112 T.C. No. 23
UNITED STATES TAX COURT
COMMON CAUSE, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent1
Docket No. 13921-97. Filed June 22, 1999.
P, an organization exempt from Federal income tax, receives payments from the rental of its mailing list. In each of P's list rental transactions, the mailer's rental payment compensates P for the mailer's use of P's list and, also, compensates a list broker, a list manager, and a computer house for their participation in the transaction. R determined that P's mailing list rental activities constitute an unrelated trade or business and that the list broker, the list manager, and the computer house are P's agents for the purpose of carrying on that business. R further determined that P's income from the rental of its mailing list is
1 This case was consolidated, for trial purposes only, with Planned Parenthood Fedn. of Am., Inc. v. Commissioner, T.C. Memo. 1999-206, in which an opinion is also being issued today. - 2 -
unrelated business taxable income pursuant to sec. 512(a)(1), I.R.C. P contends that it is not engaged in such a business and that, in any event, such payments are royalties that are excluded from unrelated business taxable income pursuant to sec. 512(b)(2), I.R.C. Held: Excepting the portion of the list rental payment that compensates the list broker, or the list manager in its capacity as list broker, the mailer's list rental payment in each list rental transaction is a royalty that is excluded from unrelated business taxable income pursuant to sec. 512(b)(2), I.R.C. Held, further, the list brokerage activities are not royalty-related activities. Held, further, the list brokers and the list manager, in its capacity as list broker, do not act as P's agents. Consequently, the list brokerage activities and any compensation received by the list brokers or the list manager, in its capacity as list broker, are not attributable to P.
Albert G. Lauber, Jr., Milton Cerny, Lloyd H. Mayer,
Julie W. Davis, and Carl S. Kravitz, for petitioner.
Dianne I. Crosby and Bettie N. Ricca, for respondent.
WELLS, Judge: Respondent determined deficiencies in
petitioner's Federal income taxes as follows:
Year Deficiency
1991 $17,905 1992 55,009 1993 133,542
Unless otherwise indicated all section references are to the
Internal Revenue Code in effect for the years in issue, and all - 3 -
Rule references are to the Tax Court Rules of Practice and
Procedure.
The issues presented by the parties include: (1) Whether,
for purposes of the unrelated business income tax provisions of
section 511, petitioner is carrying on a list rental business
that is not substantially related to its exempt purpose; (2) if
so, whether the list brokers, list manager, and computer house
used by petitioner are agents of petitioner for the purpose of
carrying on such a business; and (3) whether the mailer's list
rental payments are royalties that are excluded from unrelated
business taxable income pursuant to section 512(b)(2).
FINDINGS OF FACT
Some of the facts and certain exhibits have been stipulated
for trial pursuant to Rule 91. The parties' stipulations of fact
are incorporated herein by reference and are found as facts in
the instant case.
Petitioner is a corporation with its principal office in
Washington, District of Columbia.
Petitioner is exempt from Federal income tax as an
organization described in section 501(c)(4). Petitioner was
formed for the purpose of improving governmental institutions,
processes, and policies by making them more responsive to the
needs of the Nation and the will of its citizens. Petitioner
maintains a list of names and addresses of its members, donors, - 4 -
and other supporters (collectively supporters) to whom it
regularly sends mail (master list). The master list also
contains other information about the supporters, including their
gender and the frequency, recency, and amount of contributions
that each supporter has made to petitioner. Petitioner
communicates by direct mail with its supporters.
The master list is kept on large computerized databases that
petitioner regularly maintains and updates. Because it is very
valuable, petitioner builds its master list by acquiring new
names and addresses and guards its master list against misuse.
From the master list, petitioner creates another list that
contains names, addresses, and other limited information about a
segment of petitioner's supporters (rental list). Petitioner's
master and rental lists are intangibles in which petitioner has
ownership rights. Petitioner's master and rental lists are
valuable because they are collections of names and addresses of
people with similar characteristics such as willingness to
respond to solicitations received by mail and interest in
supporting certain types of tax-exempt organizations. Petitioner
makes its rental list available for rent or exchange with other
organizations.
The direct mail and mailing list industry has its own
industry standards and trade practices. In structuring its list
rental transactions, petitioner abides by the trade practices of - 5 -
the mailing list industry and arranges its transactions roughly
on the same terms and conditions that are standard in the
industry.
In a list rental transaction, the party (mailer) seeking to
send mail to the individuals or entities named on a list (mailing
list) pays the owner of the mailing list (list owner or owner)
for the one-time right to send mail to the named individuals or
entities. If any of the named individuals or entities to which
the mailer has mailed responds to the mailing, the mailer then
"owns" that name and can continue to send that named individual
or entity additional mail. If the named individual or entity
does not respond to the one-time mailing, the mailer may not
directly send mail to that named individual or entity again.
List owners "seed" their mailing lists with names and addresses
of their employees or of the employees of their list managers to
make sure that such unauthorized mailings do not occur.
Petitioner's rental list is stored at Triplex Direct
Marketing Corp. (Triplex), a professional computer service
business that stores and maintains computer databases for mailing
lists. From petitioner's rental list, Triplex produces a copy on
labels or magnetic tape for mailers. Although petitioner has
used Triplex's services since the early 1980's, a written
contract between petitioner and Triplex does not exist. Triplex
corresponds with petitioner regarding the fees it charges for - 6 -
computer services. Triplex provides similar services to both
nonprofit and commercial entities on the same terms.
Petitioner retains the services of Names in the News
(Names), a professional list manager and list broker that
regularly handles both nonprofit and commercial mailing lists.
As petitioner's list manager, Names promotes list rental
transactions involving petitioner's rental list via distribution
of data cards (printed cards providing basic information as to
price per thousand and all other list rental information for a
given list), solicitations, and personal sales calls directed at
list brokers and potential customers. Names pays all costs of
promoting and marketing petitioner's rental list and does not
charge petitioner additional fees for such services. Petitioner
reviews all data cards containing significant new information.
In addition to promoting and marketing petitioner's rental list,
Names coordinates any rental transactions involving petitioner's
rental list.
No written contract exists between petitioner and Names.
However, the form language on Names' list orders during 1991 and
1992 states: "We will bill mailer on behalf of list owner;
payment (less commission) will be made upon receipt of payment
from the mailer. We act only as agent for the list owner in
these transactions." During 1993, Names changed that language to
state: "We will bill mailer on behalf of list owner; payment - 7 -
(less commission) will be made upon receipt of payment from the
mailer. We act only as agent for the list owner or the mailer in
these transactions."
Names can also act for the mailer as a list broker. The
activities of a list broker include: (1) Searching
advertisements and databases for appropriate list offerings for
the mailer to rent, (2) coordinating the rental transaction on
behalf of the mailer, (3) collecting payment from the mailer to
remit to the list manager or list owner, and (4) analyzing the
results of the mailing to determine whether it was successful.
The same list broker does not participate in every transaction.
Rather, each mailer chooses its own list broker to act on its
behalf.
In a typical list rental transaction involving petitioner's
rental list, the mailer contacts Names either directly or through
a list broker and submits a proposed list rental order. If a
mailer contacts petitioner directly, petitioner refers that
mailer to Names. Along with the list order, the mailer indicates
the time of the mailing and encloses a copy of the materials to
be sent. Names either disapproves the order because it is
inconsistent with the standing instructions provided by
petitioner or forwards the order to petitioner for final
approval. - 8 -
Upon receiving approval, Names arranges with Triplex to fill
the order. Triplex produces a copy of the rental list according
to the mailer's specifications and sends it to the mailer's mail
house.
Petitioner divides its rental list into three specific
segments and, on Names' recommendation, charges a different base
price for each segment. A mailer rents the names of: (1)
Current members and donors for $70 per 1,000 names, (2) former
members and donors for $60 per 1,000 names, or (3) nonmember
donors for $55 per 1,000 names. The base price includes a 10-
percent list management commission retained by Names and a 10-
percent list brokerage commission retained by either the
independent list broker or by Names (if the mailer is not using
an independent list broker). The base price also includes a fee
of $3.90 (running fee) remitted by Names to Triplex to pay for
the computer charges incurred in producing the copy of
petitioner's rental list.
It is standard in the mailing list industry to include the
management commission, brokerage commission, and running fees in
the base price. The commissions paid to Names and the list
brokers are within the range of usual and customary amounts paid
for such services.
For an additional cost, a mailer can further customize its
order. For an extra fee per 1,000 names, a mailer can request - 9 -
that the names it rents be selected by certain other criteria.
Selection criteria (special selections) include: Gender,
ethnicity, State, and ZIP code. Petitioner includes the special
selection information on its data cards. Triplex actually
performs the special selections. Triplex charges different fees
for performing different special selections and regularly
notifies petitioner of the fees for such selections. Petitioner
offers the special selections to mailers at the same price that
Triplex charges petitioner.
The mailer also determines the type of media on which it
receives petitioner's rental list. For the base price, the
mailer receives the rental list printed on Cheshire labels
(ungummed labels that are affixed by machine). For an extra fee,
the mailer can receive the rental list on pressure-sensitive
labels or on magnetic tape. Triplex charges petitioner extra
fees for the provision of the rental list on the different media.
Petitioner offers such media options to the mailer and charges
the mailer, as media fees, the same amount which Triplex charges
petitioner. A mailer determines the way the rental list is
shipped, and, depending on the mailer's choice, Triplex charges
petitioner a shipping fee. Petitioner charges the mailer a
shipping fee equal to the amount that Triplex charges petitioner.
As is standard in the industry, the mailer is billed and
payment is collected by the following process. After filling an - 10 -
order, Triplex bills Names for the fees associated with filling
the order, including running, special selection, media, and
shipping fees. Names then bills the mailer or the mailer's list
broker. If the mailer uses an independent list broker, the bill
is for the listed base price, plus any special selection, media,
and shipping fees, less the 10-percent list brokerage commission
(which was included in the base price). Before it sends the bill
to the mailer, the list broker adds its commission to the bill.
The mailer pays the list broker the full price reflected on the
bill that the mailer receives. The list broker deducts its
commission and remits the remaining payment to Names. If Names
acts as the list broker in the transaction, the bill sent to the
mailer includes the full base price (including the 10-percent
list brokerage commission), plus any special selection, media,
and shipping fees, and the mailer remits the full payment
directly to Names.
After receiving payment from the mailer or its list broker,
Names deducts its commission, pays Triplex its fees, and remits
the remainder to petitioner. If a mailer cancels its order, it
is required to pay a "processing fee" of $50. The fee is
retained by Names.
List rental transactions are carried on continuously.
During 1991 and 1992, petitioner's gross receipts (base price
less commissions, Triplex's running fees, and other miscellaneous - 11 -
fees) from its list rental transactions were $188,171 and
$243,959, respectively. For 1991 and 1992, petitioner timely
filed Forms 990, Return of Organization Exempt from Income Tax,
and Forms 990-T, Exempt Organization Business Income Tax Return.
Petitioner did not report on either return the income it received
from its mailing list transactions. Rather, petitioner reported
such income as nontaxable royalty and/or related non-trade-or-
business income on Forms 8275, Disclosure Statement, filed as
attachments to its 1991 and 1992 Forms 990-T.
For 1993, petitioner's gross receipts (base price less
commissions, Triplex's running fees, and other miscellaneous
fees) from its list rental transactions were $219,272. For 1993,
petitioner timely filed a Form 990 but did not file a Form 990-T.
OPINION
Section 511(a)(1) imposes the unrelated business income tax
(UBIT) on the unrelated business taxable income (UBTI) of certain
tax-exempt organizations. Section 512 defines UBTI as follows:
SEC. 512. UNRELATED BUSINESS TAXABLE INCOME.
(a) Definition.--For purposes of this title--
(1) General Rule.--Except as otherwise provided in this subsection, the term "unrelated business taxable income" means 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 - 12 -
business, both computed with the modifications provided in subsection (b).
Accordingly, income is UBTI if it arises from a regularly
carried-on trade or business that is not substantially related to
the organization's tax-exempt purpose. See sec. 1.513-1(a),
Income Tax Regs. Royalties, however, are excluded from UBTI
pursuant to section 512(b)(2).2 See Sierra Club, Inc. v.
Commissioner, 86 F.3d 1526, 1531 (9th Cir. 1996), affg. T.C.
Memo. 1993-199 and revg. on another issue 103 T.C. 307 (1994);
Disabled Am. Veterans v. Commissioner, 94 T.C. 60, 76 (1990) (DAV
II), revd. on other grounds 942 F.2d 309 (6th Cir. 1991).
Neither the Code nor the regulations define the term
"royalty" for UBTI purposes. Instead, section 1.512(b)-1, Income
Tax Regs., provides that "Whether a particular item of income
falls within any of the modifications provided in section 512(b)
shall be determined by all the facts and circumstances of each
2 Sec. 512(b) provides:
SEC. 512(b). Modifications.--The modifications referred to in subsection (a) are the following:
* * * * * * *
(2) There shall be excluded all royalties (including overriding royalties) whether measured by production or by gross or taxable income from the property, and all deductions directly connected with such income. - 13 -
case." Petitioner bears the burden of proving that the list
rental payments are royalties that are excluded from UBTI
pursuant to section 512(b)(2). See Rule 142(a).
In the instant case, respondent contends that, in each of
the list rental transactions, the mailer's entire payment
(including the amounts paid to the list brokers, Names and
Triplex) constitutes UBTI to petitioner because petitioner
regularly carries on a list rental business that is not
substantially related to its exempt purpose. In that regard,
respondent contends that the list brokers, Names, and Triplex are
petitioner's agents for the purpose of carrying on the list
rental business. Petitioner disputes respondent's contentions
and, additionally, contends that the mailers' payments are
excluded from UBTI as royalties pursuant to section 512(b)(2).
Before addressing respondent's trade or business and agency
arguments, we address the royalty issue.
In the instant case, the parties accept the definition of a
royalty found in Rev. Rul. 81-178, 1981-2 C.B. 135.3
3 In Rev. Rul. 81-178, 1981-2 C.B. 135, the Internal Revenue Service sought to clarify the definition of royalty for purposes of sec. 512(b)(2). The ruling deals with two different factual situations. In the first situation, various businesses pay the taxpayer, an exempt organization, for the right to use the taxpayer's symbols and the signatures and likenesses of its members in promoting their products. See id. In the second situation, the businesses pay the taxpayer in return for its members' making appearances in endorsement of the businesses' (continued...) - 14 -
Additionally, the parties agree that petitioner's rental list is
a valuable intangible. However, the parties disagree as to
whether any portion of the list rental transaction constitutes
compensation for goods and services. The parties further
disagree as to whether the presence of any compensation for goods
and services in the list rental payment precludes royalty
treatment, pursuant to section 512(b)(2), for any portion of the
list rental payment. The issue has been the subject of much
litigation. See Disabled Am. Veterans v. United States, 227 Ct.
Cl. 474, 650 F.2d 1178 (1981) (DAV I), affd. after remand 704
F.2d 1570 (Fed. Cir. 1983); Disabled Am. Veterans v.
Commissioner, supra; Sierra Club, Inc. v. Commissioner, T.C.
3 (...continued) products. See id., 1981-2 C.B. at 136. The ruling provides, in pertinent part:
To be a royalty, a payment must relate to the use of a valuable right. Payments for the use of trademarks, trade names, service marks, or copyrights, whether or not payment is based on the use made of such property, are ordinarily classified as royalties for federal tax purposes. * * * On the other hand, royalties do not include payments for personal services. [Id.; citations omitted.]
In the first situation, the ruling concludes that, because the exempt organization receives payment solely for the use of its intangibles, the payment is a royalty. See id. In the second situation, the ruling concludes that, because the organization receives payment for the services of its members in endorsing products, the payment is not a royalty. See id. - 15 -
Memo. 1993-199. We discuss each of those cases in more detail
below.
Earlier Cases
Disabled American Veterans
In DAV I, the exempt organization engaged in the rental of
its mailing list, but, unlike petitioner, the organization itself
performed all of the list management and list fulfillment
functions. On the question of whether the list rental payments
were royalties, the Court of Claims concluded that the list
rentals "[were] the product of extensive business activity by DAV
and [did] not fit within the types of 'passive' income set forth
in section 512(b)." Disabled Am. Veterans v. United States, 650
F.2d at 1189. The court found that the payments were more akin
to rent from the use of personal property than to royalties, and
held that the income from the transaction was not excluded from
UBTI under section 512(b). See id. at 1189-1190.
In DAV II, the same exempt organization that appeared before
the Court of Claims in DAV I appeared before this Court; however,
a different taxable year was in issue. Although DAV II involved
the same parties and legal issues as DAV I, we concluded that the
issuance of Rev. Rul. 81-178, supra, had changed the legal
climate. Consequently, we held that collateral estoppel did not
apply. See Disabled Am. Veterans v. Commissioner, supra at 69.
Relying on the definition of royalty contained in Rev. Rul. 81- - 16 -
178, supra, we concluded that there is no distinction between
active and passive royalties for section 512(b)(2) purposes. See
Disabled Am. Veterans v. Commissioner, supra at 75. We also made
it clear that we could distinguish payments for the use of an
intangible, which constitute a royalty, from payments for
advertising, compensation for services, or other profits
masquerading as royalties. See id. at 77. The Court of Appeals
for the Sixth Circuit, reversing the decision of this Court, held
that the issuance of Rev. Rul. 81-178, supra, was not a
sufficient change of legal climate to preclude collateral
estoppel. See Disabled Am. Veterans v. Commissioner, 942 F.2d at
314.
Sierra Club
The issue of whether income from a mailing list transaction
is UBTI arose again in Sierra Club, Inc. v. Commissioner, T.C.
Memo. 1993-199. Unlike the exempt organization in DAV I and DAV
II, the exempt organization in Sierra Club did not itself perform
any of the list management or list fulfillment functions.
Rather, as in the instant case, a professional list manager
performed all list management functions, and a computer house
performed all list fulfillment functions. On cross-motions for
summary judgment, we held that the payment received by the exempt
organization was, at least in part, a royalty. We rejected the
Commissioner's argument that royalties, in the context of section - 17 -
512(b)(2), meant only those earned passively. We also held,
however, that an issue of fact existed regarding whether any part
of the list rental transaction price, specifically the fees for
special selections, media, and shipping, was payment for goods
and services.
Before appeal, the parties in Sierra Club settled the issue
of whether any part of the list rental payment was for goods or
substantial services provided in connection with the rental
transactions. See Sierra Club, Inc. v. Commissioner, 103 T.C. at
310. In affirming our decision as to the royalty issue, the
Court of Appeals for the Ninth Circuit held that the term
"royalty", as it is used in section 512(b)(2), "is by definition
'passive' and thus cannot include compensation for services
rendered by the owner of property." Sierra Club Inc. v.
Commissioner, 86 F.3d at 1532. Additionally, the court reasoned
that, because the exempt organization did not itself provide any
services to the mailer, the entire amount it actually received
was a royalty for UBIT purposes. See id. at 1535-1536.
Royalty-Related Activity or Services
In the instant case, we must decide whether any part of the
mailing list rental payments constitutes compensation to
petitioner for goods or services.4 In each mailing list rental
4 This is the same issue that the parties settled in DAV II (continued...) - 18 -
transaction, the mailer's rental payment compensates petitioner
for the mailer's use of petitioner's list and, also, compensates
Names, Triplex, and the list brokers for their participation in
the transaction. Certain of these activities exploit and protect
the intangible (i.e., the list). We have held that the owner of
an intangible may engage in certain activities to exploit and
protect the intangible which do not change the nature of the
payment received. See Wm. J. Lemp Brewing Co. v. Commissioner,
18 T.C. 586, 596 (1952) (payment to the owner of the intangible
was a royalty even though the owner reserved the right to
supervise the advertising, marketing, and quality of the product
which was to bear the trademarked name); see also Mississippi
State Univ. Alumni, Inc. v. Commissioner, T.C. Memo. 1997-397
(review of marketing material and endorsement of an affinity
credit card program bearing the name of an exempt organization
were not services provided to the card issuing company). To hold
otherwise, it seems to us, "would require us to hold that any
activity on the part of the owner of intangible property to
obtain a royalty, renders the payment for the use of that right
UBTI and not a royalty." Sierra Club, Inc. v. Commissioner, 86
F.3d at 1536. Accordingly, in the instant case, we carefully
4 (...continued) and Sierra Club and that the courts therefore did not have before them. - 19 -
scrutinize the activities of each of the parties compensated in
the list rental transaction to ascertain whether they are
undertaken to exploit or protect petitioner's list. Hereinafter,
we refer to activities which are undertaken to exploit or protect
the list as royalty-related activities.
Names
In a list rental transaction, Names' activities as list
manager include: (1) Promoting list rental transactions
involving petitioner's rental list via distribution of data
cards, solicitations, and personal sales calls directed at list
brokers and potential customers; (2) approving or disapproving
all list rental orders from mailers by applying petitioner's
standing instructions or forwarding the order to petitioner for
final approval; (3) arranging with Triplex to fill the order; (4)
billing the mailer or the mailer's list broker; (5) paying
Triplex the amounts it is owed; and (6) remitting payment to
petitioner.
In the context of the list rental transaction, a list owner
has certain intangible information regarding the individuals and
entities whose names and addresses appear on its list.
Specifically, the list owner knows that such individuals and
entities are responsive to direct mail and willing to support
certain tax-exempt organizations. To exploit that knowledge, the
list owner must first let others know that the list is available. - 20 -
In the instant case, that is accomplished through the promotional
efforts of Names. Accordingly, we conclude that Names'
activities in distributing data cards and other forms of
advertising directed to list brokers and potential mailers on
petitioner's behalf are royalty-related activities.
Additionally, to protect the value of its mailing list, a
list owner will not allow the individuals and entities whose
names appear on the list to receive mail that the list owner
considers objectionable. Accordingly, the list owner must engage
in activities to ensure that the list is rented only to
appropriate mailers. Consequently, we conclude that Names'
activities in clearing with petitioner all list orders, either by
applying petitioner's standing instructions or by directly
communicating with petitioner, are royalty-related activities.
To exploit its intangible and convey it to the user, the
list owner must also render it in tangible form. In the list
rental context, that is accomplished by producing a copy of the
list for the mailer. Consequently, we conclude that Names'
activities in forwarding the order to Triplex for fulfillment and
obtaining from Triplex a copy of the rental list are royalty-
related activities.
Finally, the owner of the intangible is entitled to be paid
for its use. Accordingly, we conclude that Names' activities in
billing the mailer, paying Triplex, and remitting payment to - 21 -
petitioner are royalty-related activities. On the basis of the
foregoing, we conclude that all of the activities in which Names
engages are royalty-related activities.
Petitioner
Petitioner does not directly engage in any significant
activities with regard to a rental list transaction. The only
activities in which petitioner directly engages are review of the
data cards and approval of list rental transactions. As we
discussed above, the data cards are the means by which Names
promotes and advertises petitioner's rental list. Review of
promotional and advertising material by the owner of an
intangible is not inconsistent with royalty treatment. See Wm.
J. Lemp Brewing Co. v. Commissioner, supra; Mississippi State
Univ. Alumni, Inc. v. Commissioner, supra. Similarly, as we
discussed above, petitioner's review of all list rental
transactions is part of the protection of the list.
Consequently, we conclude that all of the activities in which
petitioner directly engages are royalty-related activities.
Triplex
Triplex's activities include: (1) Printing a copy of
petitioner's list on the medium chosen by the mailer; (2)
performing the special selections chosen by the mailer; and (3)
shipping the completed order to the mailer. - 22 -
As we discussed above, producing an intangible in tangible
form is necessary for the exploitation of the intangible.
Mailers that order petitioner's list on magnetic tape, instead
of, for example, on Cheshire labels, still receive only the one-
time right to mail to the names and addresses on the rental list.
It appears to us that the medium itself is of little or no value
to the mailer without the information it contains. Moreover, the
provision of the list on various media is also customary within
the mailing list industry and consistent with the rental of a
mailing list for one-time use only. Accordingly, we conclude
that Triplex's activities in printing a copy of petitioner's list
on the medium chosen by the mailer are royalty-related
activities.
Special selections are the means by which a mailer further
narrows the types of individuals and entities whose names will
appear on the list that the mailer orders. Certain mailers may
prefer a list consisting of only the names of female donors,
while others may prefer only the names of individuals or entities
within a specific State or ZIP code. The essence of a mailer's
order is the one-time right to use a portion of petitioner's
mailing list. We conclude that there is no significant
difference between, on the one hand, the rental of a list
consisting of all of the names of petitioner's supporters and, on
the other hand, the rental of a list consisting of only - 23 -
petitioner's female supporters or, for example,5 the rental of a
list consisting of only the names of petitioner's male supporters
between the ages of 20 and 25 who reside in a particular ZIP
code. The culling out or special selection of certain names is
ancillary to the maintenance and exploitation of the list. Cf.
Glen O'Brien Movable Partition Co. v. Commissioner, 70 T.C. 492,
502 (1978) ("Where services are performed subsidiary and
ancillary to the transfer of patent rights and proprietary know-
how, they take on the nature of the patent rights and know-how as
'property'."); Ruge v. Commissioner, 26 T.C. 138, 143 (1956)
("The consulting services * * * were ancillary and subsidiary to
the assignments of the inventions"). In other words, payment for
the one-time right to mail to names on a list, no matter how
specialized that list is, is a royalty.
As to the shipping, in order to exploit the intangible, the
owner ordinarily will need to send the information contained in
the intangible to the user. Consequently, we conclude that
Triplex's activities in shipping the list to the mailer are
royalty-related activities. In sum, we conclude that, in the
course of the list rental transaction, all of the activities in
which Triplex engages are royalty-related activities.
5 Petitioner does not offer age as a special selection. - 24 -
List Brokers
The activities of the list brokers include: (1) Searching
advertisements and databases for appropriate list offerings for
the mailer to rent; (2) coordinating the rental transaction on
behalf of the mailer; (3) collecting payment from the mailer to
remit to the list manager or list owner; and (4) analyzing the
results of the mailing to determine whether it was successful.
We conclude that the list brokers' activities are not royalty-
related activities. Rather, the list brokers' activities are
provided solely to the mailers and solely for the mailers'
convenience.6 Accordingly, we conclude that the list brokers'
activities are services and are not part of the royalty-related
activities. Consequently, any portion of the mailers' payments
that is to compensate the list brokers for their activities in
the mailing list transaction is not a royalty.
Our inquiry as to the list brokers' services, however, does
not end there. Because we hold that the portion of the mailers'
payments that is related to the list brokers' activities is not a
royalty, we must address respondent's other arguments that the
list brokers are petitioner's agents for carrying on a list
6 As discussed below, this factor is also important in deciding whether the list brokers are petitioner's agents. - 25 -
rental business and that any services they provide and any
portion of the list rental payment received by them for the
rental of petitioner's list should be attributed to petitioner
for purposes of calculating petitioner's UBTI. Petitioner argues
that the list brokers are independent contractors and that the
services they provide, and any compensation they receive for such
services, should not be attributed to petitioner.
As to whether an agency relationship exists, the manner in
which the parties to an agreement designate their relationship is
not controlling. See Board of Trade v. Hammond Elevator Co., 198
U.S. 424, 437 (1905). Rather, the question of agency is based on
the surrounding facts and circumstances of each case. See id.
(citing Connecticut Mut. Life Ins. Co. v. Spratley, 172 U.S. 602,
617 (1899)). "An essential characteristic of an agency
relationship is that the agent acts subject to the principal's
direction and control." In re Shulman Trans. Enters., Inc., 744
F.2d 293, 295 (2d Cir. 1984). "[A]n independent contractor can
be an agent if, and to the extent that, the contractor acts for
the benefit of another and under its control in a particular
transaction." State Police Association v. Commissioner, 125 F.3d
1, 7 (1st Cir. 1997), affg. T.C. Memo. 1996-407; see also
National Collegiate Athletic Association v. Commissioner, 92 T.C. - 26 -
456, 467 (1989), revd. on other grounds 914 F.2d 1417 (10th Cir.
1990).
As we stated above, the list brokers act solely on behalf of
the mailers. The same list broker does not participate in every
transaction. Rather, each mailer chooses its own list broker to
act on its behalf. Additionally, petitioner does not exercise
any control over the list brokers or over Names when it acts in
its capacity as list broker. Petitioner directs all rental
inquiries to Names. Consequently, even if a mailer or broker
contacts petitioner directly, petitioner has no dealing with that
mailer or broker. Moreover, although the list broker's
commission is factored into the base price that is listed on the
data cards describing petitioner's rental list, the bill sent by
Names includes a list broker's commission only where Names acts
as the list broker. If the mailer uses an independent list
broker, Names sends that list broker a bill that does not include
a list broker's commission. Accordingly, it remains the list
broker's choice whether to charge the mailer any list brokerage
commission. On the basis of the foregoing, we conclude that the
list brokers and Names, when it is acting in its capacity as list
broker, are not agents of petitioner, and, therefore, neither
their activities nor the compensation that they receive for those
activities can be attributed to petitioner. Consequently, the - 27 -
list brokerage activities do not change the character of the
remainder of the mailers' list rental payments.
In sum, we hold that with the exception of the list
brokerage activities (which are not attributable to petitioner),
all of the activities in which the parties to the list rental
transaction engage are royalty-related activities. Consequently,
with the exception of the list brokerage commissions (which are
not attributable to petitioner), the mailer's list rental payment
in each list rental transaction is a royalty which is excluded
from UBTI under section 512(b)(2). Our holdings obviate the need
to address respondent's trade or business arguments.
Respondent's Remaining Arguments
No Written Licensing Agreement
Respondent contends that the list rental payments are not
royalties because there is no written licensing agreement between
petitioner and Names or Triplex. We conclude that, even though
there is no written agreement termed a "licensing agreement", the
terms and conditions of the transaction between the mailer and
petitioner require the mailer to receive only a one-time right to
use the information contained on petitioner's rental list.
Accordingly, we conclude that each mailing list transaction
represents a separate licensing of petitioner's list by the
mailer and that the absence of a written "licensing agreement" - 28 -
does not prevent the mailer's list rental payment from being a
royalty.
Section 513(h)
Finally, respondent argues that the enactment of section
513(h) precludes a conclusion that the list rental payment is a
royalty. The relevant parts of section 513(h) provide:
SEC. 513(h). Certain Distributions of Low Cost Articles Without Obligation to Purchase and Exchanges and Rentals of Member Lists.--
(1) In general.--In case of an organization which is described in section 501 and contributions to which are deductible under paragraph (2) or (3) of section 170(c), the term "unrelated trade or business" does not include--
(B) any trade or business which consists of--
(i) exchanging with another such organization names and addresses of donors to (or members of) such organization, or
(ii) renting such names and addresses to another such organization.
Section 513(h) provides a safe harbor for the rental and exchange
of mailing lists between certain charities. Section 513(h) was
enacted during 1986, after the decision of the Court of Claims in
DAV I. Respondent argues that, in enacting section 513(h) and - 29 -
specifically excluding the income from mailing list transactions
between charities, Congress has agreed with the holding of the
Court of Claims in DAV I that the mailer's list rental payment in
a mailing list transaction is not a royalty that is excludable
from UBTI under section 512(b)(2).
We do not agree. On the day of the adoption of the
conference report accompanying the bill which included section
513(h), Representative Daniel Rostenkowski (D-Ill.), Chairman of
the Ways and Means Committee, commented:
I also have discussed with Congressman Duncan [(R- Tenn.) Ranking Republican Member of the Ways and Means Committee] the issue of whether the provision of the bill which excludes certain income from unrelated trade or business income creates any inference under present law. We have reached a common understanding regarding the following specific issue:
The question relates to section 1601 of the bill which excludes from unrelated trade or business income revenues from the use of a tax-exempt organization's mailing list by another such organization. Section 1601 of the bill, which specifically exempts certain such revenues from the tax on unrelated business income in the future, carries no inference whatever that mailing list revenues beyond its scope or prior to its effective date should be considered taxable to an exempt organization. [132 Cong. Rec. 26208 (Sept. 25, 1986).]
Additionally, the General Explanation provided by the Staff of
the Joint Committee on Taxation explains: "No inference is
intended as to whether or not revenues from mailing list
activities other than those described in the provision, or from - 30 -
mailing list activities described in the provision, but occurring
prior to the effective date, constitute unrelated business
income." Staff of Joint Comm. on Taxation, General Explanation
of the Tax Reform Act of 1986, at 1325 (J. Comm. Print 1987). We
conclude that the enactment of section 513(h) does not require
that we hold that the revenues from the rental of petitioner's
mailing list during the years in issue are UBTI and thus subject
to UBIT.7
We have considered the parties' remaining arguments and
conclude that they are without merit, irrelevant, or unnecessary
to reach.
To reflect the foregoing,
Decision will be entered
for petitioner.
7 Respondent also contends that the list rental payments cannot be royalties because petitioner paid "development" or "production" costs. Respondent borrows those terms from the mineral royalty context, and we conclude that they are not helpful to our inquiry.