Founding Church of Scientology v. United States

• Decision Date: 16 July 1969
• Docket Number: No. 226-61.,226-61.
• Citation: 412 F.2d 1197
• Parties: The FOUNDING CHURCH OF SCIENTOLOGY v. The UNITED STATES.
• Court: U.S. Claims Court

412 F.2d 1197 (1969)

The FOUNDING CHURCH OF SCIENTOLOGY v. The UNITED STATES.

No. 226-61.

United States Court of Claims.

July 16, 1969.

Ronald Dreier, New York City, for plaintiff, Bella L. Linden, New York City, attorney of record. David Blasband, Peter C. Clapman, and Linden & Deutsch, New York City, of counsel.

Michael I. Sanders, Washington, D. C., with whom was Asst. Atty. Gen., Johnnie M. Walters, for defendant. Philip R. Miller and Norman J. Hoffman, Jr., Washington, D. C., of counsel.

Before COWEN, Chief Judge, and LARAMORE, DURFEE, DAVIS, COLLINS, SKELTON, and NICHOLS, Judges.

OPINION^*

COLLINS, Judge.

This is a suit to recover Federal income taxes and assessed interest paid by plaintiff to defendant for the fiscal year ended June 30, 1956. Defendant has counterclaimed for taxes assessed but unpaid for the fiscal years ended June 30, 1956, June 30, 1958, and June 30, 1959. The central issue presented is whether plaintiff is entitled to an exemption from Federal income taxation. The pertinent statute is section 501(c) (3) of the Internal Revenue Code of 1954, which includes among those organizations exempt from taxation a corporation "organized and operated exclusively for religious * * * or educational purposes, * * * no part of the net earnings of which inures to the benefit of any private shareholder or individual * * *."

The facts set forth in detail in the findings can be briefly summarized to the extent pertinent here:

Plaintiff is a District of Columbia corporation organized in 1955 with its purpose, as stated in the Certificate of Incorporation, "to act as a parent church for the propagation of the religious faith known as `Scientology,' and to act as a Church for the religious worship of that Faith." The beliefs of Scientology center around the spirit or "thetan," which is said to reside within the physical body of every human being. Scientologists believe that the spirit is immortal and that it receives a new body upon the death of the body in which it then resides. They also believe that in the course of its various lives the spirit is inhibited by "detrimental aberrations," or "engrams," which result from misdeeds or unpleasant experiences. The objective of Scientology is to counteract this burden through "processing," also called "auditing." This objective which is the principal practice of Scientology, attempts to make the person being audited, called a "preclear," aware of these aberrations and engrams and thus reduce the burdens and inhibitions affecting his spirit. Processing is performed by ministers of the plaintiff, or persons studying to become ministers, and is done in individual sessions with an auditor processing a single preclear through the use of a Hubbard Electro-Meter or "E-Meter." The E-Meter is an instrument which indicates changes in electrical resistance in the preclear's body, and changes in such resistance are viewed as an index of the activity of the spirit. (See finding 10, infra.)

Scientology is derived from the thoughts and writings of one L. Ron Hubbard. Its origin was an article written by Hubbard in the May 1950 issue of ASTOUNDING SCIENCE FICTION magazine, describing a new "science" called Dianetics. Dianetics, the creation of Hubbard, was offered primarily as a psychotherapeutic technique and was not presented as a religious discipline. Like its successor, Scientology, Dianetics employed a Hubbard E-Meter in its practice. In 1952 Hubbard began to focus his attention and his energies upon Scientology. He founded the plaintiff organization and completely dominated every aspect of its affairs during the relevant period. At the same time he continued to direct the growth and affairs of Scientology organizations throughout the world.

Persons coming to plaintiff for processing were usually required to sign a contract for a stated amount of auditing. The normal contract covered 25 hours of processing at a rate of $20 per hour. Other blocks of processing were available, and the per-hour fee was slightly lower for larger amounts. In addition to processing, another department of plaintiff offered various courses or training programs, and such instruction was also performed under contract for comparable fees. Most students enrolled in these courses were studying to become auditors and/or ministers of Scientology. Applicants were often required to contract for processing at the standard fee before being allowed to enroll as students.

During the period in issue, more than 90 percent of plaintiff's income was received from the sales of processing and training services, including sales of E-Meters. Additional income was realized from the sales of examinations and tests, tapes, and books, from minimal donations, and from various other sources. Plaintiff's gross receipts were $102,604 for the fiscal year ending June 30, 1956; $179,491 for the fiscal year ending June 30, 1958; and $247,674 for the fiscal year ending June 30, 1959.

For his services to plaintiff, Hubbard was paid a salary of $125 per week from plaintiff's inception through March 29, 1957; during the period October 26, 1956, through March 29, 1957, he also received an additional $125 per week which was designated as a "fee." On March 29, 1957, plaintiff adopted a compensation scheme (known as the "proportional pay plan") whereby Hubbard was paid, in lieu of salary, 10 percent of the gross income of plaintiff. Other Scientology congregations, franchises, and organizations also paid Hubbard a portion of their gross income, usually 10 percent. In addition, Hubbard received royalties on his numerous Scientology books, as well as lecture fees and other incidental income.

During the taxable years in issue, Mary Sue Hubbard and L. Ron Hubbard, Jr., the wife and son of plaintiff's founder, were compensated employees of the corporation. Also, from June 1957 through February 1959, plaintiff issued weekly checks to Kay Hubbard, the daughter of L. Ron Hubbard.

Defendant's position, briefly stated, is that plaintiff fails to qualify for the statutory exemption because (1) its sales of processing and training services constituted a substantial commercial (and hence nonexempt) purpose, and (2) a portion of its net earnings inured to the benefit of private individuals. Plaintiff denies both contentions.

It is our opinion that plaintiff has failed to prove that no part of the corporation's net earnings inured to the benefit of private individuals, and plaintiff is not entitled to recover. The court finds it unnecessary to decide whether plaintiff is a religious or educational organization as alleged, since, regardless of its character, plaintiff has not met the statutory conditions for exemption from income taxation. In any event, the Government has not raised this issue. Because of the manner in which the second question framed by the parties is resolved, we need not and do not determine whether plaintiff's operations were exclusively for religious or educational purposes.

Implicit in section 501 is the recognition that certain institutions and organizations exist and function for purposes which Congress deems beneficial to society as a whole. In order to foster these aims, funds which would otherwise be acquired and expended for the public good by the Government are left by Congress in the hands of these organizations to be used in furtherance of their beneficial ends. See Duffy v. Birmingham, 190 F.2d 738, 740 (8th Cir. 1951). For that reason, it has been held that the exemption provisions should be liberally construed. E.g., American Institute for Economic Research v. United States, 302 F.2d 934, 157 Ct.Cl. 548 (1962), cert. denied, 372 U.S. 976, 83 S.Ct. 1109, 10 L.Ed.2d 141, rehearing denied, 373 U.S. 954, 83 S.Ct. 1677, 10 L.Ed.2d 708 (1963).

The statutory language also makes it eminently clear, however, that Congress intended to extend the exemption only when the sole beneficiary of the institutional operations was the public at large. The substantial import of this express limitation cannot be ignored. See Better Business Bureau of Washington, D. C., Inc. v. United States, 326 U.S. 279, 283, 66 S.Ct. 112, 90 L.Ed. 67 (1945). The congressional intent behind the conditional language of section 501 (c) (3), coupled with the burden of proof placed upon the taxpayer in these circumstances (see, e.g., Kenner v. Commissioner of Internal Revenue, 318 F.2d 632 (7th Cir. 1963); Cleveland Chiropractic College v. Commissioner of Internal Revenue, 312 F.2d 203, 206 (8th Cir. 1963)), requires plaintiff to clearly demonstrate its right to exemption. See New Jersey Auto. Club v. United States, 181 F.Supp. 259, 149 Ct.Cl. 344 (1960), cert. denied, 366 U.S. 964, 81 S.Ct. 1913, 6 L.Ed.2d 1255 (1961).

The term "net earnings" in the inurement-of-benefit clause, as stated in section 501 and its predecessor, section 101 of the Internal Revenue Code of 1939, has been construed to permit an organization to incur ordinary and necessary expenditures in the course of its operations without losing its tax-exempt status. Birmingham Business College, Inc. v. Commissioner of Internal Revenue, 276 F.2d 476 (5th Cir. 1960); Enterprise Ry. Equip. Co. v. United States, 161 F. Supp. 590, 142 Ct.Cl. 192 (1958); Mabee Petroleum Corp. v. United States, 203 F. 2d 872 (5th Cir. 1953); Broadway Theatre League of Lynchburg, Va., Inc. v. United States, 293 F.Supp. 346, 355 (W.D.Va.1968).

By analogy to the recurrent tax question in the business sphere, whether corporate officers' salaries are reasonable and deductible, or are excessive and disguise the distribution of dividends (see, e. g., Jones Bros. Bakery, Inc. v. United States, 188 Ct.Cl. ___, 411 F.2d 1282 (June 1969)), several decisions indicate that the payment of reasonable salaries by an allegedly tax-exempt organization does not result in the inurement of net earnings to the benefit of private individuals. Birmingham Business College, Inc. v. Commissioner of Internal Revenue, supr...