Docket No. 20651-82
Robert L. Gallaway for the petitioner. Paul J. Krug, for the respondent.
JUST Petitioner, a private social club exempt from tax pursuant to section 501(c)(7), engaged in three nonexempt activities: nonmember banquets, nonmember golf tournaments with associated banquets, and an investment program.
HELD, each nonexempt activity, separately considered, was entered into by petitioner with a profit objective.
HELD, FURTHER, losses from one such profit seeking activity are deductible against net gains from another such activity. Robert L. Gallaway for the petitioner. Paul J. Krug, for the respondent.
This case was assigned to Special Trial Judge Helen A. Buckley pursuant to the provisions of section 7456(d)(3) of the Code (redesignated sec. 7443A(b)(3) by sec. 1556 of the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2755) and Rules 180, 181 and 182. The Court agrees with and adopts her opinion which is set forth below.
OPINION OF THE SPECIAL TRIAL JUDGE
BUCKLEY, SPECIAL TRIAL JUDGE: Respondent determined a deficiency of $2,846 in petitioner's 1979 Federal income tax. The issue before the Court is whether petitioner, a section 501(c)(7) tax exempt social club with different sources of ‘unrelated business taxable income,‘ may offset net gain from one source of unrelated business taxable income with the excess deductions from another such source.
FINDINGS OF FACT
Some of the facts have been stipulated, and unless otherwise noted those facts are so found. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.
Petitioner is a private social club exempt from tax pursuant to section 501(c)(7). Petitioner's exempt status was granted on September 24, 1954. Petitioner timely filed an Exempt Organization Business Income Tax Return and a Return for Organization Exempt From Income Tax, Forms 990-T and 990, respectively, for 1979. On June 7, 1982, respondent issued a valid notice of deficiency and petitioner timely filed its petition for redetermination. At that time and at all other times relevant to this litigation, petitioner had its principal place of activity and business in Fair Oaks, California.
Petitioner operates a golf club, restaurant and bar, swimming pool and tennis courts for the benefit of its members and their guests. This is and always has been petitioner's purpose. In addition to maintaining facilities for its members, petitioner also, from time to time, makes its facilities available to nonmembers.
Petitioner derives revenue from members as well as nonmembers. For 1979, petitioner had total revenue in excess of $1,200,000. All of the revenue, except for $118,789, came from members, either as membership dues or fees for services provided to members and/or their guests. Of the $118,789 in revenue which did not derive from members or their guests, $10,098 represents interest income and the remainder came from the following stipulated nonmember activities: golf, golf cart rentals; food sales; beverage sales; and guest fees.
The parties stipulated that during 1979 petitioner derived revenue from nonmember activities and incurred expenses directly connected with those activities as follows:
+--------------------------------------------------------------+ ¦ ¦Golf ¦Golf carts¦Food ¦Bar ¦Guest fees¦Interest¦ +-------+-------+----------+-------+-------+----------+--------¦ ¦Revenue¦$13,170¦$11,819 ¦$39,281¦$43,406¦$1,015 ¦$10,098 ¦ +--------------------------------------------------------------+
Expenses: Direct 8,820 3,975 43,389 28,225 Utilities 54 --- 1,899 2,099 Property taxes 36 --- 1,259 1,392 Depreciation 352 2,023 3,461 3,824 General administration 2,004 1,798 5,977 6,605 154 Club house 627 563 1,870 2,066 48 Total expenses 11,893 8,359 57,855 44,211 202 Net income 1,277 3,460 (18,574) (805) 813 10,098
The expenses listed as direct expenses are those which are incurred and increased in direct proportion to the volume of the particular nonmember activity. Included here are items such as additional labor costs and costs of goods sold. Each dollar of direct expense is traceable to the particular nonmember activity and would not have been incurred put for the activity.
The other expenses (for simplicity referred to as indirect) are those which are either fixed or quasi-fixed. Those which are fixed, such as property taxes and depreciation, are incurred by petitioner whether or not there is nonmember activity. The other indirect expenses, such as utilities, general administration and club house expense may be increased by nonmember activity, but the increases are only nominal or bear no calculable relationship to a particular nonmember activity. For purposes of computing net income, indirect expenses are allocated to each nonmember activity although they are not traceable to any particular nonmember activity.
Although the expenses attributable to nonmember activities are analyzed and recorded in terms of whether they bear direct relationships with each respective activity, the parties have stipulated that all the expenses in issue are directly connected with the production of the gross income for each activity.
The nonmember revenues, other than the interest income, derive from two sources. First, petitioner allows its facilities to be used for a number of nonmember golf tournaments each year. These tournaments are held on days when the facilities are closed to members. Civic or charitable organizations normally sponsor the nonmember tournaments. In order for nonmembers to secure the use of petitioner's facilities for tournaments the following requirements must be met:
1. There must be at least 130 tournament participants;
2. A course marshal must be provided;
3. All participants must use golf carts rented from petitioner;
4. Prizes must be purchased from petitioner's Pro shop and there must be a certain guaranteed expenditure from the shop; and
5. The organization sponsoring the tournament must have a banquet or luncheon using petitioner's dining facilities. These requirements are part of a comprehensive policy developed by petitioner's Board of Directors with respect to nonmember activity.
The second source of nonmember revenue is that which petitioner receives from food and beverage sales from nonmember banquets other than those associated with golf tournaments. These banquets are usually held once or twice a month on Saturday evenings. There are also some nonmember banquets held during the week around the Christmas holiday season.
The record is not clear with respect to the amount of nonmember food and beverage revenue which is associated with the nonmember golf tournaments as opposed to that which is independent of golf tournaments. As stated previously, however, the nonmember revenues, other than the interest income, emanate from only two sources. This is so despite the parties' stipulated classification of the nonmember activities into the five categories of golf, golf carts, food, beverage and guest fees. One source of nonmember revenue is the golf tournament activity, which includes golf, golf carts, a portion of the food and beverage revenue and guest fees. The other source is the food and beverage revenue emanating from nonmember banquets independent of golf tournaments.
Prices paid by nonmembers for the use of petitioner's facilities are substantially higher than those paid by members. In 1979, nonmember golf tournament participants paid a greens fee of $11, while the greens fee paid by guests of members was $7.50. If a member or his/her guest rented a golf cart, the cost was $9 or $10, while the cost of the mandatory golf cart rental to nonmember tournament participants was $10 or $11. The same escalated pricing structure applied to the cost of food and drink at nonmember banquets whether or not they were associated with golf tournaments.
In allowing nonmember activity, petitioner was very concerned about keeping the level of inconvenience to its members at a minimum. The record contains minutes of Board of Directors meetings where such concerns were discussed and appropriate policy changes enacted. In 1979, the policies with respect to these concerns served to limit the number of nonmember golf tournaments to six per year and to assure that they were held on days when the club was closed to members. With respect to banquets not associated with golf tournaments, petitioner avoided inconveniencing its members by maintaining separate facilities for members and nonmembers and by giving members priority in the use of the banquet facilities.
ULTIMATE FINDING OF FACT
Petitioner was engaged in all of its nonmember activities with the intention of making a profit.
CLASSIFICATION OF ACTIVITIES
For the tax year in issue (1979) petitioner had total gross income in excess of $1.2 million. The bulk of this gross income is exempt function income under section 512(a)(3)(B). However, with respect to unrelated business taxable income, the stipulation of facts, in relevant part, provides:
7. During the year 1979, petitioner received interest income of $10,098.
8. During 1979, petitioner derived gross income from nonmembers in the following activities:
(b) Golf Carts
(e) Guest Fees
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10. »This stipulation incorporates by reference to an attached exhibit the chart produced above outlining the revenues and expense for each activity†>>>>>.
We believe that the classification of petitioner's UBTI- producing activities into six separate categories (the five mentioned in stipulation number 8 and interest income) is misleading and contrary to facts disclosed by the record as a whole. Therefore, we are not bound by this aspect of the stipulation. See Jasionowski v. Commissioner, 66 T.C. 312, 318 (1976). See also Mead's Bakery, Inc. v. Commissioner, 364 F.2d 101, 106 (5th Cir. 1966).
As stated in the findings of fact, petitioner was involved in only three nonmember activities. These are: (1) nonmember golf tournaments which encompassed golf, golf cart rentals, guest fees and a portion of the food and beverage revenues; (2) nonmember food and beverage sales for associated with golf tournaments; and (3) production of interest income.
+-------------------------------------+ ¦Golf tournaments ¦ ¦ +-----------------------+-------------¦ ¦Greens fees ¦$4,350 ¦ +-----------------------+-------------¦ ¦Golf carts ¦7,844 ¦ +-----------------------+-------------¦ ¦Guest fees ¦1,015 ¦ +-----------------------+-------------¦ ¦Banquets (food and bar)¦Unknown ¦ +-----------------------+-------------¦ ¦ ¦percentage of¦ +-----------------------+-------------¦ ¦ ¦$11,073 ¦ +-------------------------------------+
Banquets Food and bar Unknown percentage of $11,073
An analysis of petitioner's nonexempt activities in earlier years also yields similar results.
COMPUTATION OF PETITIONER'S UBTI
Computation of petitioner's UBTI is governed by the special rule of section 512(a)(3) and not the general rule of section 512(a)(1).
* * *
The computation of income subject to the tax would be similar in most respects to the computation presently applicable under the unrelated business income tax in general. 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. * * * »Technical Explanation of Treasury Tax Reform proposals, Hearings on the Subject of Tax Reform before the Comm. on Ways and Means, 91st Cong., 1st Sess., part 14, 5050, 5139-5141 (Apr. 22, 1969); fn. ref. omitted; emphasis included.†
The purpose behind the change extending the tax on UBTI to social clubs was stated in the Senate Finance Committee report as follows:
Since the tax exemption for social clubs and other groups is designed to allow individuals to join together to provide recreational or social facilities or other benefits on a mutual basis, without tax consequences, the tax exemption operates properly only when the sources of income of the organization are limited to receipts from the membership. Under such circumstances, the individual is in substantially the same position as if he had spent his income on pleasure or recreation (or other benefits) without the intervening separate organization. However, where the organization receives income from sources outside the membership, such as income from investments (or in the case of employee benefit associations, from the employer), upon which no tax is paid, the membership receives a benefit not contemplated by the exemption in that untaxed dollars can be used by the organization to provide pleasure or recreation (or other benefits) to its membership. For example, if a social club were to receive $10,000 of untaxed income from investment in securities, it could use that $10,000 to reduce the cost or increase the services it provides to its members. In such a case, the exemption is no longer simply allowing individuals to join together for recreation or pleasure without tax consequences. Rather, it is bestowing a substantial additional advantage to the members of the club by allowing tax- free dollars to be used for their personal recreational or pleasure purposes. The extension of the exemption to such investment income is, therefore, a distortion of its purpose. [S. Rept. No. 91-552 (1969), 1969-3 C.B. 423, 469-470. ]9
The House Ways and Means Committee report points out that one of the main reasons for the changes was to tax passive income, such as interest. That report stated:
The bill also imposes a tax on investment income of organizations which are exempt on the grounds of mutuality or common membership. Social clubs, for example, are operated for the benefit of members and any profit derived from rendering the services to members is used by the club for the benefit of the members. Therefore, where a social club has income from interest, dividends, rents, royalties, etc., this income reduces the members' costs below the actual cost of providing the personal facilities made available by the organization. Because of this, the bill would tax the social clubs and these other membership organizations on all income other than that derived from rendering services to the members. This income would be treated and taxed as business income. [H. Rept. No. 91-413 (Part 1) (1969), 1969-3 C.B. 200, 231.]9
We considered a somewhat similar problem in Ye Mystic Krewe of Gasparilla v. Commissioner, 80 T.C. 755 (1983). Ye Mystic Krewe was an exempt social club in Tampa, Florida, which sponsored a number of social events such as banquets, balls, tea dances, a parade and a closing party. Its principal activity was a mock invasion of the city of Tampa, utilizing a replica of a West Indian bark, the Jose Gaspar. After the club's ‘pirates‘ debarked and captured the city, there was an annual parade of about 2- 1/2 hours in which some members of the Krewe participated. The city of Tampa awarded concession rights to the Krewe along the parade route. The Krewe also received proceeds from an official logbook of the proceedings. In addition to these income sources the Krewe realized revenue from interest on savings accounts and Treasury bills. The bulk of its revenues, however, came from assessments on its members. We held that the concession income and interest income both constituted unrelated business taxable income. We then went on to determine that the Krewe was not entitled to offset the expenses of staging the invasion and parade against the concession income received by it, holding that the expenses of staging the invasion and parade were not ‘directly connected with the production‘ of the concession income within the meaning of section 512(a)(3)(A). In Krewe, the taxpayer received only the net income from the concessions and logbook sales so that in effect the expenses were already deducted from the gross proceeds since respondent agreed that the net amount constituted the unrelated business income. Further, we note that in Krewe, the taxpayer was attempting to offset some of the costs of its exempt activities against the unrelated income.