Subject:  PORTLAND GOLF CLUB v. COMMISSIONER, Syllabus



 
    NOTE: Where it is feasible, a syllabus (headnote) will be released, as
is being done in connection with this case, at the time the opinion is
issued.  The syllabus constitutes no part of the opinion of the Court but
has been prepared by the Reporter of Decisions for the convenience of the
reader.  See United States v. Detroit Lumber Co., 200 U. S. 321, 337.
SUPREME COURT OF THE UNITED STATES


Syllabus



PORTLAND GOLF CLUB v. COMMISSIONER OF
INTERNAL REVENUE


certiorari to the united states court of appeals for the ninth circuit

No. 89-530.  Argued April 17, 1990--Decided June 21, 1990

As a nonprofit corporation that owns and operates a private social club,
petitioner's income derived from membership fees and other receipts from
members is exempt from income tax.  However, all other income is nonexempt
"unrelated business taxable income," defined in MDRV 512(a)(3)(A) of the
Internal Revenue Code as "the gross income (excluding any exempt function
income), less the deductions allowed by this chapter which are directly
connected with the production of the gross income (excluding exempt
function income)."  Petitioner has nonexempt income from sales of food and
drink to nonmembers and from return on its investments.  During its 1980
and 1981 tax years, petitioner offset net losses on nonmember sales against
the earnings from its investments and reported no unrelated business
taxable income.  In computing its losses, petitioner identified two
categories of expenses incurred in nonmember sales: (1) variable (direct)
expenses, such as the cost of food, which, in each year in question, were
exceeded by gross income from nonmember sales; and (2) fixed (indirect)
overhead expenses, which would have been incurred whether or not sales had
been made to nonmembers.  It determined what portions of fixed expenses
were attributable to nonmember sales by employing an allocation formula
known as the "gross-to-gross method," based on the ratio that nonmember
sales bore to total sales.  The total of these fixed expenses and variable
costs exceeded petitioner's gross income from nonmember sales.  On audit,
the Commissioner determined that petitioner could deduct expenses
associated with nonmember sales up to the amount of receipts from the sales
themselves, but could not use losses from those activities to offset its
investment income because it had failed to show that its nonmember sales
were undertaken with an intent to profit.  Petitioner sought
redetermination, and the Tax Court ruled in petitioner's favor, concluding
that petitioner had adequately demonstrated that it had a profit motive,
since its gross receipts from nonmember sales consistently exceeded the
variable costs associated with those activities.  The Court of Appeals
reversed, holding that the Tax Court had applied an incorrect legal
standard in determining that petitioner had demonstrated an intent to
profit, because profit in this context meant the production of gains in
excess of all direct and indirect costs.  The court remanded the case for a
determination whether petitioner engaged in its nonmember activities with
the required intent to profit from those activities.

Held: Petitioner may use losses incurred in sales to nonmembers to offset
investment income only if those sales were motivated by an intent to
profit, which is to be determined by using the same allocation method as
petitioner used to compute its actual profit or loss.  Pp. 5-16.

    (a) The statutory scheme for the taxation of social clubs was intended
to achieve tax neutrality by ensuring that members are not subject to tax
disadvantages as a consequence of their decision to pool their resources
for the purchase of social or recreational services, but was not intended
to provide clubs with a tax advantage.  Pp. 5-8.

    (b) By limiting deductions from unrelated business income to those
expenses allowable as deductions under "this chapter," MDRV 512(a)(3)(A)
limits such deductions to expenses allowable under Chapter 1 of the Code.
Since only MDRV 162 of Chapter 1 serves as a basis for the deductions
claimed here, and since a taxpayer's activities fall within MDRV 162's
scope only if an intent to profit is shown, see Commissioner v.
Groetzinger, 480 U. S. 23, 35, petitioner's nonmember sales must be
motivated by an intent to profit.  Dispensing with the profit-motive
requirement in this case would run counter to the principle of tax
neutrality underlying the statutory scheme.  Pp. 9-11.

    (c) The Commissioner correctly concluded that the same allocation
method must be used in determining petitioner's intent to profit as in
computing its actual profit or loss.  It is an inherent contradiction to
argue that the same fixed expenses that are attributable to nonmember sales
in calculating actual losses can also be attributed to membership
activities in determining whether petitioner acted with the requisite
intent to profit.  Having chosen to calculate its actual losses on the
basis of the gross-to-gross formula, petitioner is foreclosed from
attempting to demonstrate its intent to profit based on some other
allocation method.  Pp. 11-15.

    (d) Petitioner has failed to show that it intended to earn gross income
from nonmember sales in excess of its total costs, where fixed expenses are
allocated using the gross-to-gross method.  P. 16.

876 F. 2d 897, affirmed.

Blackmun, J., delivered the opinion of the Court, in which Rehnquist, C.
J., and Brennan, White, Marshall, and Stevens, JJ., joined, and in which
O'Connor, Scalia, and Kennedy, JJ., joined except as to Parts III-B and IV.
Kennedy, J., filed an opinion concurring in part and concurring in the
judgment, in which O'Connor and Scalia, JJ., joined.
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Subject: 89-530--OPINION, PORTLAND GOLF CLUB v. COMMISSIONER

 


NOTICE: This opinion is subject to formal revision before publication in
the preliminary print of the United States Reports.  Readers are requested
to notify the Reporter of Decisions, Supreme Court of the United States,
Washington, D. C. 20543, of any typographical or other formal errors, in
order that corrections may be made before the preliminary print goes to
press.

SUPREME COURT OF THE UNITED STATES


No. 89-530



PORTLAND GOLF CLUB, PETITIONER v. COMMIS- SIONER OF INTERNAL REVENUE

on writ of certiorari to the united states court of appeals for the ninth
circuit

[June 21, 1990]



    Justice Blackmun delivered the opinion of the Court.
    This case requires us to determine the circumstances under which a
social club, in calculating its liability for federal income tax, may
offset losses incurred in selling food and drink to nonmembers against the
income realized from its investments.

I
    Petitioner Portland Golf Club (Portland Golf) is a nonprofit Oregon
corporation, most of whose income is exempt from federal income tax under
MDRV 501(c)(7) of the Internal Revenue Code of 1954, 26 U. S. C. MDRV
501(c)(7). {1}  Since 1914 petitioner has owned and operated a private golf
and country club with a golf course, restaurant and bar, swimming pool, and
tennis courts.  The great part of petitioner's income is derived from
membership dues and other receipts from the club's members; that income is
exempt from tax.  Portland Golf also has two sources of nonexempt
"unrelated business taxable income": sales of food and drink to nonmembers,
and return on its investments. {2}
    The present controversy centers on Portland Golf's federal income tax
liability for its fiscal years ended September 30, 1980, and September 30,
1981, respectively.  Petitioner received investment income in the form of
interest in the amount of $11,752 for fiscal 1980 and in the amount of
$21,414 for fiscal 1981.  App. 18.  It sustained net losses of $28,433 for
fiscal 1980 and $69,608 for fiscal 1981 on sales of food and drink to
nonmembers.  Petitioner offset these losses against the earnings from its
investments and therefore reported no unrelated business taxable income for
the two tax years.  In computing these losses, petitioner identified two
different categories of expenses incurred in selling food and drink to
nonmembers.  First, petitioner incurred variable (or direct) expenses, such
as the cost of food, which varied depending on the amount of food and
beverages sold (and therefore would not have been incurred had no sales to
nonmembers been made).  For each year in question, petitioner's gross
income from nonmember sales exceeded these variable costs. {3}  Petitioner
also included as an unrelated business expense a portion of the fixed (or
indirect) overhead expenses of the club-- expenses which would have been
incurred whether or not petitioner had made sales to nonmembers.  In
determining what portions of its fixed expenses were attributable to
nonmember sales, petitioner employed an allocation formula, described as
the "gross-to-gross method," based on the ratio that nonmember sales bore
to total sales. {4}  When fixed expenses, so calculated, were added to
petitioner's variable costs, the total exceeded Portland Golf's gross
income from nonmember sales. {5}
    On audit, the Commissioner took the position that petitioner could
deduct expenses associated with nonmember sales up to the amount of
receipts from the sales themselves, but that it could not use losses from
those activities to offset its investment income.  The Commissioner based
that conclusion on the belief that a profit motive was required if losses
from these activities were to be used to offset income from other sources,
and that Portland Golf had failed to show that its sales to nonmembers were
undertaken with an intent to profit. {6}  The Commissioner therefore
determined deficiencies of $1,828 for 1980 and $3,470 for 1981; these
deficiencies reflected tax owed on petitioner's investment income.  App.
48-51.
    Portland Golf sought redetermination in the Tax Court.  That court
ruled in petitioner's favor.  55 TCM 212 (1988).  The court assumed,
without deciding, that losses incurred in the course of sales to nonmembers
could be used to offset other nonexempt income only if the sales were
undertaken with an intent to profit.  The court, however, held that
Portland Golf had adequately demonstrated a profit motive, since its gross
receipts from sales to nonmembers consistently exceeded the variable costs
associated with those activities. {7}  The court therefore held that
"petitioner is entitled to offset its unrelated business taxable income
from interest by its loss from its nonmember food and beverage sales
computed by allocating a portion of its fixed expenses to the nonmember
food and beverage sales activity in a manner which respondent agrees is
acceptable."  Id., at 217.
    The United States Court of Appeals for the Ninth Circuit reversed.
App. to Pet. for Cert. 1a.  The Court of Appeals held that the Tax Court
had applied an incorrect legal standard in determining that Portland Golf
had demonstrated an intent to profit from sales to nonmembers.  The
appellate court relied on its decision in North Ridge Country Club v.
Commissioner, 877 F. 2d 750 (1989), where it had ruled that a social club
"can properly deduct losses from a non-member activity only if it
undertakes that activity with the intent to profit, where profit means the
production of gains in excess of all direct and indirect costs."  Id., at
756.  The same court in the present case concluded: "Because Portland Golf
Club could have reported gains in excess of direct and indirect costs, but
did not do so, relying on a method of allocation stipulated to be
reasonable by the Commissioner, we REMAND this case to the tax court for a
determination of whether Portland Golf Club engaged in its non-member
activities with the intent required under North Ridge to deduct its losses
from those activities."  App. to Pet. for Cert. 2a-3a. {8}
    Because of a perceived conflict with the decision of the Sixth Circuit
in Cleveland Athletic Club, Inc. v. United States, 779 F. 2d 1160 (1985),
{9} and because of the importance of the issue, we granted certiorari.
---- U. S. ---- (1990).

II
    Virtually all tax-exempt business organizations are required to pay
federal income tax on their "unrelated business taxable income."  The law
governing social clubs, however, is significantly different from that
governing other tax- exempt entities.  As to exempt organizations other
than social clubs, the Code defines "unrelated business taxable income" as
"the gross income derived by any organization from any unrelated trade or
business (as defined in section 513) regularly carried on by it, less the
deductions allowed by this chapter which are directly connected with the
carrying on of such trade or business."  26 U. S. C. MDRV 512(a)(1). {10}
As to social clubs, however, "unrelated business taxable income" is defined
as "the gross income (excluding any exempt function income), less the
deductions allowed by this chapter which are directly connected with the
production of the gross income (excluding exempt function income)."  MDRV
512(a)(3)(A). {11}  The salient point is that MDRV 512(a)(1) (which applies
to most exempt organizations) limits "unrelated business taxable income" to
income derived from a "trade or business," while MDRV 512(a)(3)(A) (which
applies to social clubs) contains no such limitation.  Thus, a social
club's investment income is subject to federal income tax, while the
investment income of most other exempt organizations is not.
    This distinction reflects the fact that a social club's exemption from
federal income tax has a justification fundamentally different from that
which underlies the grant of tax exemptions to other nonprofit entities.
For most such organizations, exemption from federal income tax is intended
to encourage the provision of services that are deemed socially beneficial.
Taxes are levied on "unrelated business income" only in order to prevent
tax-exempt organizations from gaining an unfair advantage over competing
commercial enterprises. {12}  See United States v. American College of
Physicians, 475 U. S. 834, 838 (1986) ("Congress perceived a need to
restrain the unfair competition fostered by the tax laws").  Since Congress
concluded that investors reaping tax-exempt income from passive sources
would not be in competition with commercial businesses, it excluded from
tax the investment income realized by exempt organizations. {13}
    The exemption for social clubs rests on a totally different premise.
Social clubs are exempted from tax not as a means of conferring tax
advantages, but as a means of ensuring that the members are not subject to
tax disadvantages as a consequence of their decision to pool their
resources for the purchase of social or recreational services.  The Senate
Report accompanying the Tax Reform Act of 1969, 83 Stat. 536, explained
that that purpose does not justify a tax exemption for income derived from
investments:


"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 . . . 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. . . .  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. Rep. No. 91-552, p. 71 (1969).


    In the Tax Reform Act of 1969, Congress extended the tax on "unrelated
business income" to social clubs.  As to these organizations, however,
Congress defined "unrelated business taxable income" to include income
derived from investments.  Our review of the present case must therefore be
informed by two central facts.  First, Congress intended that the
investment income of social clubs should be subject to federal tax, and
indeed Congress devised a definition of "unrelated business taxable income"
with that purpose in mind.  Second, the statutory scheme for the taxation
of social clubs was intended to achieve tax neutrality, not to provide
these clubs a tax advantage: even the exemption for income derived from
members' payments was designed to ensure that members are not disadvantaged
as compared with persons who pursue recreation through private purchases
rather than through the medium of an organization.

III
    Petitioner's principal argument is that it may deduct losses incurred
through sales to nonmembers without demonstrating that these sales were
motivated by an intent to profit.  In the alternative, petitioner contends
(and the Tax Court agreed) that if the Code does impose a profit-motive
requirement, then that requirement has been satisfied in this case.  We
address these arguments in turn.

A
    We agree with the Commissioner and the Court of Appeals that petitioner
may use losses incurred in sales to nonmembers to offset investment income
only if those sales were motivated by an intent to profit.  The statute
provides that, as to social clubs, "the term `unrelated business taxable
income' means the gross income (excluding any exempt function income), less
the deductions allowed by this chapter which are directly connected with
the production of the gross income (excluding exempt function income)."
MDRV 512(a)(3)(A) (emphasis added).  As petitioner concedes, the italicized
language limits deductions from unrelated business income to expenses
allowable as deductions under Chapter 1 of the Code.  See Brief for
Petitioner 21-22.  In our view, the deductions claimed in this
case--expenses for food, payroll, and overhead in excess of gross receipts
from nonmember sales--are allowable, if at all, only under MDRV 162 of the
Code.  See North Ridge Country Club v. Commissioner, 877 F. 2d 750, 753
(CA9 1989); The Brook, Inc. v. Commissioner, 799 F. 2d 833, 838 (CA2 1986).
{14}  Section 162(a) provides a deduction for "all the ordinary and
necessary expenses paid or incurred during the taxable year in carrying on
any trade or business."  Although the statute does not expressly require
that a "trade or business" must be carried on with an intent to profit,
this Court has ruled that a taxpayer's activities fall within the scope of
MDRV 162 only if an intent to profit has been shown.  See Commissioner v.
Groetzinger, 480 U. S. 23, 35 (1987) ("to be engaged in a [MDRV 162] trade
or business, . . . the taxpayer's primary purpose for engaging in the
activity must be for income or profit").  Thus, the losses that Portland
Golf incurred in selling food and drink to nonmembers will constitute
"deductions allowed by this chapter" only if the club's nonmember sales
were performed with an intent to profit. {15}
    We see no basis for dispensing with the profit-motive requirement in
the present case.  Indeed, such an exemption would be in considerable
tension with the statutory scheme devised by Congress to govern the
taxation of social clubs.  Congress intended that the investment income of
social clubs (unlike the investment income of most other exempt
organizations) should be subject to the same tax consequences as the
investment income of any other taxpayer.  To allow such an offset for
social clubs would run counter to the principle of tax neutrality which
underlies the statutory scheme.
    Petitioner concedes that "[g]enerally a profit motive is a necessary
factor in determining whether an activity is a trade or business."  Brief
for Petitioner 23.  Petitioner contends, however, that by including
receipts from sales to nonmembers within MDRV 512(a)(3)(A)'s definition of
"unrelated business taxable income," the Code has defined nonmember sales
as a "trade or business," and has thereby obviated the need for an inquiry
into the taxpayer's intent to profit.  We disagree.  In our view, Congress'
use of the term "unrelated business taxable income" to describe all
receipts other than payments from the members hardly manifests an intent to
define as a "trade or business" activities otherwise outside the scope of
MDRV 162.  Petitioner's reading would render superfluous the words "allowed
by this chapter" in MDRV 512(a)(3)(A): if each taxable activity of a social
club is "deemed" to be a trade or business, then all of the expenses
"directly connected" with those activities would presumably be deductible.
Moreover, Portland Golf's interpretation ignores Congress' general intent
to tax the income of social clubs according to the same principles
applicable to other taxpayers.  We therefore conclude that petitioner may
offset losses incurred in sales to nonmembers against investment income
only if its nonmember sales are motivated by an intent to profit. {16}

B
    Losses from Portland Golf's sales to nonmembers may be used to offset
investment income only if those activities were undertaken with a profit
motive--that is, an intent to generate receipts in excess of costs.  The
parties and the other courts in this case, however, have taken divergent
positions as to the range of expenses that qualify as costs of the non
exempt activity, and are to be considered in determining whether petitioner
acted with the requisite profit motive.  In the view of the Tax Court,
petitioner's profit motive was established by the fact that the club's
receipts from nonmember sales exceeded its variable costs.  Since Portland
Golf's fixed costs, by definition, have been incurred even in the absence
of sales to nonmembers, the Tax Court concluded that these costs should be
disregarded in determining petitioner's intent to profit.
    The Commissioner has taken no firm position as to the precise manner in
which Portland Golf's fixed costs are to be allocated between member and
nonmember sales.  Indeed, the Commissioner does not even insist that any
portion of petitioner's fixed costs must be attributed to nonmember
activities in determining intent to profit. {17}  He does insist, however,
that the same allocation method is to be used in determining petitioner's
intent to profit as in computing its actual profit or loss.  See Brief for
Respondent 44-46.  In the present case the parties have stipulated that the
gross-to- gross method provides a reasonable formula for allocating fixed
costs, and Portland Golf has used that method in calculating the losses
incurred in selling food and drink to nonmembers.  The Commissioner
contends that petitioner is therefore required to demonstrate an intent to
earn gross receipts in excess of fixed and variable costs, with the
allocable share of fixed costs being determined by the gross-to-gross
method.
    Although the Court of Appeals' opinion is not entirely clear on this
point, see n. 8, supra, that court seems to have taken a middle ground.
The Court of Appeals expressly rejected the Tax Court's assertion that
profit motive could be established by a showing that gross receipts
exceeded variable costs; the court insisted that some portion of fixed
costs must be considered in determining intent to profit.  The court
appeared, however, to leave open the possibility that Portland Golf could
use the gross-to-gross method in calculating its actual losses, while using
some other allocation method to demonstrate that its sales to nonmembers
were undertaken with a profit motive. {18}
    We conclude that the Commissioner's position is the correct one.
Portland Golf's argument rests, as the Commissioner puts it, on an
"inherent contradiction."  Brief for Respondent 44.  Petitioner's
calculation of actual losses rests on the claim that a portion of its fixed
expenses is properly regarded as attributable to the production of income
from nonmember sales.  Given this assertion, we do not believe that these
expenses can be ignored (or, more accurately, attributed to petitioner's
exempt activities) in determining whether petitioner acted with the
requisite intent to profit.  Essentially the same criticism applies to the
Court of Appeals' approach.  That court required petitioner to include some
portion of fixed expenses in demonstrating its intent to profit, but it
left open the possibility that petitioner could employ an allocation method
different from that used in calculating its actual losses.  Under that
approach, some of petitioner's fixed expenses could be attributed to exempt
functions in determining intent to profit and to nonmember sales in
establishing the club's actual loss.  This, like the rationale of the Tax
Court, seems to us to rest on an "inherent contradiction."
    Petitioner's principal response is that MDRV 162 requires an intent to
earn an economic profit, and that this is quite different from an intent to
earn taxable income.  Portland Golf emphasizes that numerous provisions of
the Code establish deductions and preferences which do not purport to
mirror economic reality.  Therefore, petitioner argues, taxpayers may
frequently act with an intent to profit, even though the foreseeable (and,
indeed, the intended) result of their efforts is that they suffer (or
achieve) tax losses.  Much of the Code, in petitioner's view, would be
rendered a nullity if the mere fact of tax losses sufficed to show that a
taxpayer lacked an intent to profit, thereby rendering the deductions
unavailable.  In Portland Golf's view, the parties have stipulated only
that the gross-to-gross formula provides a reasonable method of determining
what portion of fixed expenses is "directly connected" with the nonexempt
activity for purposes of computing taxable income.  That stipulation,
Portland Golf contends, is irrelevant in determining the portion of fixed
expenses that represents the actual economic cost of the activity in
question.
    We accept petitioner's contention that MDRV 162 requires only an intent
to earn an economic profit.  We acknowledge, moreover, that many Code
provisions are designed to serve purposes (such as encouragement of certain
types of investment) other than the accurate measurement of economic
income.  A taxpayer who takes advantage of deductions or preferences of
that kind may establish an intent to profit even though he has no
expectation of realizing taxable income. {19}  The fixed expenses that
Portland Golf seeks to allocate to its nonmember sales, however, are
deductions of a different kind.  The Code does not state that fixed costs
are allocable on a gross-to-gross basis irrespective of economic reality.
Rather, petitioner's right to use the gross-to-gross method rests on the
club's assertion that this allocation formula reasonably identifies those
expenses that are "directly connected" to the nonmember sales, MDRV
512(a)(3)(A), and are "the ordinary and necessary expenses paid or
incurred" in selling food and drink to nonmembers, see MDRV 162(a). {20}
Language such as this, it seems to us, reflects an attempt to measure
economic income--not an effort to use the tax law to serve ancillary
purposes.  Having calculated its actual losses on the basis of the
gross-to-gross formula, petitioner is therefore foreclosed from attempting
to demonstrate its intent to profit by arguing that some other allocation
method more accurately reflects economic reality. {21}

IV
    We hold that any losses incurred as a result of petitioner's nonmember
sales may be offset against its investment income only if the nonmember
sales were undertaken with an intent to profit.  We also conclude that in
demonstrating the requisite profit motive, Portland Golf must employ the
same method of allocating fixed expenses as it uses in calculating its
actual loss.  Petitioner has failed to show that it intended to earn gross
income from nonmember sales in excess of its total (fixed plus variable)
costs, where fixed expenses are allocated using the gross-to-gross method.
{22}  The judgment of the Court of Appeals is therefore affirmed.

It is so ordered.


 
 
 
 
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1
    Section 501(c)(7) grants an exemption from federal income tax to
"[c]lubs organized for pleasure, recreation, and other nonprofitable
purposes, substantially all of the activities of which are for such
purposes and no part of the net earnings of which inures to the benefit of
any private shareholder."

2
    Section 511 of the Code provides that the "unrelated business taxable
income" of an exempt organization shall be taxed at the ordinary corporate
rate.  The term "unrelated business taxable income," as applied to the
income of a club such as petitioner, is defined in MDRV 512(a)(3)(A).  That
definition encompasses all sources of income except receipts from the
club's members.

3
    For 1980, gross receipts from nonmember sales in the bar and dining
room totalled $84,422, while variable expenses were $61,821.  For 1981,
gross receipts totalled $106,547 while variable expenses were $78,407.
App. 85.

4
    For example, if 10% of petitioner's gross receipts were derived from
nonmember sales, 10% of petitioner's fixed costs would be allocated to the
nonexempt activity.  That method of allocation appears rather generous to
Portland Golf.  The club charges nonmembers higher prices for food and
drink than members are charged, even though nonmembers' meals presumably
cost no more to prepare and serve.  It therefore seems likely that the
gross-to-gross method overstates the percentage of fixed costs properly
attributable to nonmember sales.  The parties, however, stipulated that
this allocation method was reasonable.  Id., at 17.

5
    The following table shows petitioner's losses when fixed costs are
allocated using the gross-to-gross method:



|1980\1981\

Gross income|$84,422 ^$106,547 ^
Variable expenses|(61,821)^(78,407)^
Allocated fixed expenses|(51,034)^(97,748)^

Net loss|($28,433)^ ($69,608)^

    It is of interest to note that if petitioner's fixed costs had been
allocated using an alternative formula, known as the "square foot and hours
of actual use" method, see id., at 29, its gross receipts exceeded the sum
of variable and allocated fixed costs for both years:

|1980\1981\

Gross income|$84,422 ^$106,547 ^
Variable expenses|(61,821)^(78,407)^
Allocated fixed expenses|(3,153)^(4,666)^


Net profit|$19,448 ^$23,474 ^


6
    The general rule under the Code is that losses incurred in a profit-
seeking venture may be deducted from unrelated income; expenses of a
not-for-profit activity may be offset against the income from that
activity, but losses may not be applied against income from other sources.
See 1 B. Bittker & L. Lokken, Federal Taxation of Income, Estates and Gifts
14 20.1.2, 22.5.4, pp. 20-6, 22-63 to 22-64 (2d ed. 1989).

7
    The Tax Court stated that Portland Golf "did intend to make a profit,
and did make a profit between the amount received from sales to nonmembers
and the costs related to those sales which would not have been incurred
absent those sales."  55 TCM, at 216.  The Tax Court, in articulating this
standard for determining whether intent to profit had been shown, relied on
its earlier reviewed decision in North Ridge Country Club v. Commissioner,
89 T. C. 563 (1987).  That decision subsequently was reversed.  877 F. 2d
750 (CA9 1989).

8
    The basis for the Court of Appeals' remand order is not entirely clear
to us.  It appears, however, that the court left open the possibility that
petitioner could establish its intent to profit by using some other method
of allocating fixed costs (such as the "actual use" method, see n. 5,
supra), while continuing to use the gross-to-gross formula in computing
actual losses.  Both parties interpret the Court of Appeals' decision in
this manner, and both express disapproval of that approach.  See Brief for
Respondent 47, n. 25 ("this argument is untenable"); Brief for Petitioner
48 ("While the Ninth Circuit's formula is better than that of the
Government, it is basically unprincipled").  Our disposition of the case
makes unnecessary precise interpretation of the Court of Appeals' opinion.

9
    See also The Brook, Inc. v. Commissioner, 799 F. 2d 833 (CA2 1986);
Rev. Rul. 81-69, 1981-1 C. B. 351; A. Scialabba, Unrelated Business Taxable
Income of Social Clubs, 10 Campbell L. Rev. 249 (1988).

10
    Section 513(a) defines "unrelated trade or business" as "any trade or
business the conduct of which is not substantially related . . . to the
exercise or performance by such organization of its charitable,
educational, or other purpose or function constituting the basis for its
exemption. . . ."

11
    Section 513(a)(3)(B) defines "exempt function income" as "the gross
income from dues, fees, charges, or similar amounts paid by members of the
organization as consideration for providing such members or their
dependents or guests goods, facilities, or services in furtherance of the
purposes constituting the basis for the exemption of the organization to
which such income is paid."

12
    See S. Rep. No. 2375, 81st Cong., 2d Sess., 28 (1950) ("The problem at
which the tax on unrelated business income is directed is primarily that of
unfair competition.  The tax-free status of [these] organizations enables
them to use their profits tax-free to expand operations, while their
competitors can expand only with the profits remaining after taxes"); H. R.
Rep. No. 2319, 81st Cong., 2d Sess., 36 (1950).  The tax on "unrelated
business income" was added to the Code by the Revenue Act of 1950, ch. 994,
64 Stat. 906.

13
    See S. Rep. No. 2375, at 30-31; H. R. Rep. No. 2319, at 38.

14
    Portland Golf appears to concede this point, too.  See Brief for
Petitioner 10 ("The parties agree that all of the expenses in issue . . .
are the types of corporate expenses allowed as deductions by Code Section
162").  Petitioner does not identify any other Code provision which would
serve as a basis for the deduction claimed in this case.

15
    Section 183 of the Code permits a taxpayer to offset expenses incurred
in a not-for-profit activity against income from that activity up to the
amount of the income.  Even before the enactment of MDRV 183, moreover, the
courts and the Commissioner had not required that revenues earned in
activities showing a net loss be declared as taxable income.  See 1 B.
Bittker & L. Lokken, n. 6, supra, MDRV 22.5.4, p. 22-63.  Although MDRV 183
is inapplicable to a nonprofit corporation such as Portland Golf, the
Commissioner has followed longstanding tax principles in permitting the
deduction of expenses incurred in nonmember sales up to the amount of
petitioner's receipts.  See Brief for Respondent 33.  At issue in this case
is petitioner's right to offset losses from nonmember sales against income
from unrelated investments.

16
    The Code distinguishes a social club's "exempt function income" from
its "unrelated business taxable income" by looking to the source of the
payment: "exempt function income" is limited to money received from the
members.  MDRV 512(a)(3)(B).  However, a social club could easily organize
events whose primary purpose was to benefit the membership, yet arrange for
nonmembers to make modest contributions toward the cost of the event.
Those contributions would constitute "unrelated business taxable income";
but if losses incurred in such activities could be used to offset
investment income, it would be relatively easy for clubs to avoid taxation
on their investments.
    The general rule that losses incurred in a not-for-profit activity may
not be used to offset unrelated income rests on the recognition that one
who incurs expenses without an intent to profit presumably derives some
intrinsic pleasure or benefit from the activity.  The Code's limitation on
deductibility (expenses may be deducted up to but not above the gross
income produced by the activity) reflects the view that taxpayers should
not be allowed to deduct what are, in essence, personal expenses simply
because the activity in question generates some receipts.  Just as an
individual taxpayer may not offset personal expenses against income from
other sources, a social club should not be allowed to deduct expenses
incurred for the benefit of the membership from unrelated business income.

17
    The parties stipulated that the gross-to-gross formula was a reasonable
method of allocating fixed expenses.  App. 17.  In his brief to this Court,
however, the Commissioner states: "There may be room to debate whether the
fixed costs allocated by petitioner to its nonmember sales constitute true
economic costs of that activity that ought to be treated as `directly
connected' to the production of the nonmember sales income.  It might be
argued that only the variable costs are `directly connected with' the
nonmember income, and therefore that only those variable costs should
offset the gross receipts from the nonmember income."  Brief for Respondent
45, n. 24.

18
    See n. 8, supra.  The Tax Court noted that petitioner would have shown
a profit on sales to nonmembers in both 1980 and 1981 if fixed costs had
been allocated under the "actual use" method.  See 55 TCM, at 213.

19
    The Tax Court consistently has held that the possibility of realizing
tax benefits should be disregarded in determining whether an intent to earn
an economic profit has been shown.  (That is, the reduction in tax
liability cannot itself be the "profit.")  See, e. g., Gefen v.
Commissioner, 87 T. C. 1471, 1490 (1986) ("A transaction has economic
substance and will be recognized for tax purposes if the transaction offers
a reasonable opportunity for economic profit, that is, profit exclusive of
tax benefits"); Seaman v. Commissioner, 84 T. C. 564, 588 (1985) ("
`profit' means economic profit, independent of tax savings"); Surloff v.
Commissioner, 81 T. C. 210, 233 (1983) (same).  Accord, Simon v.
Commissioner, 830 F. 2d 499, 500 (CA3 1987).  Portland Golf does not
dispute this principle.  See Brief for Petitioner 39 ("The cases have
uniformly held that taxable businesses, in order to deduct expenses in
excess of income, need only show an `economic profit' independent of tax
savings, or `economic gain' independent of tax savings") (footnotes
omitted).  We therefore assume, without deciding, that potential reductions
in tax liability are irrelevant to the determination whether a profit
motive exists.

20
    As stated earlier, MDRV 512(a)(3)(A) limits deductions from unrelated
business taxable income to "deductions allowed by this chapter."  In the
present case, petitioner may offset losses from nonmember sales against
investment income only if those losses are deductible under MDRV 162.  That
Code provision states: "There shall be allowed as a deduction all the
ordinary and necessary expenses paid or incurred during the taxable year in
carrying on any trade or business."  Thus, the expenses petitioner seeks to
deduct will constitute "deductions allowed by this chapter" only if they
are "the ordinary and necessary expenses paid or incurred" in selling food
and drink to nonmembers.

21
    We do not hold that, for other cases, any particular method of
allocating fixed expenses must be used by social clubs.  We hold only that
the allocation method used in determining actual profit or loss must also
be used in determining whether the taxpayer acted with a profit motive.
Petitioner here has stipulated, however, to the reasonableness of the
gross- to-gross method, and has used that method in calculating its actual
losses.  We note that no other allocation method, used consistently, would
have produced a  result more favorable to petitioner.  Had petitioner
employed the actual-use method, or ignored fixed costs entirely, it could
have established its intent to profit, but it would have realized a net
gain from nonmember sales and its "unrelated business taxable income" would
have been higher.

22
    The fact that petitioner suffered actual losses in 1980 and 1981 does
not, by itself, prove that Portland Golf lacked a profit motive.  A
taxpayer's intent to profit is not disproved simply because no profit is
realized during a particular year.  See Treas. Reg. MDRV 1.183-1(c)(1)(ii),
26 CFR MDRV 1.183-1(c)(1)(ii) (most activities presumed to be engaged in
for profit if gross income exceeds costs in any 2 of 5 consecutive years);
Treas. Reg. MDRV 1.183-2(b)(6), 26 CFR MDRV 1.183-2(b)(6) (1989) ("A series
of losses during the initial or start-up stage of an activity may not
necessarily be an indication that the activity is not engaged in for
profit").  Petitioner could offset these losses against investment income
if it could demonstrate that it intended to earn gross income in excess of
total costs, with fixed expenses being allocated under the gross-to-gross
formula.  Portland Golf has not asserted, however, that it possessed such a
motive.  The club's reluctance to make that argument is understandable: in
every year from 1975 through 1984, petitioner incurred losses from its
sales to nonmembers when fixed costs are allocated on a gross-to-gross
basis.  55 TCM, at 213.





Subject: 89-530--CONCUR, PORTLAND GOLF CLUB v. COMMISSIONER

 


    SUPREME COURT OF THE UNITED STATES


No. 89-530



PORTLAND GOLF CLUB, PETITIONER v. COMMIS- SIONER OF INTERNAL REVENUE

on writ of certiorari to the united states court of appeals for the ninth
circuit

[June 21, 1990]



    Justice Kennedy, with whom Justice O'Connor and Justice Scalia join,
concurring in part and concurring in the judgment.
    The Tax Court found that Portland Golf Club's nonmember activity
qualified as a trade or business under MDRV 162(a) of the Internal Revenue
Code of 1954, 26 U. S. C. MDRV 162(a), and it allowed the Club to deduct
expenses associated with the activity from its income.  55 TCM 212 (1988).
The Court of Appeals reversed because it found the Club's profit motive
unclear.  App. to Pet. for Cert. 1a.  Although the Tax Court had determined
that the Club intended the gross receipts from the nonmember activity to
exceed the direct costs, the Court of Appeals held that MDRV 162(a)
requires an intent to produce gains in excess of both direct and indirect
costs.  The Court of Appeals remanded the case to allow the Tax Court to
reconsider the Club's profit motive, taking account of the overhead and
other fixed costs attributable to the nonmember activity.  I agree with
that decision, and so would affirm the Court of Appeals.
    I join all but Parts III-B and IV of the Court's opinion.  I otherwise
concur only in the judgment because the Court decides a significant issue
that is unnecessary to our disposition of the case and, in my view, decides
it the wrong way.  When the Court of Appeals instructed the Tax Court to
consider the Club's indirect costs, it did not specify how the Club should
allocate these costs between its member and nonmember activities.  In
particular, it left open the possibility that the Club could use one
allocation method to calculate its expenses under MDRV 162(a), while using
some other allocation method to demonstrate its profit motivation.  See
ante, at 13.  Although the Court purports to affirm the Court of Appeals,
its opinion eliminates this possibility, and thus works a dramatic change
in the remand order.  The Court rules in Parts III-B and IV that, if the
Club uses the so-called gross- to-gross method to allocate its fixed costs
when computing its expenses, it must use the same allocation method to
prove its profit motivation.  The Tax Court and Court of Appeals, in my
view, should have had the opportunity to consider this issue in the first
instance.  Because the Court has reached the question, however, I must
state my disagreement with its conclusion.
    A taxpayer's profit motive, in my view, cannot turn upon the particular
accounting method by which it reports its ordinary and necessary expenses
to the Internal Revenue Service (IRS).  The Court cites no authority for
its novel rule and we cannot adopt it simply because we confront a hard
case.  Section 162(a) provides: "There shall be allowed as a deduction all
the ordinary and necessary expenses paid or incurred during the taxable
year in carrying on any trade or business . . . ."  26 U. S. C. MDRV
162(a).  Although the section does not require a profit motivation by its
express terms, we have inferred such a requirement because the words "trade
or business," in their ordinary usage, contemplate activities undertaken to
earn a profit.  See Commissioner v. Groetzinger, 480 U. S. 23, 27-28
(1987); Flint v. Stone Tracy Co., 220 U. S. 107, 171 (1911).  Yet, I see no
justification for making the profit-motive requirement more demanding than
necessary to distinguish trades and businesses from other activities
pursued by taxpayers.  See Whipple v. Commissioner, 373 U. S. 193, 197
(1963).  Because an activity may be a trade or business even if the
taxpayer intended to show losses on its income tax forms under a
permissible accounting method, the Court endorses an improper conception of
profit motivation.
    A taxpayer often may choose from among different accounting methods
when computing its ordinary and necessary expenses under MDRV 162(a).  In
this case, as stipulated by the IRS, the Club could have allocated its
fixed costs either by the gross-to-gross method or by the so-called
actual-use method.  Although the gross-to-gross method showed a net loss
for the relevant tax years, the actual-use method would have shown a net
profit.  See ante, at 3, n. 5.  If profit motivation turns upon the
allocation method employed by the Club in filling out its tax forms, then
the status of the nonmember activity as a trade or business may lie within
the control of the Club's accountants.  I find this interpretation of the
words "trade or business" simply "to affront common understanding and to
deny the facts of common experience."  Helvering v. Horst, 311 U. S. 112,
118 (1940).  A taxpayer does not alter the nature of an enterprise by
selecting one reasonable allocation method over another.
    The Court's decision also departs from the traditional practice of the
courts and the IRS.  Rather than relying on strict consistency in
accounting, the courts long have evaluated profit motivation according to a
variety of factors that indicate whether the taxpayer acted in a manner
characteristic of one engaged in a trade or business.  See, e. g.,
Teitelbaum v. C. I. R., 294 F. 2d 541, 545 (CA7 1961); Patterson v. United
States, 459 F. 2d 487, 493-494 (Ct. Cl. 1972); see Boyle, What is a Trade
or Business?, 39 Tax Law. 737, 743-745 (1986); Lee, A Blend of Old Wines in
a New Wineskin: Section 183 and Beyond, 29 Tax L. Review 347, 390-447
(1974).  In a regulation based on a wide range of prior court decisions,
the IRS itself has explained MDRV 162 and profit motivation as follows:


"Deductions are allowable under section 162 for expenses of carrying on
activities which constitute a trade or business of the taxpayer and under
section 212 for expenses incurred in connection with activities engaged in
for the production or collection of income or for the management,
conservation, or maintenance of property held for the production of income.
Except as provided in section 183 and [26 CFR] MDRV 1.183-1 [which
authorize individuals and S-corporations to offset hobby losses], no
deductions are allowable for expenses incurred in connection with
activities which are not engaged in for profit. . . .  The determination
whether an activity is engaged in for profit is to be made by reference to
objective standards, taking into account all of the facts and circumstances
of each case.  Although a reasonable expectation of profit is not required,
the facts and circumstances must indicate that the taxpayer entered into
the activity, or continued the activity, with the objective of making a
profit."  26 CFR MDRV 1.183-2(a) (1989).


To facilitate the application of this general standard, the IRS has
supplied a list of nine factors, also based on a wide body of case law, for
evaluating the taxpayer's profit motive.  These factors include: (1) the
manner in which the taxpayer carries on the activity; (2) the expertise of
the taxpayer or his advisors; (3) the time and effort expended by the
taxpayer in carrying on the activity; (4) the expectation that assets used
in the activity may appreciate in value; (5) the success of the taxpayer in
carrying on other similar or dissimilar activities; (6) the taxpayer's
history of income or losses with respect to the activity; (7) the amount of
occasional profits, if any, which are earned; (8) the financial status of
the taxpayer; and (9) the elements of personal pleasure or recreation.  See
id., at MDRV 1.183-2(b)(1)-(9).
    The Court today limits this longstanding approach by pinning the
profit-motive requirement to the accounting method that a taxpayer uses to
report its ordinary and necessary expenses under MDRV 162(a).  Although the
tax laws in general strive to reflect the true economic income of a
taxpayer, the IRS at times allows taxpayers to use accounting methods that
understate their income or overstate their expenses.  In this case, as the
Court itself acknowledges, the IRS stipulated that the Club could use the
gross-to-gross allocation method to calculate its expenses under MDRV
162(a) even though this method tends to exaggerate the percentage of fixed
costs attributable to the Club's nonmember sales.  See ante, at 3, n. 4.
Yet, I see no basis for saying that, when the Club took advantage of this
unconditional stipulation, it committed itself to the legal position that
the gross-to-gross method best reflects economic reality.  Some
inconsistency will exist if the Club uses the gross-to-gross allocation
method in computing the expenses, while using some other reasonable
accounting method to prove that it undertook the nonmember activity as a
trade or business.  But the solution to this inconsistency lies in altering
the stipulation in other cases, not in changing the longstanding
interpretation of profit motivation.
    The precise effect of the Court's holding with respect to the Club
remains unclear.  The Court states only that the Club may not offset its
losses from nonmember sales against its investment income.  But I do not
understand how the Court can confine its ruling to investment income alone.
If the Club's nonmember activity does not qualify as a trade or business,
then the Club cannot use MDRV 162(a) to deduct any of the expenses
associated with the nonmember activity, not even to the extent of gross
receipts.  Confronted with this difficultly at oral argument, respondent
stated that, in the absence of statutory authority, the IRS has allowed an
offset of expenses against gross receipts out of its own "generosity," a
characteristic as rare as it is implausible.  Tr. of Oral Arg. 42-43.  The
IRS, indeed, asserts the authority to disallow the offset in the future.
See id., at 44.  Cf. 26 U. S. C. MDRV 183 (authorizing individuals and
S-corporations to offset hobby losses).  This possibility further counsels
against making the profit-motive requirement more stringent than necessary
to determine whether the Club undertook the nonmember activity as a trade
or business.  For these reasons, I join the Court's opinion, with the
exception of Parts III-B and IV, and concur in the judgment.
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