American Institute for Economic Research v. United States

                    UNITED STATES COURT OF CLAIMS

Prior to 1957, plaintiff had invested in the common stock of Tri -Continental Corporation, an investment trust. During 1957 and 1958, Tri-Continental paid, on plaintiff's account, income taxes on undistributed capital gains allocated to plaintiff's stock holdings in the amounts of $ 231 for 1957, and $ 510 for 1958. Properly exhausting its administrative remedies, plaintiff here asserts exemption from these assessments under section 501(c)(3) of the Internal Revenue Code of 1954. 26 U.S.C. (I.R.C. 1954) Section 501(c)(3) (1958 Ed.).

Generally, section 501(c)(3) allows exemption to corporations "organized and operated exclusively" for charitable, scientific, or educational purposes where no part of the earnings inures to the benefit of any private shareholder or individual.

Plaintiff was organized in 1935 as a trust, and Edward C. Harwood, who was instrumental in the trust's creation, was appointed trustee. Plaintiff's stated aim was:

     teaching and disseminating economic knowledge with a view to

In 1939, pursuant to applicable Massachusetts law, plaintiff reorganized as a charitable corporation. Mr. Harwood was named its director and cotrustee. In the latter capacity he was to be entitled to life tenure with plaintiff. During the years involved in this suit, Mr. Harwood's compensation totaled about $ 18,000 annually.

Plaintiff's charter indicated its organizational purposes were:

     To conduct scientific research in the general economic field and

     11. From time to time the Institute shall publish the results of

Having outlined plaintiff's organizational aspects, which are more completely delineated in our findings of fact to which reference is made, we not turn to the facts necessary for an understanding of plaintiff's actual operations.

During the period involved in this suit, and almost from its inception, plaintiff has published two periodicals, the Investment Bulletin and the Research Reports. According to plaintiff,

     * * * The bulletins are issued twice monthly and include brief

Charging one-quarter of one percent of the annual capital involved, plaintiff provides, for about 300 clients, a "Continuous Supervising Service" whereby the client is given specific recommendations for sales and purchases of securities in his portfolio. Further, plaintiff will prepare, for a $ 1 fee, an analysis of any specified security with a conclusion as to its investment merit.

On the basis of information furnished by any individual, plaintiff offers, without cost, to ascertain

     Whether or not the probable savings or other reasons would

     * * * Current economic events are analyzed, and important

The faculty and staff of plaintiff conduct the research necessary for the preparation of all publications. In addition to those discussed above, such research also provides source material for many books published in pamphlet form which deal with economic and financial problems.

Plaintiff is able to accomplish about one-half its printing requirements on its own premises; an independent printing establishment prints the remainder.

A fellowship program, consisting of a two-year course of training in research and advanced economics at the post-graduate level, was initiated by plaintiff in 1946. From three to eight Fellows participated at various times between the program's inception and its discontinuance, because of the Korean War, in 1955.

Plaintiff was also instrumental in the formation in 1955 of The Interfoundation Committee for Economic Scholarships. This program, in which plaintiff was joined by three private foundations, was an attempt to interest qualified high school students in the field of economic research. It was believed this program would help to supply the future talent for plaintiff's then inactive fellowship program. Agreeing to bear the program's administrative expense and to provide any scholarships which the foundations were unable to provide at a given time, plaintiff received $ 43,535.46 from the three foundations during 1957 and 1958. Sometime during the years 1955 through 1960, plaintiff itself contributed from $ 12,000 to $ 14,000 to the scholarship program. For 1957 and 1958, scholarships were made available in the total amount of $ 32,625, averaging about $ 80 per student.

The subscription cost for the semi-monthly Investment Bulletin is $ 10 per year; the weekly Research Reports costs $ 25 per year. Some subscribers, nominated "Annual Sustaining Members," pay $ 35 annually, for which they receive the Investment Bulletin, Research Reports, and all book publications (including annual revisions) currently available. In the years 1957 and 1958, plaintiff received $ 96,540.17 and $ 117,300.78, respectively, from these individuals. From those who subscribe to the Investment Bulletin alone or one of the investment services, plaintiff received $ 132,226.59 and $ 157,544.31. The Research Reports and many of the books dealing with various economic problems are distributed free to approximately 2,000 libraries, the Investment Bulletin is not so distributed.

Plaintiff's burden is to show that the facts discussed above place it within the language of section 501(c)(3) which requires exclusive devotion to an exempted purpose. "This plainly means that the presence of a single [nonexempt] * * * purpose, if substantial in nature, will destroy the exemption regardless of the number or importance of truly [exempted] * * * purposes." Better Business Bureau v. United States 326 U.S. 279, 283 (1945). ¹

A major argument of defendant proceeds, paraphrased, as follows: Many of plaintiff's publications, specifically the semi-monthly Investment Bulletin and the Quarterly List of Recommended Securities, merely provide advice for a fee to individual subscribers toward achieving a sound investment program. Plaintiff's "Continuous Supervising Service" (which gives recommendations for sales and purchases of securities in the individual's portfolio) and its analysis for a fee of specific securities are of a similar nature. The totality of these activities is indicative of a business, and plaintiff's purpose is thus a commercial purpose and nonexempt.

Since the presence of a single substantial nonexempt purpose will defeat its claim, plaintiff must necessarily answer defendant's preliminary argument even though this argument is directed toward these selected activities, rather than plaintiff's operations as a whole. This is so because, as shown by plaintiff's current receipts found in finding 13, these particular activities clearly demonstrate a substantial purpose of plaintiff. As its answer, plaintiff contends that dissemination of information of this nature, gained by scholarly research which would go for naught without dissemination, is primarily educational.

"Education" is an extremely broad concept, and Congress has not specifically defined its meaning in a tax sense. We note that the judiciary will liberally construe, and rightfully so, provisions giving exemptions for charitable, religious, and educational purposes. See e.g., Harrison v. Barker Annuity Funds, 90 F. 2d 286 (7th Cir. 1937).

Of constructional pertinence is our decision in Scripture Press Foundation v. United States, 152 Ct. Cl. 463, 285 F. 2d 800, cert. den., 368 U.S. 985. There the problem was "whether a religious publishing house, lacking denominational ties, merits tax exempt status." In denying exemption, we found the dispositive test to be "whether the business activities of the taxpayer are incidental to its charitable [or educational] objectives, or whether, in fact, the converse is true."

Our approach, then, is to first assume arguendo an educational purpose without giving definitive meaning to that concept, and next ascertain whether or not the taxpayer has an additional commercial purpose. Should the answer to the latter inquiry be affirmative, we must decide whether the commercial purpose is primary or incidental to the exempt purpose. That on the facts before us the answer to the first question is affirmative requires no extensive discussion. The difficult question is whether the commercial purpose is primary.

Plaintiff admits the amounts received for the publications giving investment advice are above their actual cost of production. (And see finding 13, which shows an operating profit in this sense of approximately 9.2 percent and 4.5 percent in 1957 and 1958, respectively.) In Scripture Press, we indicated that profits are, although not conclusive, at least some evidence that the business purpose is primary.

It is obvious that the service offered by plaintiff is one commonly associated with a commercial enterprise. Plaintiff contends, however, that there is a difference; i.e., that it is not concerned with making a profit in a business sense. Plaintiff argues that the subscriptions of "Annual Sustaining Members" are charitable gifts, and that this method of obtaining funds was chosen so as to preclude any obligation to large contributors. But it is impossible to ignore the fact that these "Members" and those individuals who solely subscribe to the Investment Bulletin are paying for and receiving a desired service, investment advice, and that they subscribe, for the most part, to the publications for that purpose. Since the subscribers receive full value in exchange for their money, it is difficult, if not impossible, to regard these payments as charitable contributions.

In order for plaintiff to obtain its "contributions," it must proffer something valuable in return. This necessity or purpose to provide such information and service as would be desired by the public places plaintiff in competition with other commercial organizations providing similar services. Plaintiff has chosen to compete in this manner and, as a consequence, plaintiff's activities acquire a commercial hue.

It is thus readily apparent that those operations emphasized by defendant are more analogous to commerce than to education. And, of course, the operational test of section 501(c)(3) is as decisive as the organizational test. Exclusivity is required by both. By the sale of these publications and services, plaintiff has entered, unwittingly or not, a business. We conclude that this business purpose is primary and not incidental to any educational purpose which may be present. It is not the fact of profits alone which compels this conclusion, for plaintiff is also hampered, as we have discussed above, by the methods it has selected to disseminate this type of subject matter.

All we have said regarding the comparative stress of business as opposed to educational purpose applies as well to any contention that plaintiff is a charitable or scientific corporation. If there be a substantial nonexempt purpose, the corporation is nonexempt. Plaintiff's investment service in all its ramifications may be educational, but its purpose is primarily a business one.

As to plaintiff's argument that, since any profits gained from the sale of its publications are used for nonexempt purposes, it is therefore entitled to exemption, we need only refer to the adoption by the majority of this court of our Commissioner's opinion in Sico Foundation v. United States, 155 Ct. Cl. 554, 295 F. 2d 924.

Plaintiff's petition will be dismissed.

It is so ordered.

FINDINGS OF FACT

The court, having considered the evidence, the report of Trial Commissioner Lloyd Fletcher, and the briefs and argument of counsel, makes findings of fact as follows:

1. The plaintiff by this action seeks the refund of income taxes (plus statutory interest) alleged to have been paid erroneously to the defendant for the taxable years 1957 and 1958 in the amounts of $ 231 and $ 510, respectively. The issue involved is whether, for the taxable years involved, plaintiff was an organization exempt from the payment of income taxes under section 501(c)(3) of the Internal Revenue Code of 1954, 26 U.S.C. (I.R.C. 1954) Section 501(c)(3) (1958 Ed.) That section, in pertinent part, provides an exemption from income taxes for any corporation, fund, or foundation which is "organized and operated exclusively" for charitable, scientific, or educational purposes, no part of the net earnings of which inures to the benefit of any private shareholder or individual.

2. The plaintiff organization was conceived in 1934 by Edward C. Harwood and Helen Fowle. They first formalized the organization as an unincorporated trust by an Agreement and Declaration of Trust dated January 10, 1935, by which they transferred to Edward C. Harwood, as Trustee, "all the books, papers, records, office equipment, good will, and property of whatever nature and wherever situated which is at present used in the conduct of the work of the American Institute for Economic Research, for the purpose of teaching and disseminating economic knowledge with a view to advancing the welfare of the American people, and the doing of everything necessary, suitable and proper for the accomplishment of said purposes."

3. On August 19, 1938, the Commissioner of Internal Revenue ruled that plaintiff, as an unincorporated trust, was an exempt organization within the purview of section 101 (6) of the Revenue Act of 1938, 52 Stat. 447, 481, and relieved plaintiff of the need to file returns of income so long as its purposes and activities remained unchanged. The ruling stated in pertinent part, as follows:

     According to the evidence recently furnished this office, the

     We, whose names are hereto subscribed, do, by this agreement,

The corporate bylaws (including amendments to December 31, 1959) provide, in pertinent part, as follows:

                                Part I

6. On August 23, 1955, the Commissioner of Internal Revenue advised plaintiff, in substance, that the act of incorporation had created, or converted plaintiff into, a new legal entity and directed that plaintiff file a new claim for exemption from payment of income taxes.

On September 12, 1955, plaintiff filed its claim for exemption from payment of income taxes as an exempt corporation under section 501(c)(3) of the Internal Revenue Code of 1954. By letter dated March 13, 1957, the Internal Revenue Service denied plaintiff's claim to exemption, stating:

     * * * *

     * * * *

9. Plaintiff's predecessor organization commenced its operations in a small office at the Massachusetts Institute of Technology. Shortly thereafter, it moved to larger quarters in Cambridge, Massachusetts near Harvard University and, in 1939, became incorporated. By 1946, plaintiff had expanded to a point where it was able to acquire and move into a 31-room building located on 100 acres of land near Great Barrington, Massachusetts, where its activities have been carried on ever since.

10. Almost from its inception, and continuing to date, the plaintiff has prepared and published two periodicals. One of these is called the Investment Bulletin and is published twice monthly at a subscription cost of $ 10 per year; the other is called Research Reports, which is published weekly at a subscription cost of $ 25 per year.

The Investment Bulletin and Related Services

This publication is described by plaintiff as "intended to provide adequate advice for investors at the lowest possible cost." Four times a year subscribers to this bulletin receive a supplementary document entitled Quarterly List of Recommended Securities in which plaintiff makes recommendations as to purchase or sale of selected fixed income securities, investment trust shares, and common stocks. The recommendations may vary, dependent upon whether the reader is interested in (1) the "Investment Plan," which is intended to meet the needs of the investor dependent on the income from his security holdings, (2) the "Speculative-Investment Plan," which is intended to meet the needs of the individual who has a reasonably certain and adequate business or other income and who desires to augment that income and increase his capital, or (3) the "Speculative Plan," which is intended to meet the needs of the speculator who desires to augment his capital in spite of the fact that speculation necessarily involves the risk of losses as well as the possibility of gains. Plaintiff describes its Investment Bulletin in the following language:

     * * * The bulletins are issued twice monthly and include brief

Finally, plaintiff holds itself out to make, without cost, a "preliminary survey" of any individual's financial problems in order to ascertain:

     Whether or not the probable savings or other reasons would

Research Reports and Related Publications

The other, and still continuing, periodical prepared and published by plaintiff from a very early date in its history is a weekly publication entitled Research Reports. The contents of this weekly publication are described by plaintiff as follows:

     * * * Current economic events are analyzed, and important

The extensive research which goes into the preparation of the aforesaid weekly reports and special bulletins is frequently made use of by plaintiff's faculty and staff in preparing for publication in pamphlet forma large number of books devoted to economic and financial problems. ² These books are sold at a price of $ 1 each. Due to the subject matter discussed, the conclusions arrived at in these books may fairly be characterized as controversial. However, there can be little doubt that they reflect extensive and scholarly research in the field of economics and finance. The director and co-founder of plaintiff has long been an exponent of applying to the study of economics, where possible, the general methods of research and inquiry developed in the domain of the natural sciences. For example, in one of his major works, he asserts:

     That the revolution in method fostered by Galileo has begun to be

11. Apart from the activities described in the immediately preceding finding, plaintiff's only other significant activity has been carried on in the general field of formal education. Plaintiff has no authority to award degrees and has never conducted a college or university in the usual sense. During the years involved herein, it provided no formal educational program of any type on its own premises.

The Fellowship Program

In 1946, plaintiff had inaugurated a fellowship program which it discontinued in 1955 due to the adverse effects of the draft and the Korean War. This fellowship program during those years comprised a 2-year course of training in research and advanced economics at the postgraduate level, ⁴ and from three to eight Fellows were in attendance at various times. Such training took the form of participation in active research projects on various economic problems. During their mornings, the Fellows in attendance rotated among the members of the faculty, gaining experience in the actual conduct of economic research. In the words of plaintiff's fellowship award notice, afternoons were spent in "study, research, and conference (class) periods." In its training program, plaintiff did not make use of the formal classroom method, as that concept is traditionally understood. Rather, its course instruction was accomplished in small conference groups attended by an instructor and three to five Fellows. Such a conference was described by plaintiff's director as "a seminar period." Course grades were simply "satisfactory" or "unsatisfactory". Plaintiff's goal was "not a passing grade but research and writing of quality fit for publication as a part of the Institute's work." However, during the 9-year period of plaintiff's fellowship program, it appears that only two Fellows were credited with a part in any of plaintiff's publications. ⁵ Arrangements had been made by plaintiff, so that Fellows would be given some credit towards a doctorate in economics by Claremont Graduate School in California and The University of Washington.

Applications for a fellowship were secured through fellowship award announcements to all members of the American Economic Association, and the departments of economics in a number of colleges and universities. Each applicant was offered, if he should be chosen, free tuition and books plus an annual stipend. The stipend was scaled as follows: In the case of Fellows with a B.S. or B.A. degree, $ 1800 the first year and $ 2100 the second; for those with M.A. or M.S. degrees, $ 2000 and $ 2400; for those with Ph. D. or D. Sc. degrees, $ 2500 and $ 3000. During the period 1947-1950 this method of recruitment resulted in plaintiff's receipt of 60 or 70 applications each year of which 4 or 5 were accepted for the 2-year program. Fellows were required to be in attendance from Monday through Friday. They were given three weeks' summer leave. Fellows who failed to demonstrate fitness for continuing the program could be discharged by plaintiff on 30 days' notice. At the trial of this case, plaintiff's director testified that in the following month, the fellowship program would be revived with six Fellows in attendance, only two of whom, however, would receive the stipend above described.

The Scholarship Program

Through the efforts of its director, the plaintiff was instrumental in the formation during 1955 of The Interfoundation Committee for Economic Scholarships. Three private foundations joined with plaintiff in a program designed to seek out the best students to be found in secondary, or high schools, and to interest them in the field of economic research, through an offer of scholarship awards in aid of college expenses. Plaintiff agreed to pay the expense necessary to administering the program and to provide any scholarships which the foundations were unable to provide at any given time. Plaintiff believed such program would provide a source of talented students for its then inactive fellowship program, and it agreed to set aside $ 50,000 in the form of a fund available for fellowship stipends if and when such students had completed college and were accepted into plaintiff's fellowship program. ⁶ Plaintiff's director has always been an active member of this Committee.

In behalf of the Committee, plaintiff prepared and printed two brochures, including a form of application for scholarship, describing the details of the program. These were distributed by plaintiff annually to high school students throughout the country who, by reason of high-ranking grades in their academic courses, had been placed on the annual list of the National Merit Scholarship program. The Interfoundation Committee, acting through plaintiff as its administrative agency, made scholarship awards to 184 students during the academic year 1956-57 and to 219 students during the academic year 1957-58. The sums received by plaintiff from the Foundations for scholarship awards during the calendar years 1957 and 1958 totaled $ 43,535.46. For those same years, plaintiff paid out in scholarship funds the total sum of $ 32,625.00, or an average award of approximately $ 80 per student. At December 31, 1958, plaintiff's "Scholarship Account" showed a balance of $ 8.34. The record is inconclusive as to whether the difference of about $ 10,900 between the scholarship funds so received by plaintiff and the awards so expended was used by plaintiff to defray its expenses of administering the fund or was placed in some investment account. In one year during the period 1955-60, plaintiff contributed to the scholarship program an amount somewhere between $ 12,000 and $ 14,000.

12. Any person paying the sum of $ 35 per year to plaintiff will receive its biweekly Investment Bulletin, its weekly Research Reports, and all its book publications currently available including annual revisions thereto. During the years 1957 and 1958, the plaintiff received the sums of $ 96,540.17 and $ 117,300.78, respectively, from individuals subscribing for these publications on an annual basis. Plaintiff refers to these subscribers as its "Annual Sustaining Members." Plaintiff also received in 1957 and 1958 the sums of $ 132,226.59 and $ 157,544.31, respectively, from persons subscribing for the Investment Bulletin alone or for one of the plaintiff's investment services. The weekly research reports and many of plaintiff's treatises on economic problems are distributed free of charge to approximately 2,000 college, university and public libraries throughout the United States. The Investment Bulletin is not so distributed. Plaintiff accepts no outside advertising from any source but does carry extensive advertising of its own publications and services in its various books and periodicals. Plaintiff owns a printing press and related facilities located on its premises where it accomplishes about one-half its total printing requirements. The remainder of its printing is done by a printing establishment in Pittsfield, Massachusetts.

13. The following are condensations of pertinent parts of plaintiff's financial statements for the years involved herein:

                  Receipts and Expenditures Statement

In organizing the plaintiff, Mr. Harwood believed, and still does believe, that his concept of soliciting financial support from a large number of individuals rather than from only a few wealthy sources would have the salutary result of freeing plaintiff's management, faculty, and research workers from possible bias in their analyses of economic problems. This concept resulted in plaintiff's system of "Annual Sustaining Members" who pay plaintiff $ 35 a year for which they are entitled to receive, if desired, all of plaintiff's publications. The number of annual sustaining members has ranged from a low point of 300 during World War II ⁷ to the present number of 4500. In recent years a small number of these have volunteered their services by interviewing students under the scholarship program described above in order to keep plaintiff in touch with the student's scholastic programs and progress. In addition to amounts received from annual sustaining members and from sales of its publications, plaintiff has received one individual grant of $ 60,000 for the fellowship program and an annual $ 5,000 contribution from one foundation for the past 11 years. Although plaintiff's Certificate of Incorporation, Agreement of Association, and Bylaws make no specific provision for the distribution of plaintiff's net assets in the event of liquidation or dissolution, Mr. Harwood interprets the Bylaws as requiring court approval on any such distribution, and he believes that the net assets would be distributed to the National Bureau of Economic Research.

15. In his capacity as the original trustee, Mr. Harwood is empowered to employ, discharge, and determine the compensation of members of the faculty, subject to the approval of the majority of the faculty then in office. No part of plaintiff's real or personal property can be disposed of without his consent in writing, except for sales in the ordinary course of business. He has the power to manage plaintiff's properties in accordance with instructions from the faculty, and in the event of disagreement between him and the faculty in this respect, provision is made in the Bylaws for obtaining a solution of the disagreement by a court of competent jurisdiction. In his capacity as trustee, Mr. Harwood is entitled to life tenure with plaintiff. During the years involved herein, Mr. Harwood's annual compensation covering all of his offices with plaintiff totaled about $ 18,000. Annual salary to the next highest paid employee was $ 12,000.

16. Plaintiff has never engaged in the carrying on of propaganda or otherwise attempting to influence legislation, nor has it participated in, or intervened in, any political campaign on behalf of any candidate for public office.

17. Prior to 1957, plaintiff had accumulated certain funds, a portion of which was invested by it in 1200 shares of common stock of the Tri-Continental Corporation, an investment trust. During the calendar years 1957 and 1958, these shares became entitled to a proportionate share of the undistributed capital gains earned by that company for those years in the amounts of $ 924 and $ 2,040, respectively. The Tri-Continental Corporation paid to the United States, on plaintiff's account, income taxes on said undistributed capital gains in the amount of $ 231 for 1957, and $ 510 for 1958, said taxes being computed at the rate of 25 percent.

On November 4, 1959, plaintiff timely filed its claims for refund of the full amount of the taxes so paid on its behalf by the Tri -Continental Corporation, citing as grounds therefor its alleged tax exempt status. On December 4, 1959, both claims were disallowed in full by the District Director, Internal Revenue Service, New York, N.Y. Thereafter, plaintiff timely filed its petition in this court.

CONCLUSION OF LAW

Upon the foregoing findings of fact, which are made a part of the judgment herein, the court concludes as a matter of law that the plaintiff is not entitled to recover, and the petition is therefore dismissed.

¹ This case involved section 811(b)(8) of the Social Security Act, 49 Stat. 620, 639, which is in terms substantially the same as section 501(c)(3) of the Internal Revenue Code. See Scripture Press Foundation v. United States, 152 Ct. Cl. 463, 285 F. 2d 800, cert. den., 368 U.S. 985, in which we cited the case as relevant authority for the construction of section 501(c)(3).

² One of plaintiff's books also deals extensively with elementary legal concepts involved in wills, trusts, administration of estates, contracts, negotiable instruments, marital rights, insurance, title to property, and Federal and State taxation. The reader is cautioned, however, to seek the advice of a lawyer on "intricate financial and legal tangles." Masteller, How to Avoid Financial Tangles.

³ Harwood, Reconstruction of Economics, p. 82.

⁴ Plaintiff has never had any undergraduate students in attendance.

⁵ These two Fellows were originally credited with co-authorship of Economic Tides and Trends, but by 1960 this credit had been removed apparently as a result of a revision to the book.

⁶ This sum was placed in an account called Special Reserve for Fellowships.

⁷ No publications were issued by plaintiff during the period of World War II.