Searching over 5,500,000 cases.

Buy This Entire Record For $7.95

Official citation and/or docket number and footnotes (if any) for this case available with purchase.

Learn more about what you receive with purchase of this case.



August 24, 1956

UNITED STATES of America, Defendant

The opinion of the court was delivered by: WORTENDYKE

The significant issue in this case involves the extent to which a charitable organization may accumulate income without losing its tax-exempt status under the accumulation limitations imposed by a section of the Revenue Act of 1950, 64 Stat. 957, 26 U.S.C.A. § 3814. *fn1" Although not bearing upon the disposition of this case, it is interesting to note that this section has been carried over into the Internal Revenue Code of 1954, *fn2" making the subject of more than passing interest. Since this case is controlled by the Internal Revenue Code of 1939, as amended, all references in the course of this opinion are to sections of the 1939 Code and regulations thereunder, unless the contrary is indicated.

The matter of income accumulation arises, along with some other questions, in this proceeding by the Samuel Friedland Foundation to recover $ 57,154.49 representing income taxes which it paid for the years 1951 and 1952. The Foundation's claim for refund is based upon the contention that during the two years mentioned it was exempt from income tax as a charitable organization under Section 101 of the Internal Revenue Code of 1939, 26 U.S.C.A. § 101 *fn3" and that the amendments made by the Revenue Act of 1950 *fn4" were not applicable to the Foundation, or if they were applicable they did not effect any loss of exemption as to the Foundation. The Government takes the extreme position that the Foundation by the very nature of its certificate and operation is not an organization exempt from tax under Section 101 and that if it were it lost its exemption for the years 1951 and 1952 by an accumulation and use of income proscribed by Section 3814.

 The facts are virtually undisputed, both parties relying upon contentions as to the interpretation and application of the pertinent statutory provisions. For convenience all of the facts are set forth in a footnote. *fn5"

  The questions raised by the Government's numerous arguments as to why the Foundation is not entitled to a refund of income taxes for the years involved are basically these:

 Is the Foundation exempt from income tax under Section 101? Is the Foundation, within the meaning of Section 3813, 'an organization the principal purposes or functions of which are the providing of medical or hospital care or medical education or medical research'? If not, were the amounts accumulated by the Foundation out of income (a) unreasonable in amount, (b) used to a substantial degree for non-charitable purposes, or (c) invested in such manner as to jeopardize the charitable purpose or function of the Foundation, within the meaning of Section 3814?

 Before turning to these specific questions, it is helpful to consider the tax exemption created by Congress for the benefit of charitable organizations. The term 'charitable' is only one of a number of adjectives appearing in Section 101(6) descriptive of organizations which may be exempt from tax. However, the term has been commonly used in its generic sense as embracing all such adjective including 'educational' and 'scientific', and it will be so used here.

 The exemption from income tax for charitable organizations has been in existence for many years in the company of comparable sections relieving charitable organizations from other Federal taxes and encouraging gifts and bequests to such organizations by excluding donations to varying extents from the donors' income and estate tax bases. *fn6" Hardly any change has occurred in the criteria or language of these provisions since their earliest employment. Up until 1950, the only significant change seems to have been the addition of the restrictive clause denying tax relief if a 'part of the net earnings' of the organization 'inures to the benefit of any private shareholder or individual' or if a 'substantial part of the activities * * * is carrying on propaganda, or otherwise attempting, to influence legislation.' We are not concerned here with those limitations for it is conceded that factors of individual profit and influencing legislation are not present.

 Section 101(6) contains the following words of long-standing use for tax-exemption purposes:

 'Corporations * * * organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes * * *.'

 While this language does not seem difficult on its face, its meaning has, nevertheless, given rise to considerable litigation. Some of this litigation has involved the scope of the words 'religious, charitable, scientific, literary, or educational', and some the meaning of the words 'organized and operated exclusively'. It is this latter phrase which gives rise to one of the contentions in this proceeding.

 Few cases involving interpretations of Section 101(6) or related provisions couched in similar terminology have ever reached the Supreme Court of the United States. Consequently, much emphasis has been placed upon decisions and opinions of the Circuit and District Courts and the Tax Court.

 The Supreme Court has said generally that statutory provisions exempting from tax funds which are devoted to charity 'were begotten from motives of public policy, and are not to be narrowly construed.' Helvering v. Bliss, 1934, 293 U.S. 144, 151, 55 S. Ct. 17, 20, 79 L. Ed. 246. The Court has never retreated from that view. See Old Colony Trust Co. v. Commissioner of Internal Revenue, 1937, 301 U.S. 379, 57 S. Ct. 813, 81 L. Ed. 1169; United States v. Pleasants, 1939, 305 U.S. 357, 59 S. Ct. 281, 83 L. Ed. 217. The Court's express refusal to pass upon the matter when argued in Better Business Bureau of Washington, D.C. v. United States, 1945, 326 U.S. 279, 283, 66 S. Ct. 112, 90 L. Ed. 67, cannot be taken as a retreat. The facts of that case made it wholly unnecessary for the Court to consider the point. The Circuit Courts, too, have usually applied the doctrine of liberality. Seasongood v. Commissioner of Internal Revenue, 6 Cir., 1955, 227 F.2d 907, 910; Arthur Jordan Foundation v. Commissioner of Internal Revenue, 7 Cir., 1954, 210 F.2d 885, 889; C. F. Mueller Co. v. Commissioner of Internal Revenue, 3 Cir., 1951, 190 F.2d 120, 122; Commissioner of Internal Revenue v. Citizens and Southern National Bank, 5 Cir., 1945, 147 F.2d 977, 979; Bohemian Gymnastic Association Sokol of City of New York v. Higgins, 2 Cir., 1945, 147 F.2d 774, 777; United States v. Proprietors of Social Law Library, 1 Cir., 1939, 102 F.2d 481, 482; Cochran v. Commissioner of Internal Revenue, 4 Cir., 1935, 78 F.2d 176, 179.

 The meaning of the key words 'organized and operated exclusively for' charitable purposes has been the subject of disagreement not only among litigants but also among the courts. As to 'organized' the Supreme Court has given no direct light, but the better view, based in part upon the doctrine of liberality of construction respecting charitable exemptions which resolves ambiguities in favor of the taxpayer and in part upon a refusal to allow from to control over substance, is that 'organized' means 'created to perform' or 'established to promote' charitable purposes rather than meaning merely 'incorporated' with powers limited solely to charitable activities. In Commissioner of Internal Revenue v. Battle Creek, Inc., 5 Cir., 1942, 126 F.2d 405, 406 a sanitarium was held to be a charitable organization exempt from income tax under Section 101(6) although its charter gave the trustees power to conduct any lawful business. The Court observed that 'It is not unusual for charters of corporations to grant broad powers and privileges that are never intended to be used.' Roche's Beach, Inc. v. Commissioner of Internal Revenue, 2 Cir., 1938, 96 F.2d 776 and Forest Press, Inc., v. Commissioner of Internal Revenue, 1954, 22 T.C. 265 are to the same effect. To grant or deny tax benefits to organizations upon a basis of recitations in a charter or certificate would not seem to accomplish what Congress was getting at. The issue of 'organized,' as this Court now conceives the law, is primarily a question of fact not to be determined merely by an examination of the certificate of incorporation but by the actual objects motivating the organization and the subsequent conduct of the organization. To some degree, 'organized' cannot be divorced from 'operated,' for the true purposes of organization may well have to be drawn in final analysis from the manner in which the corporation has been operated.

 With particular reference to 'exclusively,' the Supreme Court has twice given this word meaning as it appears in Section 101(6) and related sections. In Trinidad v. Sagrada Orden de Predicadores, 1924, 263 U.S. 578, 44 S. Ct. 204, 205, 68 L. Ed. 458, the Court was faced with the question as to whether the production of income prevented an organization from being operated exclusively for charitable purposes. The Court held that the carrying on of income-producing activities did not offend the limitation of 'exclusively' so long as the activities were purely incidental to the principal charitable purposes to which the income was ultimately devoted. The Court's reasoning was that the exempting section itself recognized that a corporation might be organized and operated exclusively for charitable purposes and yet have an income; furthermore, the section said 'nothing about the source of the income' but made the 'destination' of income the 'ultimate test of exemption.' The organization held to be exempt in this case was religious, and the Court specifically approved income-producing investments in real estate, corporate stocks, loans at interest, occasional sales of stocks, and sales of wine, chocolate and other articles purchased and supplied for use in its churches, missions, schools and subordinate agencies. However, the Court suggested that the result might not be the same if the organization had been engaged in 'a business pursuit' or 'in trade in any proper sense of the term.' The Court pointed out: 'It is not claimed that there is any selling to the public or in competition with others. * * * That the transactions yield some profit is in the circumstances a negligible factor. Financial gain is not the end to which they are directed.'

 It is indeed hard to rationalize the divergent statements of the Court. Surely, if the 'destination of income' is the 'ultimate test of exemption', it would not seem to matter how the income is produced so long as it is eventually devoted to charitable purposes. The notion that engaging in business pursuits in competition with others might bring about denial of the exemption runs into a headon conflict with the 'ultimate destination' theory. The likely explanation is that there were members of the Court who foresaw the economic effect of permitting to tax-free organizations carte blanche entry into the competitive business area. *fn7" Certainly the opinion left serious doubts as to the adequacy of the statutory language.

 The second occasion upon which the Supreme Court considered 'exclusively' was in Better Business Bureau of Washington, D.C. v. United States, 1945, 326 U.S. 279, 66 S. Ct. 112, 90 L. Ed. 67. That case involved Section 811(b)(8) of the Social Security Act, 49 Stat. 620, 639, 42 U.S.C. § 1011(b)(8), but it contains the same language as Section 101(6) from which it was undoubtedly drawn. Income-producing activity was not involved, the Better Business Bureau's exemption being opposed on the ground that its chief purpose was to promote business interests rather than education. In the course of its opinion, the Court expressed the view that 'exclusively' plainly means without the presence of a single non-charitable purpose substantial in nature.

 Thus, the Trinidad case was the only Supreme Court decision dealing with income-producing activity. Drawing from this case the rule that the fundamental or ultimate test of exemption is the destination of income, several of the Circuit Courts held organizations engaged in a wide variety of income-producing activities to be within the exempting language. Furthermore, it was held that it made no difference that the organization did not itself perform any charitable services so long as the income was used for such purposes. The latter type of organization, which merely produced and paid over income to some charitable organization, came to be frequently referred to as a 'feeder'. The value of this term is questionable. *fn8"

 A few of the decisions will indicate the extent to which the ultimate destination test has been applied in holding organizations exempt from income tax under Section 101(6). Roche's Beach, Inc., v. Commissioner of Internal Revenue, 2 Cir., 1938, 96 F.2d 776 (corporation operating bathing beach; income was turned over to a charitable foundation); Debs Memorial Radio Fund, Inc., v. Commissioner of Internal Revenue, 2 Cir., 1945, 148 F.2d 948 (corporation operated commercial radio station; income used for broadcast of educational, civic and cultural programs); Commissioner of Internal Revenue v. Orton, 6 Cir., 1949, 173 F.2d 483 (foundation engaged in the manufacture of standard pyrometric cones; income devoted to study and research in the field of ceramics); Willingham v. Home Oil Mill, 5 Cir., 1950, 181 F.2d 9, certiorari denied, 1950, 340 U.S. 852, 71 S. Ct. 80, 95 L. Ed. 624 (corporation engaged in oil business; income paid over to charitable organizations); C. F. Mueller Co. v. Commissioner of Internal Revenue, 3 Cir., 1951, 190 F.2d 120 (corporation engaged in the manufacture and sale of macaroni and allied products; income paid over to educational institution).

 On the other hand, some courts refused to read the Trinidad opinion to the same effect and concluded that Congress could never have intended to accord tax exempt status to a corporation, regardless of its own activities, merely because its profits were used for charitable purposes. Bear Gulch Water Co. v. Commissioner of Internal Revenue, 9 Cir., 1941, 116 F.2d 975 (water company whose stock was held by a university which received and used the income for educational purposes); United States v. Community Services, 4 Cir., 1951, 189 F.2d 421, certiorari denied 1952, 342 U.S. 932, 72 S. Ct. 375, 96 L. Ed. 694 (corporation operated canteen refreshment service and other commercial enterprises, sales being limited to employees of a certain company; income turned over to charitable organizations); Ralph H. Eaton Foundation v. Commissioner of Internal Revenue, 9 Cir., 1955, 219 F.2d 527 (foundation engaged in various commercial and business enterprises; income paid to charitable organizations); John Danz Charitable Trust v. Commissioner of Internal Revenue, 9 Cir., 1956, 231 F.2d 673 (trust bought and sold stocks, operated a hotel and candy stores; distributions made to charitable organizations).

 Although the application of the ultimate destination test by the Circuit Courts was called to the attention of Congress in 1942, no amendment was made pending further study. C. F. Mueller Co. v. Commissioner of Internal Revenue, 3 Cir., 1951, 190 F.2d 120, 122 note 5. It was not until 1950 that Congress made any change in the provisions of Section 101(6) and related sections.

 The exemption from tax of business corporations paying over income to charity and charitable organizations themselves engaged in commercial ventures not related to their charitable purposes was not the only problem of consequence flowing from the provisions of Section 101(6) and related sections. The study of exempt organizations during the 1940s brought to light other matters which had never been the subject of litigation under the exempting provision. The picture presented to members of Congress in 1950 not only included this broad application of the doctrine of destination as the ultimate test of exemption and its effect on competition, but also revealed among other things that in some instances (a) exempt organizations had made investments in real property through the incurring of substantial indebtedness and lease-back transactions not requiring the use of any funds of the exempt organization; *fn9" (b) exempt organizations were using or distributing little or none of their income for current charitable purposes, but were amassing vast amounts of money without any apparent limitation; (c) creators of charitable foundations retained a control which enabled them to use and manipulate the foundation funds to their own personal financial advantage; and (d) certain charitable trusts were established for the principal purpose of operating family controlled businesses to effectively avoid various taxes otherwise due. *fn10"

 To remedy the foregoing the Revenue Act of 1950 clarified and changed the existing law respecting charitable organizations in five major respects. Roughly, the amendments were these:

 (1) a tax was imposed on rentals from property leased by charitable organizations to others on a long-term basis where the property was purchased with borrowed funds;

 (2) a paragraph was added to Section 101 which eliminated tax exemption for business corporations devoting income to charity (for text see footnote 4);

  (3) a tax was imposed on net income in excess of $ 1,000 derived by any organization within Section 101(6) from business activities not related to the purposes for which exemption was granted to the organization;

 (4) a new Section 3813 was added denying exemption to organizations which engage in any of a number of specific 'prohibited transactions' with creators or donors or corporations controlled by such persons; however, certain organizations were specifically exempted from the application of this section (see footnote 1); and

 (5) a new Section 3814 was added denying exemption for the particular tax year involved to any Section 101(6) organization which unreasonably accumulate income, use income to a substantial degree for purposes other than those constituting the basis of exemption, or invest income in such manner as to jeopardize the carrying out of those purposes; again, however, certain organizations were specifically exempted from the application of this section (see footnote 1).

 With the foregoing background of fact and law, the questions posed by this litigation may be considered

 I. Is The Foundation Exempt From Income Tax Under Section 101?

 It would seem that the Foundation was created and operated to promote medical care, education and research. That such purposes are charitable, educational or scientific within the meaning of Section 101(6) is not disputed by the Government. However, the Government contends that because of the powers and activities of the trustees of the Foundation respecting financial matters the Foundation was not organized and operated exclusively for charitable purposes in the sense required by Section 101(6) and, furthermore, the financial activities caused it to be 'operated for the primary purpose of carrying on a trade or business for profit' within the meaning of the amendment to Section 101 made by the Revenue Act of 150 set forth in footnote 4.

 While the powers given to the trustees in the certificate of incorporation in respect of investments may be broad, as already pointed out the certificate provisions are not determinative of whether an organization meets the requirements of Section 101.

 Upon analysis, the financial activities of the Foundation during the years 1951 and 1952, apart from the receipt of contributions and the distribution of funds to charitable organizations, consisted only of investing in stocks, debentures and mortgages on real and personal property.

 The investment of funds of a charitable organization in securities has never been conceived of as a 'purpose' of the organization. It has always been treated as an incidental activity subservient to the fundamental charitable objects. It is safe to say that the vast majority of charitable organizations and trusts in this country today have funds invested in stocks, bonds, mortgages, or real property not merely for safekeeping but for earning income. In many cases these investments provide the very lifeblood of the charitable work carried on or supported. If any authority is needed that such investments are incidental to the purposes of a charity it will readily be found in the Supreme Court's decision in the Trinidad case already discussed. In that case, approximately 35% of income was derived from rents and 59% from dividends and interest on investments. The Court observed (263 U.S. 578, 44 S. Ct. 205):

 'Such (charitable) activities cannot be carried on without money; and it is common knowledge that they are largely carried on with income received from properties dedicated to their pursuit. This is particularly true of many charitable, scientific and educational corporations and is measurably true of some religious corporations. Making such properties productive to the end that the income may be thus used does not alter or enlarge the purposes for which the corporation is created and conducted.'

 As noted in the Trinidad case, Section 101(6) clearly recognizes that charitable organizations may have income, and it is hard to conceive of a more passive way to acquire income than through investment in securities. Treasury Regulations 111, promulgated under the Internal Revenue Code of 1939 and amended to embrace changes made by the Revenue Act of 1950, expressly state in Section 29.101(6)-1

 'A corporation otherwise exempt under section 101(6) does not lose its status as an exempt corporation by receiving income such as rent, dividends, and interest from investments, provided such income is devoted exclusively to one or more of the purposes specified in that section.' The investment and security transactions of the Foundation during the years 1951 and 1952 consisted of the following: Purchases Sales Item March 1951 - $75,000 Jackson County V. A. Construction Mortgage May 1951 (satisfied by pre- $805,000 Casablanca Hotel Mortgage payment in 1952) May 1951 October 1951 $403,000 Casablanca Hotel Conditional Sales Notes May 1951 - 55,000 shares Food Fair Stores, Inc. Common Stock (Contribution) May 1951 120,000 shares Official Films, Inc. Common Stock June 1951 - $1,000 Miami Jewish Center Debenture (Contribution) October 1951 2,000 shares Food Fair Stores, Inc. Common Stock June 1951 - 500 shares Food Fair Stores, Inc. Common Stock February 1952 April 1952 $100,000 Sun Tan and Palm Vel Buildings Mortgage October 1952 - $17,500 Dwelling Mortgage


© 1992-2004 VersusLaw Inc.

Buy This Entire Record For $7.95

Official citation and/or docket number and footnotes (if any) for this case available with purchase.

Learn more about what you receive with purchase of this case.