Univ. Hill Found. v. Comm'r of Internal Revenue , Docket Nos. 73993

• Decision Date: 08 January 1969
• Docket Number: 1482-66.,Docket Nos. 73993,5311-65
• Citation: 51 T.C. 548
• Parties: UNIVERSITY HILL FOUNDATION, FORMERLY LOYOLA UNIVERSITY FOUNDATION, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

51 T.C. 548

UNIVERSITY HILL FOUNDATION, FORMERLY LOYOLA UNIVERSITY FOUNDATION, PETITIONER

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket Nos. 73993

5311-65

1482-66.

Tax Court of the United States.

Filed January 8, 1969.

Austin H. Peck, Jr., Dana Latham, and Henry J. Steinman, Jr., for the petition.

Richard W. Janes and J. Earl Gardner, for the respondent.

Petitioner was organized in 1945 as a nonprofit corporation under the laws of the State of California to raise funds for Loyola University of Los Angeles, and has been operated for that purpose up to the present time. It was ruled exempt from Federal income tax until 1956, when the exemption was revoked. Over the 1947-54 period, petitioner purchased a number of going businesses and leased the assets to newly formed operating companies in which the former owners acquired minority interests. Held, petitioner was not a ‘feeder organization’ as defined in sec. 502, I.R.C. 1954. Held, further, that the rent which petitioner received from its lessees was not ‘unrelated business taxable income’ as defined in sec. 512 of the Code.

TANNENWALD, Judge:

These consolidated proceedings involve income and excess profits taxes for the fiscal years ended April 30, 1952, through April 30, 1965, in the aggregate amount of $10,070,677.25. The principal questions in issue are whether petitioner is exempt from Federal income tax under sections 501(c)(3) of the 1954 Code and 101(6) of the 1939 Code; whether petitioner is a ‘feeder organization’ within the meaning of sections 502 and 101 of the 1954 and 1939 Codes, respectively; and what part, if any, of petitioner's income is taxable as ‘unrelated business taxable income’ within the meaning of sections 511-513 of the 1954 Code and 421-422 of the 1939 Code.¹ If any of those questions are decided against petitioner, there are several remaining questions which will require consideration.

The trial of the case extended over a period of approximately 6 weeks. It was held before Tax Court Commissioner Marshall D. Davis, who prepared a lengthy report, approximately 70 pages, containing the essential details of the petitioner's purchase-and-lease transactions. The report was served on the parties and is of public record. The parties have filed certain objections to the commissioner's report, which have been given consideration in making the findings of fact herein.

FINDINGS OF FACT

Petitioner is a California corporation. Its principal office was located at 218 North Juanita Avenue, Los Angeles, at the time its petition herein was filed. Its returns were filed with the district director of internal revenue at Los Angeles.

Petitioner, hereinafter sometimes called the foundation, was organized April 26, 1945, under the General Non-Profit Corporation Law of the State of California for the sole purpose of raising funds for Loyola University of Los Angeles. Its founders were Lorenzo M. Malone, hereinafter called Father Malone, a Catholic priest of the Jesuit Order (Society of Jesus), and Daniel G. Marshall and J. P. Carroll, prominent Catholic laymen living in Los Angeles.

Under its articles of incorporation the foundation had broad powers to conduct various charitable and educational activities, to contribute funds to other tax-exempt organizations, to engage in various fund-raising business transactions such as acquiring, selling, or leasing real and personal property, and—

In general to do all things authorized to be done by the laws relating to non-profit corporations of the state of California, whether or not specifically set forth in these articles of incorporation, and to do all acts necessary or expedient for the administration of its affairs but the corporation shall not have the authority to do anything which would deprive it of exemption from federal income tax under Section 101(6) of the Internal Revenue Code.

Loyola University, hereinafter sometimes called the university, is an educational institution and at all times relevant herein has been exempt from Federal income tax under section 101(6) of the 1939 Code and section 501(c)(3) of the 1954 Code. It was organized by the Jesuit order and has always been under its management and control. It maintains a full time university for male students located at 7101 West 80th Street, Los Angeles, and a school of law in the downtown Los Angeles area.

The foundation's original bylaws provided for three directors, one of whom was to be nominated by the president of the university. All three of the directors were to be nominated or approved by the Jesuit Order. There has always been a close relationship and complete unanimity of interest between the foundation and the university. The university made the foundation an initial gift of $10,000 at the time of its organization.

Father Malone became associated with the university prior to 1935, after having taught for several years at St. Ignatius High School in San Francisco. His whole remaining life, until his death in 1956, was devoted principally to Loyola University and the education of young men. He was untiring in his efforts to raise funds for the financial needs and growth of the university. He served as its treasurer and director of development. He organized a number of university-supporting various fund-raising guilds and he was constantly soliciting and obtaining private donations for the university.

Father Malone had been a banker before he entered the Catholic priesthood. The financial survival of Loyola University and the success of the foundation in its fund-raising operation was due largely to his extraordinary business acumen and capacity for work and his personal charm and persuasiveness. In his later years, he came to be known as the symbol, or patron saint, of Loyola University. He never received any compensation for his services to Loyola University or to the foundation. As a Jesuit priest, he was subject to the vows common to Catholic orders, of chastity, poverty, and obedience.

About 1942 Father Malone, with the help of Mildred Spencer, prepared a mailing list of about 5,000 names of Southern California businessmen from whom they began soliciting donations to the university. Mildred was a recent Catholic convert whose husband had died in 1941. After becoming acquainted with Father Malone, she volunteered to help him with his work on behalf of the university and remained associated with him until his death. She was a woman of independent means and never received any compensation of her services from Father Malone, the university, or the foundation.

The idea of forming a nonprofit corporation to raise money for Loyola University was first suggested to Father Malone by Joseph W. Drown, a successful California businessman with whom Father Malone had become acquainted in 1942. Through Father Malone, Drown became interested in the university and made substantial contributions to it and to the foundation. He told Father Malone that he owned a valuable income-producing hotel property which he would be willing to sell to such a corporation under a plan which he thought would be helpful in raising money for the university.

After further conferences, in which Father Malone and Drown and others connected with or interested in Loyola University participated, the foundation was formed and soon thereafter purchased the hotel property.

The property was the U.S. Grant Hotel, located in downtown San Diego, Calif. It was then the largest hotel in San Diego. It was owned by H. C. Fryman Hotel Co., whose stock was all owned by Drown. The hotel was then in a prosperous condition with an annual net profit, before depreciation, of approximately $1 million. Essentially, the plan agreed upon, which will be discussed in more detail below, was for the foundation to purchase the H. C. Fryman Hotel Co. stock, dissolve the corporation, then lease the hotel properties back to the operators and pay the balance of the purchase price for the stock out of the rentals from the lessee. Under this plan it was contemplated that the tax-exempt foundation would incur no tax liability on the receipt of the rental payments, that the operating group would be able to deduct the rent as a business expense, and that the profit on the sale of the stock would be taxed to Drown at capital gains rates.

The acquisition of the U.S. Grant Hotel property was the first of a series of transactions of the same general character in which the foundation purchased the assets or the stock ownership of a going business and leased the assets back to the former operators, or others, without any disrupting change in the conduct of the business. One of the chief architects of the plan, as later developed, was Paul Cote. It came to be known as the Cote formula. Cote was a Los Angeles attorney and Catholic layman who had assisted in organizing the foundation. He had attended school with Father Malone and they had remained close friends and associates. He served as legal counsel for the foundation from its inception and as its president and a member of its board of directors from 1947 until his death in November 1956. The foundation's business affairs were conducted from his office. He received no compensation for his services to the foundation prior to 1953. From 1953 to 1956, he was paid $1,000 per month, and from July 1956 until his death, $1,500 per month, for his legal services to the foundation.

J. P. Carroll became president of the foundation in 1957 to succeed Paul Cote and has continued to serve in that capacity. He has also served as a director since the foundation's inception. Carroll is a successful businessman and is president and a majority stockholder of J. P. Carroll Co., a large paint-contracting firm located in Los Angeles. The foundation's business affairs are conducted from his offices. He has never received directly any compensation for his services to the foundation but since 1959 the foundation has paid the J. P. Carroll Co. from $15,000 to...