(3)(A).
The Club further contends the distinction is explained by Treasury's Tax Reform Studies and Proposals, (H. Ways and Means Comm. and Senate Finance Comm. Jt. Pub. Feb. 5, 1969), Pt. 3, at 324:
Thus, under the proposal, all income, other than that from members in exchange for exempt function facilities, would be included in gross income, whether or not the activities generating the income were sufficient to meet the requirements of a 'trade or business regularly carried on' generally applicable under the unrelated business income tax.
That publication continued:
However, consistent with the elimination of the 'trade or business regularly carried on' tests, deductions would be allowable if directly connected with an activity generating income subject to tax, rather than only if directly connected with an unrelated trade or business regularly carried on. (emphasis in original) Id., at 325.
The Club attacks the trial court's reliance on Adirondack League Club v. C.I.R., 55 T.C. 796 (1971), aff'd per curiam, 458 F.2d 506 (2nd Cir., 1972) which the Club points out involved the attempted deduction of member activity losses from non-member income. Adirondack League also involved tax years prior to the Tax Reform Act of 1969 and the enactment of section 512(a)(3) and an organization which had lost its exemption and was being taxed as a for-profit corporation.
The Club argues...
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