Definition of 'Rents' for Purposes of Personal Holding Company Provisions

Personal holding company income is defined in section 543 of the I.R.C. of 1954. Section 543(b)(7) states that 'rents' mean compensation, however designated, for the use of, or right to use, property . . ." The issue presented is whether or not this definition encompasses room charges received by a hotel. This office feels that room charges generated by the various facilities and services provided in the course of a hotel's business are not within the category of receipts Congress intended to identify by using the term rent in section 543(b)(7). Accordingly, this memorandum does not concur in the conclusions reached in the proposed ruling.

This case thus deals with the recurrent question of what constitutes rent within the various provisions of the Internal Revenue Code. The case of * * * A-628142, generated three memoranda (G.C.M. 31186, April 17, 1959; G.C.M. 31442, November 16, 1959; G.C.M. 31895, February 20, 1961) considering the meaning of the term rent as used in sections 1402(a)(1) (excluding rents from the self- employment income tax), 1372(e)(5) (denying subchapter S qualification to a corporation when rent constitutes more than 21 percent of its gross receipts), and 512(b)(3) (excluding rents from the unrelated business income tax). G.C.M. 31895 concluded that a uniform interpretation of the word "rent" in those sections was desirable in view of the substantially identical regulations promulgated under all three sections. See sections 1.512(b)-1(c)(2), 1.1372-4(b)(5)(iv), and 1.140(a)-1(c)(1)(ii)(iii) of the regulations. These three regulations all contain specific reference to payments for hotel rooms that would preclude such payments from qualifying as rent under those sections. However, this does not resolve the problem for purposes of section 543, as that section contains a very broad definition of rent, varying greatly from that contained in the regulations focused on in G.C.M. 31895. After emphasizing this difference, G.C.M. 31895 stated that "this office does not here pass on the question of whether the income in question would represent rents for purposes of the personal holding company provisions." Id. at 6. The instant case must, therefore, be decided on the statutory language and underlying Congressional purpose of section 543(b)(7).

The personal holding company tax was enacted in response to the following observations by the House Ways and Means Committee:

Although the House bill included rent within the definition of personal holding company income, the Senate excluded rent, reasoning:

Congress attempted to preclude this avoidance in section one of the Rev. Act. of 1937 by adding section 353(g) to the Rev. Act of 1936, which included rents in the definition of personal holding company income if they constitute less than 50 percent of the gross income of the corporation. ¹ Congress defined rents as follows:

One of the largest problems of a hotel business is personnel, a problem not shared by a business in the nature of an incorporated pocketbook. The pamphlet "This Is Our Story", published by the American Hotel and Motel Ass'n. [Hereafter AH & MA] states that "one of the greatest problems [hotels] face is lack of adequately trained personnel." Some of the courses produced by the AH & MA and offered in technical schools, colleges, special schools and adult education programs are "Front Office Procedure", "Hotel Accounting", "Maintenance and Engineering", "Food and Beverage Purchasing", "Human Relations", "Supervisory Housekeeping", and "Supervisory Development." Ibid. Unions and employee organizations, neither of which trouble the theoretical incorporated pocketbook, are a challenge to hotel management.

In addition to commercial risks created by what is essentially a service business, hotels are subjected to a high degree of care in fulfilling the many duties the civil law declares that a hotel owes to its guest. Under certain circumstances a hotel is liable for the property of a paying guest as a bailee for hire or mutual benefit /3/, for the spread of contagious disease /4/, and for the failure to properly garage a car put in its charge by overnight guests /5/. A hotel owes a duty to those who come to the hotel to protect them from insult and other annoyances and dangers from other guests /6/, and even from strangers where the hotel negligently fails to provide proper protection /7/, and from damage to person or property from fire. These are risks not associated with the investment activity Congress denominated the "incorporated pocketbook", nor of the rental activities Congress thought subject to the abuse remedied by the 1937 inclusion of "rents" within the categories of personal holding company income.

It is common knowledge that a hotel provides a variety of services, including beverages, phone service, laundry, cleaners, tailors, bus, cash advances, garage, maid and linen service, baggage handling and storing, safe deposits and room check service, house detectives, messenger service, lobby facilities, room service, swimming and recreation facilities, porter service, radio and television, and many others. Information on church services, current movies and plays, athletic events and other entertainment facilities is posted and distributed in brochures. Separate charges are made for some of these services, but most of those listed are provided without specific charge and must be sustained from the room rental charges. The AH & MA publishes a booklet entitled the "Hubbart Formula" which appears designed to assist hotels in establishing room rents adequate to meet these varied costs and insure a reasonable return on investment. And, even though separate charges are made, the operation of a hotel is an integrated business that cannot be perfectly fragmented into its income producing components.

Finally, the traditional connotations of the term rent, even though broadly expanded by the statutory definition, retain some residual meaning in the statute. Although a landlord-tenant relationship is not a prerequisite to a finding that a payment is rent as defined in the statute, the courts have implied its presence or absence is a factor to be considered. ⁸ /Thus the following characterization of a hotel guest's status seems relevant.

The situation in this case is somewhat analogous to that involved in Webster Corporation 25 T.C. 55 (1955), aff'd per curiam 240 Fed. 163 (2nd Cir. 1957) in which it was held that because of the supervision and control exercised by a personal holding company and its agents over a crop sharing farm operation, the crop shares received by the personal holding company were not "rents" within the meaning of section 502(g) of the 1939 Code which is now section 543(a)(7) of the 1954 Code. The Service acquiesced in this decision. 1960-2 Cum. Bull. 7. As pointed out in G.C.M. 32084, September 20, 1961, * * *., I-70, the clear inference from Webster is that, if there had been no material participation in the management and operation of the farm by the taxpayer the crop shares would have been "rents". As you know it was concluded in the * * * case that * * * payments should be treated in the same manner as crop share payments for personal holding company purposes. Attention is also invited to G.C.M. 31949, March 29, 1951, * * * A-635075 in which it was necessary to determine whether cold storage charges in connection with a warehouse operation are classifiable as rents. This office concurred in your determination that the amounts in question were not "rent". Although the factual situations in the above mentioned cases can be distinguished from the facts in the instant case there is an indication, particularly in the Webster case, that the extent to which services are performed is an important consideration in determining whether payments are ". . . compensation . . . for the use of, or right to use, property . . ." within section 543(b)(7).

In conclusion, it is believed that room charges constitute income generated by many facets of a hotel's business and that this business is not within the remedial scope of the 1937 statutory inclusion of "rent" in personal holding company income. Additionally, room charges are produced in large part by provision of a variety of services and facilities, and therefore is not "compensation . . . for the use of or right to use, property." In view of the foregoing, G.C.M. 20525 in re: * * * dated July 28, 1938) A-318075, which concurred in a ruling that income received by hotels for the use of rooms is rental income for personal holding companies purposes, is revoked.

After you have had an opportunity to consider this memorandum we will be glad to confer with you if you care to do so and then if necessary we will give this matter further formal consideration.

The administrative file is herewith enclosed.

Before the Committee on Ways and Means, 75th Cong., 1st Sess. 61 (1937) (remarks of Mr. Kent).

² A reading of the hearings indicates that income from apartment and office buildings, and rental situations where services to the occupant are involved were included within the broad definition of rent, unless, or course such income constituted 50 percent or more of gross income. See Hearings on Tax Evasion and Avoidance Before the Committee on Ways and Means, supra n.1 at 61 (remarks of Mr. Kent), 128 and 130 (remarks of Mr. Gerrity); Hearings on The Rev. Act of 1937 Before the Committee on Finance, 75th Cong., 1st Sess., 5-7.

The statement above, supra n. 1 tends to confirm this analysis.

³ 29 Am. Jur. Innkeepers section 142 (1960).

⁴ Id. at section 63.

⁵ Id. at section 137.

⁶ Id. at section 62.

⁷ Id. at section 63.

⁸ See C.I.R. v. Webster Corp., 240 F.2d 164 (2nd Cir. 1957), Acq. 1969-2 Cum. Bull. 7, stating: