Rev. Rul. 74-319

Advice has been requested as to the proper treatment of amounts received by a corporation, under the facts and circumstances described below.

M corporation is engaged in the manufacture and sale of a particular product. M's franchised dealers (dealers) desirous of increasing profits from the sale of M's product decided to conduct a national advertising campaign to advertise M's product. They agreed on the establishment of a "fund" in which money from all dealers would be accumulated and spent for national advertising of M's product.

M and its dealers entered into a written agreement that required each dealer to pay into a fund administered by M an amount to be used for the purpose of conducting a national advertising campaign. Under the agreement the money received by M is accumulated and spent on national advertising of M's product for the benefit of all the dealers.

The amounts received by M from the dealers are commingled and deposited by M, together with receipts from its business, in M's regular checking account. M did not establish a separate bank account for national advertising funds because such funds received from the dealers were segregated and earmarked on its books. M has on hand at all times cash and securities in excess of the unspent cash earmarked for national advertising. No refunds were ever to be made to any dealer of any payment made to M for national advertising. If a dealer sold his franchise, the purchaser was credited with the prior dealer's contributions. In the event that a majority of the dealers decide to terminate the program, and there are funds on hand at such time, all funds on hand are to be spent by M for national advertising until exhausted.

M neither includes the money received from its dealers in its gross income nor does it deduct the amounts spent on national advertising for the benefit of its dealers. The unexpended money on hand at the end of the year is treated by M on its books as a liability to the dealers.

Facts similar to those above were considered in The Seven-Up Company, 14 T.C. 965 (1950), acq., 1950-2 C.B. 4. The Tax Court of the United States found that payments collected by the Seven-Up Company from its bottlers did not constitute gross income to the company since the funds were collected pursuant to an explicit written agreement that required them to be turned over to an advertising campaign that was negotiated and controlled by the bottlers.

The Internal Revenue Service continues to agree that the Tax Court was correct in Seven-Up Company that the Seven-Up Company did not have to include the payments it received from its bottlers in its gross income. Under the circumstances described above, however, the dealers associated themselves together in the formation of an unincorporated organization for the purpose of conducting a nationwide program for advertising the product that each dealer distributed.

The question is whether that organization is an association taxable as a corporation for Federal income tax purposes.

Section 7701(a)(3) of the Internal Revenue Code of 1954 provides that the term "corporation" includes associations, joint stock companies, and insurance companies.

Not all activities conducted jointly by individuals are treated as separate entities for tax purposes. Regulations under section 7701 of the Code set forth criteria for determining whether individuals engaging in common activities are entities for tax purposes and for distinguishing between organizations which are taxable as trusts, partnerships or corporations. However, those criteria were developed without reference to, and do not definitively cover, unincorporated organizations (other than trusts) that are engaged in not-for-profit activities. Based upon all the circumstances of the instant case, it is concluded that the organization is a separate taxable entity that more nearly resembles a corporation rather than a trust or partnership, and that the tax rules for corporations apply.

Accordingly, in the instant case, the amounts received by M to be spent on national advertising for the benefit of the dealers are not includible in the gross income of M, but are includible in the gross income of the association of the dealers. This association is required to file a U. S. Corporation Income Tax Return, Form 1120. It is entitled to all allowable deductions, including amounts paid or incurred for advertising M's product, subject to the provisions of section 277 (relating to deductions by membership organizations from transactions with its members).

In view of the foregoing, the acquiescence in The Seven-Up Company is withdrawn and acquiescence in result only substituted therefor. See page 4, this Bulletin.

See also, Rev. Rul. 74-318, page 14, of this Bulletin, which relates to the treatment of amounts received by an entity whose members are automobile dealers.