University Hill Foundation v. CIR

• Decision Date: 20 September 1971
• Docket Number: No. 24929.,24929.
• Citation: 446 F.2d 701
• Parties: UNIVERSITY HILL FOUNDATION, etc., Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.
• Court: U.S. Court of Appeals — Ninth Circuit

446 F.2d 701 (1971)

UNIVERSITY HILL FOUNDATION, etc., Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.

No. 24929.

United States Court of Appeals, Ninth Circuit.

May 17, 1971.

Rehearing Denied September 20, 1971.

Gilbert E. Andrews (argued), Atty. Tax Div., Johnnie M. Walter, Asst. Atty. Gen., Washington, D. C., for respondent-appellant.

Austin Peck (argued), Dana Latham, Henry Steinman, and John Hall, Los Angeles, Cal., for petitioner-appellee.

Before BARNES and DUNIWAY, Circuit Judges, and SCHNACKE, District Judge.^*

DUNIWAY, Circuit Judge:

This case involves disputed income and excess-profits taxes in the aggregate amount of $10,070,677.25, for the period beginning with the fiscal year ended April 30, 1952, and ending with fiscal year ended April 30, 1965. The Commissioner of Internal Revenue appeals from a decision of the Tax Court finding the University Hill Foundation free from liability for the disputed taxes. We reverse.

The Tax Court's opinion contains comprehensive findings of fact, University Hill Foundation, 1969, 51 T.C. 548, 549-559, and we do not restate them here. There is no dispute as to the facts, and this opinion will assume familiarity with the findings and opinion of the Tax Court, to which reference will be made from time to time.

The Commissioner, on June 15, 1945, ruled on a temporary basis that the Foundation was tax exempt under Section 101(6) of the Internal Revenue Code of 1939. That subsection exempted from taxation

"(6) Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, and no substantial part of the activities of which is carrying on propaganda or otherwise attempting, to influence legislation."

The ruling was made final on November 19, 1946.

The Revenue Act of 1950 amended Section 101:

"(b) Feeder organizations. — Section 101 is hereby amended by adding at the end thereof the following paragraph:

`An organization operated for the primary purpose of carrying on a trade or business for profit shall not be exempt under any paragraph of this section on the ground that all of its profits are payable to one or more organizations exempt under this section from taxation. For the purposes of this paragraph the term "trade or business" shall not include the rental by an organization of its real property (including personal property leased with the real property).\'" (Revenue Act of 1950, Title III, § 301(b), 64 Stat. 906, 953.)

We refer to this amendment as the feeder organization amendment. Under Section 303 of the Revenue Act of 1950, the amendment applies only to fiscal years beginning after December 31, 1950.

When the Internal Revenue Code of 1954 was adopted, Section 101(6) became section 501(c) (3), and the feeder organization amendment became section 502, but without material change in either provision.

On April 4, 1956, the Commissioner revoked the exemption ruling. The only ground for the revocation now pertinent is that the Foundation was not "organized and operated exclusively for" exempt purposes under section 101(6) or 501(c) (3). The revocation ruling was made effective beginning with the fiscal year ended April 30, 1952, i. e., the first fiscal year beginning after December 31, 1950. The question is whether this ruling is correct. We hold that it is.

1. The charitable exemption.

Sections 101(6) (1939) and 501(c) (3) (1954) require that, to qualify for the exemption, an organization such as the Foundation must be both organized exclusively for and operated exclusively for religious, charitable, or educational purposes. Commissioner of Internal Revenue v. John Danz Charitable Trust, 9 Cir., 1960, 284 F.2d 726, 730, citing Universal Oil Products Co. v. Campbell, 7 Cir., 1950, 181 F.2d 451, cert. den. 1950, 340 U.S. 850, 71 S.Ct. 78, 95 L.Ed. 623. The Tax Court properly determined that the organization requirement was satisfied in this case. 51 T.C. at 566. The only question under sections 101(6) and 501(c) (3), therefore, is whether the Foundation was operated exclusively for exempt purposes.

Organizations directly engaged in concededly religious, charitable, or educational activities are of course tax exempt; thus, in this case Loyola University, the beneficiary of the Foundation's activities, is tax exempt. The Foundation, however, is directly engaged not in educational activities, but rather in commercial ventures, the profits from which are paid over to Loyola University. The immediate question is whether that activity allows us to characterize the Foundation as operated exclusively for exempt purposes. The question is one of first impression in this court.¹

a. Section 101(6) before 1951.

Before 1951, when the Revenue Act of 1950 took effect, the courts took two approaches in determining whether organizations such as the Foundation were tax exempt under section 101(6). The first approach applied the so-called "destination of income" test, according to which an organization was exempt under the section if all of its income was distributed exclusively for charitable purposes, even though the organization's primary or sole activity consisted of carrying on active business operations. Roche's Beach, Inc. v. Commissioner of Internal Revenue, 2 Cir., 1938, 96 F.2d 776; C. F. Mueller Co. v. Commissioner of Internal Revenue, 3 Cir., 1951, 190 F.2d 120; Willingham v. Home Oil Mill, 5 Cir., 1950, 181 F.2d 9, 10; Lichter Foundation v. Welch, 6 Cir., 1957, 247 F.2d 431, 436; Boman v. Commissioner of Internal Revenue, 8 Cir., 1957, 240 F.2d 767, 770-771; Sico Co. v. United States, 1952, 121 Ct.Cl. 373, 102 F.Supp. 197.² The rationale underlying this test is that "the benefit from revenue is outweighed by the benefit to the general public welfare gained through the encouragement of charity." C. F. Mueller Co. v. Commissioner of Internal Revenue, supra, 190 F.2d at 122. The Tax Court applied the destination-of-income test in the instant case, concluding that under pre-1951 law the Foundation would be entitled to a section 101(6) exemption. 51 T.C. at 562, 567.

The second pre-1951 approach to section 101(6) focussed on the nature of the organization's activities and the source of the income, and expressly rejected the destination-of-income test as applied to organizations (like the Foundation) not directly engaged in exempt activity. This court has consistently adhered to this second, source-of-income approach. Ralph H. Eaton Foundation v. Commissioner of Internal Revenue, 9 Cir., 1955, 219 F.2d 527; John Danz Charitable Trust v. Commissioner of Internal Revenue, 9 Cir., 1955, 231 F.2d 673, 675-676; Riker v. Commissioner of Internal Revenue, 9 Cir., 1957, 244 F.2d 220, 230-235; Randall Foundation v. Riddell, 9 Cir., 1957, 244 F.2d 803, 806-808; cf. Commissioner of Internal Revenue v. John Danz Charitable Trust, 9 Cir., 1960, 284 F.2d 726, 732-733. The Fourth and Seventh Circuits have also taken this approach. United States v. Community Services, Inc., 4 Cir., 1951, 189 F.2d 421, 424-425; Universal Oil Products Co. v. Campbell, 7 Cir., 1950, 181 F.2d 451, 461. Underlying this approach is the judgment that section 101(6) was intended by Congress "to tax all business income, however destined, unless the company was really not in business at all." Roche's Beach, Inc. v. Commissioner of Internal Revenue, supra, 96 F.2d at 779 (L. Hand, dissenting). We illustrated the approach most clearly in Ralph H. Eaton Foundation, supra. The question in that case was whether a nonprofit corporation was entitled to exemption under section 101(6), where "the corporation itself was not intended to operate and did not operate as a religious, educational, or charitable institution" but merely "turned over to such institutions * * * the profits from its various business activities." 219 F.2d at 528. Rejecting the destination-of-income test, we cited the Fourth Circuit's opinion in the Community Services case, supra, and stated (id. at 529):

"The court, speaking through Judge Dobie, thought that the taxpayer involved was in effect organized and operated for two purposes: (1) to engage in commercial business for profit, and (2) to turn over the profits realized from those commercial activities to charitable organizations. It said that `the second purpose is charitable; the first purpose clearly is not. To qualify for the exemption here, the corporation must be "organized and operated exclusively for * * * charitable * * * purposes."\'

In the case before us it would appear that none of the activities in which petitioner actually engaged was charitable or religious. All were of a business or commercial nature. But assuming the function of turning over the profits was an activity or operation it certainly was not the principal one. We agree with the Fourth Circuit that the word `exclusively\' as used in the statute must be given effect."

Cf. Better Business Bureau v. United States, 1945, 326 U.S. 279, 283, 66 S.Ct. 112, 90 L.Ed. 67.

We think it clear that, under our construction of the pre-1951 section 101(6) exemption, the University Hill Foundation was not "operated exclusively for religious, charitable, or * * * educational purposes." The businesses involved in the 21 Cote-formula transactions were a diverse lot, including inter alia a hotel, three sand, gravel and concrete companies, three dairies, a foundry, and eight manufacturing concerns making and selling a wide variety of products. It is arguable that the Foundation was engaged in the respective trade or business of each of the companies whose assets it had bought and then leased. We need not decide this question, however, and we may assume that the Tax Court was correct in finding that the form of the transactions successfully...