149 T.C. No. 22
UNITED STATES TAX COURT
NEW JERSEY COUNCIL OF TEACHING HOSPITALS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 2822-16. Filed December 20, 2017.
P is a tax-exempt charitable organization described in I.R.C. sec. 501(c)(3) whose exempt purposes include promoting health care and medical education. During its calendar tax years 2004-2007, P contracted with third-party vendors, V1 and V2, to provide its mem- bers (hospitals and a medical school) access to debt-collection serv- ices and group purchasing programs. P received fees from V1 and V2 in exchange for administering these programs and promoting the pro- grams to its members.
On its Forms 990, Return of Organization Exempt From In- come Tax, P treated all of these receipts as “substantially related” to the conduct of its tax-exempt purposes, see I.R.C. sec. 513(a), and thus as exempt from Federal income tax. The IRS selected P’s re- turns for examination and determined that the fees it received from V1 and V2 constituted unrelated business taxable income (UBTI) subject to unrelated business income tax (UBIT) under I.R.C. secs. 511(a)(1) and 512(a). -2-
1. Held: The fees P received from V1 represented payments for services, not for the use of intangible property, and thus did not constitute “royalties” within the meaning of I.R.C. sec. 512(b)(2).
2. Held, further, the business activities that gave rise to the fees P received from V1 and V2 were not “carried on * * * primarily for the convenience of its members” within the meaning of I.R.C. sec. 513(a)(2).
3. Held, further, given the inapplicability of the exclusions in I.R.C. secs. 512(b)(2) and 513(a)(2), the fees P received from V1 and V2 were subject to UBIT because they were derived from an “unre- lated trade or business” that P regularly carried on.
T. J. Sullivan and Joseph A. Rillotta, for petitioner.
Joan Casali and Mark L. Hulse, for respondent.
OPINION
LAUBER, Judge: With respect to petitioner’s calendar tax years 2004,
2005, 2006, and 2007, the Internal Revenue Service (IRS or respondent) deter-
mined deficiencies in unrelated business income tax (UBIT) under section
511(a)(1) as follows:1
1 All statutory references are to the Internal Revenue Code (Code), in effect for the tax years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. We round all monetary amounts to the nearest dollar. -3-
Year Deficiency
2004 $51,104 2005 156,502 2006 234,193 2007 319,527
Although petitioner is exempt from Federal income tax under section 501(a)
and (c)(3), it is subject to tax on its “unrelated business taxable income” (UBTI).
See secs. 511(a)(1), 512(a)(1). The question presented is whether fees petitioner
received under certain contracts with third parties are excluded from UBTI as
“royalties” under section 512(b)(2) or as amounts received in a trade or business
“carried on * * * primarily for the convenience of its members” under section
513(a)(2). We conclude that neither of these exclusions applies and hence that the
fees petitioner received are subject to UBIT.
Background
The parties submitted this case for decision without trial under Rule 122.
The stipulation of facts and the attached exhibits are incorporated by this refer-
ence. Petitioner had its principal place of business in New Jersey when it filed its
petition.
Petitioner was incorporated in 1986 as University Health Systems of New
Jersey, Inc. In February 2001 it changed its name to New Jersey Council of -4-
Teaching Hospitals. Since its incorporation petitioner has been a membership or-
ganization whose members consist primarily of teaching hospitals operating in
New Jersey. At all relevant times petitioner’s board of trustees has consisted of
petitioner’s president and the chief executive officer (CEO) of each of its
members.
In November 1988 the IRS issued petitioner a determination letter recogniz-
ing it as exempt from Federal income tax under section 501(a) and (c)(3). The IRS
classified petitioner as a public charity rather than a private foundation by virtue of
its status as a “supporting organization,” i.e., an entity organized and operated “ex-
clusively for the benefit of, to perform the functions of, or to carry out the pur-
poses of” one or more public charities. Sec. 509(a)(3)(A). The entities petitioner
supports are its members, all of which are tax-exempt organizations as specified in
section 509(a)(1) or (2).
In its application for tax exemption petitioner stated that its “charitable ob-
jectives, like those of its supported organizations, are to further undergraduate and
graduate medical education, to coordinate such education with the clinical pro-
grams available in [its affiliated] hospitals, and to help provide innovative and cost
efficient health care delivery systems” in New Jersey. On its Forms 990, Return of
Organization Exempt From Income Tax, for 2004-2007, petitioner defined its ex- -5-
empt purposes to include “promoting health care, medical education and techno-
logy by studying and improving graduate medical education” and “articulat[ing] a
vision of a superior healthcare system for all New Jerseyans.” Petitioner incurred
the following expenses in advancing these goals:
Year Expenses
2004 $1,895,228 2005 2,214,338 2006 2,299,562 2007 2,633,921
During 2004-2007 petitioner’s members consisted of 9 to 11 teaching hospi-
tals, one nonteaching hospital, and one medical school. Each member paid annual
dues. The dues for major teaching hospitals were generally set at $257,500 per
year; other members paid annual dues between $25,750 and $130,000. During the
tax years at issue petitioner received dues from its members as follows:
Year Dues
2004 $1,570,750 2005 1,828,250 2006 1,893,250 2007 1,932,500
Besides dues income, petitioner received fees under contracts with third par-
ties. Petitioner’s “business model” was to offer various programs and services to
its members. If its members patronized or contracted with the third parties who -6-
supplied these programs and services, the third parties would make payments to
petitioner based on the revenues thus derived.
The third-party programs and services petitioner offered to its members dur-
ing 2004-2007 included credit cards, internet services, research and polling, equip-
ment maintenance, transportation services, debt collection, and group purchasing
arrangements. The revenues at issue in this case were derived from agreements
with two third parties: OSI Collection Services, Inc. (OSI),2 which provided debt-
collection services, and Greater New York Hospital Association (GNYHA), which
provided (directly or through affiliates) group purchasing programs.3
A. OSI Agreement
OSI was formerly known as Payco-General American Credits, Inc. (Payco).
In July 1992 petitioner and Payco executed a contract, captioned “Service Agree-
ment,” that was renewed periodically through the tax years at issue. This agree-
ment recites that petitioner “had been appointed purchasing agent by certain of its
2 During 2004-2007 OSI was a subsidiary of Outsourcing Solutions, Inc. For convenience we will refer to OSI and its parent collectively as OSI. 3 Petitioner also appears to have derived fees during 2004-2007 from third parties that supplied its members with transportation services and research and polling services. The aggregate amounts of these fees were $2,402 in 2004, $3,273 in 2005, $5,042 in 2006, and $4,535 in 2007. The notice of deficiency did not include these amounts in petitioner’s UBTI. -7-
members” and that petitioner “desire[d] to recommend the services of Payco to its
members” under the conditions stated in the agreement. For its part, Payco agreed
to provide petitioner’s current and future members, in exchange for specified fees,
“a full range of collection services for primary accounts, secondary accounts, and
accounts subject to litigation.”
Article 1 of the agreement, captioned “Purpose,” states that petitioner “here-
by endorses Payco as a * * * collection agency and shall advise its members that
Payco is one of * * * [petitioner’s] selected vendors.” Article 3, which sets forth
petitioner’s “Rights and Responsibilities,” provides that petitioner “shall endorse
Payco as a * * * collection agency” and shall “advise its members that * * * Payco
is one of [petitioner’s] selected vendors to provide collection agency services.”
Neither these nor any other provisions of the agreement license Payco to use peti-
tioner’s intangible property or obligate petitioner to make intangible property
available to Payco. Nowhere in the agreement is there any reference to tangible or
intangible property owned by petitioner.
To fulfill its obligations under the OSI agreement, petitioner listed OSI in
the “member services” section of its website. This listing included OSI’s logo, a
“hot link” to OSI’s website, and a paragraph-long description of OSI’s offerings.
During several board meetings petitioner’s president encouraged the CEOs of its -8-
member hospitals to hire OSI to perform their debt collection services, represent-
ing that OSI’s fees were important to petitioner’s financial stability. Petitioner
provided OSI with a list of its member hospitals, but that list was already publicly
available on petitioner’s website, along with the names and phone numbers of the
hospitals’ CEOs and chief financial officers.
In article 2 of the agreement, captioned “Payco’s Rights and Responsibili-
ties,” Payco agreed to pay petitioner “for its services as group purchasing organi-
zation a fee equal to three percent (3%) of the amount collected on * * * [petition-
er’s] members’ accounts placed with Payco.” Additionally, “in consideration for
the coordination and liaison services to be provided by * * * [petitioner] in its ca-
pacity as group purchasing agent,” Payco agreed to pay petitioner a distinct 3% fee
“pursuant to a separate agreement” previously executed. During the tax years at
issue, OSI (as successor to Payco) paid petitioner aggregate fees as follows:
Year Fees
2004 $97,577 2005 157,304 2006 165,049 2007 120,399 Total 540,329
During 2004 three of petitioner’s nine dues-paying members participated in
the OSI program. During 2005 three of petitioner’s ten dues-paying members par- -9-
ticipated in the OSI program. During 2006 three of petitioner’s 11 dues-paying
members participated in the OSI program. During 2007 four of petitioner’s ten
dues-paying members participated in the OSI program. Members who chose not
to participate in the OSI program were free to contract with other debt-collection
service providers. Petitioner did not track or assess, and cannot now quantify, the
extent to which its members saved money as a result of discounts or favorable pri-
ces offered by OSI.
B. GNYHA Agreement
In 2002 Health Alliance, Inc., a for-profit affiliate of petitioner, entered into
a “management agreement” with GNYHA.4 Under this agreement Health Alliance
was paid a share of the fees that GNYHA received as a result of enrollment by pe-
titioner’s members in certain group purchasing programs. This agreement applied
only with respect to hospitals that did not have contracts with GNYHA before be-
coming members of petitioner. The agreement had an initial term of two years but
was extended periodically through the tax years at issue.
Health Alliance subsequently assigned to petitioner all of its rights and obli-
gations under the GNYHA agreement. Health Alliance filed its final Federal in-
4 Certain activities under this agreement were performed by affiliates of GNYHA, including GNYHA Services, Inc., and GNYHA Ventures, Inc. For con- venience we will refer to these entities collectively as GNYHA. -10-
come tax return for its 2003 tax year and apparently became dormant sometime the
following year. Thus, during the tax years at issue, all fee payments under the
GNYHA agreement were received by petitioner.
During 2004-2007 GNYHA offered hospitals in New York, New Jersey,
and Connecticut the opportunity to select purchasing agreements from two port-
folios: its own “regional portfolio” and a “national portfolio” offered in conjunc-
tion with Premier, Inc., a national healthcare group purchasing organization. The
products and services that hospitals might purchase in this way included medical
and surgical supplies, pharmaceuticals, imaging and cardiology products, nutrition
services, operating room instruments, and various types of capital equipment. If a
hospital enrolled in either program, it was able to purchase products and services
from vendors at discounted prices that GNYHA and Premier had negotiated with
those vendors.
Under the 2002 agreement petitioner received “sales-related administrative
fees” for promoting GNYHA’s group purchasing programs to its members and for
helping to administer those programs (e.g., by distributing application forms and
instructions). Petitioner listed GNYHA in the “member services” section of its
website. This listing included a description of GNYHA’s offerings, a “hot link” to
its website, and the name and telephone number of a GNYHA contact person. -11-
The fees petitioner received from GNYHA were labeled “commissions” in
petitioner’s financial statements. These commissions were calculated as a percent-
age of the fees that vendors paid GNYHA and/or Premier with respect to pur-
chases by petitioner’s members who chose to participate in the group purchasing
programs. During the tax years at issue GNYHA paid petitioner fees as follows:
2004 $77,407 2005 303,996 2006 524,754 2007 820,388 Total 1,726,545
During 2004 three of petitioner’s nine hospital members participated in a
GNYHA group purchasing program. During 2005 six of petitioner’s ten hospital
members participated in a GNYHA group purchasing program. During 2006 six
of petitioner’s 11 hospital members participated in a GNYHA group purchasing
program. During 2007 seven of petitioner’s ten hospital members participated in a
GNYHA group purchasing program. Members who chose not to enroll with
GNYHA were free to enter into group purchasing agreements with Premier direct-
ly or to participate in arrangements offered by other providers, such as the Volun-
tary Hospitals of America. -12-
During 2004-2007 a hospital was not required to belong to an association
such as petitioner in order to participate in GNYHA’s group purchasing programs.
Hospitals received essentially the same vendor discounts regardless of whether
they joined individually or through an association. However, whereas GNYHA
paid fees to petitioner when its members enrolled through it, GNYHA did not pay
fees to hospitals that enrolled individually (and would not have paid fees to peti-
tioner’s members had they done so). Petitioner did not track or assess, and cannot
now quantify, the extent to which its members saved money (in absolute terms or
in comparison with other group purchasing programs available to them) as a result
of discounts made available through GNYHA.
C. IRS Examination
Petitioner timely filed Form 990 for each year at issue. On these returns it
treated all of its receipts as “substantially related” to the conduct of its tax-exempt
purposes, see sec. 513(a), and thus as exempt from Federal income tax. It did not
include with any of these returns Form 990-T, Exempt Organization Business In-
come Tax Return.
Following an examination of these returns the IRS sent petitioner a timely
notice of deficiency determining that the fees it had received from OSI and
GNYHA constituted UBTI subject to tax under sections 511(a)(1) and 512(a). -13-
The IRS determined that petitioner had “marketed and administered” the GNYHA
program and that this activity was not substantially related to its educational pur-
poses. The IRS likewise concluded that the fees received from OSI were subject
to UBIT, concluding that a charity’s need for “revenues to accomplish its charit-
able mission does not make a questioned activity related to its exempt purposes.”
In reaching these conclusions the IRS rejected petitioner’s reliance on sec-
tion 513(a)(2), which provides that an “unrelated trade or business” does not in-
clude an activity “which is carried on * * * by the organization primarily for the
convenience of its members.” According to the IRS, petitioner’s efforts to secure
“economic benefit[s] due to bulk marketing” did not constitute an activity under-
taken primarily for its members’ convenience. The IRS likewise rejected petition-
er’s reliance on section 512(b)(2), which excludes “royalties” from UBIT. In the
IRS’ view, OSI and GNYHA were paying fees to petitioner, not for use of its in-
tangible property, but for its services in endorsing, marketing, and administering
those programs.
Petitioner timely petitioned this Court for redetermination of the deficien-
cies set forth in the notice. See supra p. 3. By order dated March 20, 2017, we
granted the parties’ motion to submit the case under Rule 122 for decision without
trial. -14-
Discussion
A. Burden of Proof
The IRS’ determinations in a notice of deficiency are generally presumed
correct, and the taxpayer bears the burden of proving them erroneous. Rule
142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Petitioner does not con-
tend that the burden of proof should shift to respondent under section 7491. In
any event, because only legal issues remain, the burden of proof is irrelevant. See,
e.g., Nis Family Tr. v. Commissioner, 115 T.C. 523, 538 (2000).
B. Governing Statutory Structure
Congress enacted the UBIT regime in 1950, prompted in part by a universi-
ty’s acquisition of a macaroni company. See Note, “The Macaroni Monopoly:
The Developing Concept of Unrelated Business Income of Exempt Organiza-
tions,” 81 Harv. L. Rev. 1280 (1968). The goal of these provisions was to level
the playing field between for-profit companies and tax-exempt entities that engage
in business activities. Otherwise, charitable and educational organizations could
leverage their tax-exempt status to gain an unfair competitive advantage over
businesses required to pay the corporate income tax. See United States v. Am.
College of Physicians, 475 U.S. 834, 837-838 (1986); S. Rept. No. 81-2375, at 28
(1950), 1950-2 C.B. 483, 504. -15-
Section 511(a)(1) imposes a tax at regular corporate tax rates on the UBTI
of most charitable and educational organizations. Section 512(a)(1) defines UBTI
as the “gross income derived by any organization from any unrelated trade or bus-
iness * * * regularly carried on by it,” subject to certain modifications and less al-
lowable deductions.5 Consistently with its legislative purpose, Congress excluded
from UBTI most types of passive investment income, such as dividends, interest,
and capital gains. See sec. 512(b)(1), (5). Among the excluded forms of passive
income are “royalties.” Sec. 512(b)(2).
Section 513(a) generally defines an “unrelated trade or business” as:
any trade or business the conduct of which is not substantially related (aside from the need of such organization for income or funds or the use it makes of the profits derived) to the exercise or performance by such organization of its charitable, educational, or other purpose or function constituting the basis for its exemption under section 501.
The statute provides three exceptions to this general rule. The exception relevant
here, set forth in section 513(a)(2), provides that an “unrelated trade or business”
does not include a trade or business that an organization carries on “primarily for
the convenience of its members, students, patients, officers, or employees.”
5 Petitioner does not contend that it incurred any allowable deductions for expenses incurred in generating its fee income from OSI and GNYHA. -16-
C. Analysis
Petitioner concedes that the activities by which it earned fees from OSI and
GNYHA constituted a “trade or business,” that this business was “regularly car-
ried on,” and that the conduct of this business was “not substantially related” to
the performance of its educational purposes. But it urges that these fees were nev-
ertheless exempt from UBIT on the grounds that its fees from OSI constituted
“royalties” and that its fees from both vendors were derived from a business “car-
ried on * * * primarily for the convenience of its members.” We address these
contentions in turn.
1. Royalty Exclusion
Section 512(b)(2) excludes from UBTI “all royalties (including overriding
royalties) whether measured by production or by gross or taxable income from the
property.” The regulations do not define “royalty,” except to indicate that the term
includes “mineral royalties.” Sec. 1.512(b)-1(b), Income Tax Regs. Whether an
item of income constitutes a royalty is to be determined “by all the facts and cir-
cumstances of each case.” Id. sec. 1.512(b)-1 (first sentence).
As relevant here, “royalties” are “payments for the right to use intangible
property.” Sierra Club, Inc. v. Commissioner, 86 F.3d 1526, 1532 (9th Cir. 1996),
aff’g in part, rev’g in part, and remanding 103 T.C. 307 (1994); see Disabled Am. -17-
Veterans v. Commissioner, 94 T.C. 60, 70 (1990) (concluding that “royalties” for
purposes of section 512(b)(2) “are payments for the use of valuable intangible pro-
perty rights”), rev’d on other grounds, 942 F.2d 309 (6th Cir. 1991). We have
held that “royalties” include payments to a tax-exempt organization for use of such
intangible assets as its name, logo, service marks, and membership list. See, e.g.,
Common Cause v. Commissioner, 112 T.C. 332 (1999); Planned Parenthood
Fed’n of Am., Inc. v. Commissioner, T.C. Memo. 1999-206; Sierra Club, Inc. v.
Commissioner, T.C. Memo. 1999-86, 77 T.C.M. (CCH) 1569, 1575.6
On the other hand, “royalties” for purposes of section 512(b)(2) “cannot in-
clude compensation for services rendered by the owner of the property.” Sierra
Club, 86 F.3d at 1532. For example, in Texas Farm Bureau v. United States, 53
F.3d 120 (5th Cir. 1995), an insurance company paid a tax-exempt organization to
“use its good offices, influence and prestige” to promote the companies’ life insur-
ance plans and provide various administrative services. The Court of Appeals
held these fees subject to UBIT, reasoning that “the plain language of the agree-
6 See also Disabled Am. Veterans, 94 T.C. at 70-71 (noting that “royalties” are generally defined to include payments for “the rights to use copyrights, literary works, motion picture rights, and dramatic rights”). The Commissioner has ruled that “royalties” for purposes of section 512(b)(2) include proceeds derived by a tax-exempt organization from licensing the use of its members’ names, photo- graphs, likenesses, and facsimile signatures. Rev. Rul. 81-178, 1981-2 C.B. 135. -18-
ments demonstrates that the agreements were strictly for services and did not con-
template a royalty payment.” Id. at 124; see Nat’l Water Well Ass’n, Inc. v. Com-
missioner, 92 T.C. 75, 100-101 (1989) (ruling that “a royalty is a payment for the
use of a valuable right” and that “compensation for services rendered” does not
constitute royalty income); cf. Sierra Club, 77 T.C.M. (CCH) at 1579 (holding that
the organization’s receipts were not received “in consideration for services pro-
vided” but rather “in consideration for the use of * * * intangible property”).
Petitioner’s contract with OSI was captioned “Service Agreement.” Peti-
tioner thereby agreed to advise its members that OSI was a “selected vendor,” to
endorse OSI as a collection agency, and to provide various administrative services.
In exchange for petitioner’s “services as group purchasing organization” and its
“coordination and liaison services,” OSI agreed to pay petitioner specified fees.
Nowhere in the agreement does petitioner license OSI to use its intangible
property or obligate itself to make intangible property available to OSI. Indeed,
the agreement makes no reference whatever to tangible or intangible property
owned by petitioner. That being so, it is hard to see how the fees petitioner re-
ceived under the agreement could be regarded as “royalties * * * measured by pro-
duction or by gross or taxable income from the property.” See sec. 512(b)(2)
(emphasis added). -19-
Petitioner urges that the services it actually provided OSI were quite mod-
est. It listed OSI on the “member services” page of its website, which displayed
OSI’s name and logo, supplied a “hot link” to OSI’s website, and provided a para-
graph-long description of OSI’s offerings. During several board meetings peti-
tioner’s president encouraged the CEOs of its member hospitals to hire OSI to per-
form their debt collections, representing that OSI’s fees were important to petition-
er’s financial stability. Hypothesizing that this volume of services could not have
been worth the $540,329 it received from OSI during 2004-2007, petitioner urges
that OSI must in fact have been paying for something else. That “something else,”
petitioner says, was “OSI’s acquisition of the right to associate its name and mark
with * * * [petitioner’s] name and mark” and with petitioner’s “reputation with its
members.” In petitioner’s view, this was “the crux of the contract.”
This argument is unpersuasive because petitioner has failed to identify any
intangible property of its own that it licensed OSI to use. The placement of OSI’s
trademark on petitioner’s website obviously did not constitute the use of petition-
er’s intangible property by OSI; rather, it constituted the rendition of a service to
OSI by petitioner. And while petitioner’s “reputation” might be described as an
intangible asset, petitioner did not license OSI to use petitioner’s reputation. Rath- -20-
er, petitioner exploited its own reputation with its members by endorsing OSI and
inducing its members to patronize that company.
It is not our role to second-guess the value that OSI placed on petitioner’s
endorsement and administrative services. By agreeing to endorse OSI as one of its
“selected vendors,” petitioner directed to OSI’s door a potentially large stream of
revenue, and OSI agreed to pay petitioner at least 3% of the resulting receipts.
The fact that petitioner’s share of these receipts amounted to $540,329 simply at-
tests to the depth of that revenue stream; it creates no inference that OSI was pay-
ing petitioner for the right to use some unspecified intangible property. We con-
clude that OSI was paying petitioner for its services, not for the use of its intangi-
ble property, and that the OSI fees cannot be excluded from UBTI as “royalties”
under section 512(b)(2).
2. “Convenience” Exception
Section 513(a)(2) excepts from the definition of “unrelated trade or busi-
ness” any trade or business “which is carried on, in the case of an organization de-
scribed in section 501(c)(3) or in the case of a college or university described in
section 511(a)(2)(B), by the organization primarily for the convenience of its
members, students, patients, officers, or employees.” Neither the Code nor the
regulations explain the scope of this exception or define the term “convenience.” -21-
However, the regulations supply three examples of activities that qualify for the
“convenience” exception: “the sale of books by a college bookstore to students,”
“the sale of pharmaceutical supplies by a hospital pharmacy to patients of the hos-
pital,” and “a laundry operated by a college for the purpose of laundering dormi-
tory linens and the clothing of students.” Sec. 1.513-1(c)(2)(ii), (e) (flush lan-
guage), Income Tax Regs. These examples resemble those set forth in the legis-
lative history. See H.R. Rept. No. 81-2319, at 37 (1950), 1950-2 C.B. 380, 409
(stating that, “[i]n the case of an educational institution, income from dining halls,
restaurants, and dormitories operated for the convenience of the students” would
qualify for the section 513(a)(2) exception).
The Commissioner has expanded on these examples in a series of revenue
rulings.7 Elaborating on one regulatory example, the IRS has ruled that a laundry
7 We are not bound by revenue rulings. Under Skidmore v. Swift & Co., 323 U.S. 134, 140 (1944), the weight we afford them depends upon their persuasive- ness and the consistency of the Commissioner’s position over time. PSB Hold- ings, Inc. v. Commissioner, 129 T.C. 131, 142 (2007) (“[W]e evaluate the revenue ruling under the less deferential standard enunciated in Skidmore [.]”); see United States v. Mead Corp., 533 U.S. 218, 234 (2001) (citing Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837 (1984) (“Chevron did nothing to eliminate Skidmore’s holding that an agency’s interpretation may merit some de- ference whatever its form [.]”)) The Commissioner’s rulings on the “convenience exception” date back to 1955 and reflect a consistent position. We conclude that these rulings are entitled to some deference. See Webber v. Commissioner, 144 T.C. 324, 352-353, 357-358 (2015). -22-
and dry-cleaning plant operated by a university primarily to serve its students and
faculty qualified for the “convenience” exception, even though some members of
the public were also served. Rev. Rul. 55-676, 1955-1 C.B. 266. The Commis-
sioner has similarly ruled that the operation of vending machine facilities on a
college campus, including food and soft drink vending and laundromat facilities,
would qualify for the “convenience” exception. Rev. Rul. 81-19, 1981-1 C.B.
353, 354. The Commissioner concluded that “[t]he goods and services dispensed
by the vending machines are necessary for the day-to-day living on the campus of
students, faculty, and staff.” Accordingly, these activities “further[ed] the educa-
tional program of the university” and qualified for the section 513(a)(2) exception
“by operating facilities for the convenience of the university community.” Ibid.;
see also Rev. Rul. 58-194, 1958-1 C.B. 239, 240-241 (holding that an organization
operating a bookstore and cafeteria on a college campus for the convenience of
students and faculty qualified for exemption under section 501(c)(3)).
On the other hand, distinguishing another of the regulatory examples, the
Commissioner has ruled that sales of pharmaceutical supplies by a tax-exempt
hospital to members of the general public, or to private patients of physicians prac-
ticing in a building owned by the hospital, do not qualify for the “convenience”
exception. Rev. Rul. 68-375, 1968-2 C.B. 245; Rev. Rul. 68-374, 1968-2 C.B. -23-
242. The Commissioner reasoned that “[t]he buyer-seller relationship between
these off-street patrons and the pharmacy” was insufficient to classify them as
“patients” of the hospital. Rev. Rul. 68-374, 1968-2 C.B. at 243. The Commis-
sioner concluded that these revenues were subject to UBIT because there was “no
substantial causal relationship between the achievement of the hospital’s exempt
purposes and the sale of pharmaceutical supplies” to such individuals. Ibid.; Rev.
Rul. 68-375, 1968-2 C.B. at 246.
Read together, these examples suggest that a business conducted by a uni-
versity or a hospital will be regarded as carried on for the convenience of its stu-
dents or patients if the business activity assists those individuals in their capacity
as such, viz., by helping them be better students or healthier patients. On-campus
cafeterias assist students in fulfilling their role as students by facilitating student
interaction before and after class. On-campus dormitories allow students to live
close to classrooms and libraries and share quarters with fellow students. On-
campus bookstores, laundromats, and vending machines enable students to obtain
day-to-day living necessities without the inconvenience of traveling to distant off-
campus locations. And operation of a pharmacy helps hospital patients stay
healthier by enabling them to secure needed drugs and supplies without endanger-
ing their health by leaving the premises. In each case, the university or hospital -24-
furthers its own educational or health-advancement purpose by helping the recipi-
ents of its services to perform better. See also St. Luke’s Hosp. v. United States,
494 F. Supp. 85, 92 (W.D. Mo. 1980) (pathology tests performed by hospital pri-
marily for convenience of member physicians).
The case law on this subject, while sparse, supports this interpretation of the
“convenience” exception. See Am. College of Physicians v. United States, 3 Cl.
Ct. 531 (1983), rev’d on other grounds, 743 F.2d 1570, 1577 (Fed. Cir. 1984),
rev’d on other grounds, 475 U.S. 834 (1986). The question addressed by the Su-
preme Court in that case was whether a medical association’s publication of com-
mercial advertising in its medical journal was “substantially related” to its tax-
exempt purposes. See Am. College of Physicians, 475 U.S. at 835-836. But the
College advanced an alternative argument at the trial and appellate levels, namely,
that its advertising activity was “carried on primarily * * * for the convenience its
members” within the meaning of section 513(a)(2). The Claims Court rejected
that argument, and its holding to this effect was affirmed on appeal. See Am.
College of Physicians, 743 F.2d at 1577.
The Claims Court’s reasoning is instructive here. The College contended
that journal advertising served the convenience of its physician members by bring-
ing to their attention new medical products and positions offered in classified ads. -25-
The court assumed that this advertising might benefit the College’s members in
their capacity as practicing physicians. Am. College of Physicians, 3 Cl. Ct. at
536. But it found the “convenience” exception unavailable because the advertis-
ing was not published for the convenience of members in their capacity as such:
The members’ interests as members concern such matters as attending the College’s educational functions, participating in research and test- ing, disseminating health information to the public and promoting quality medical education. The members’ interests as physicians are much broader and include all aspects of medical practice. * * * [Ibid.]
Although journal advertising might “assist practicing physicians by inform-
ing them of new products [or] publicizing the availability of positions,” the court
found that the College’s advertising “does not * * * have any connection with
their responsibilities as members of the College.” Ibid. It accordingly ruled that
the College’s advertising business was not carried on “for the convenience of its
members” within the meaning of section 513(a)(2).
Petitioner contends that its activities under the GNYHA contract were un-
dertaken for the purpose of “providing members access to discounted supplies and
services” and “generating non-dues revenue to support * * * [its] operations on
behalf of its members.” Its activities under the OSI contract were allegedly under-
taken for the purpose of “refer[ring] to its members a vetted and reliable collec- -26-
tions vendor.” Because its business activity allegedly assisted its members in
these ways, petitioner insists that this activity was carried on primarily for their
convenience.
We reject this contention for a variety of reasons. First, by helping its mem-
bers save time or money by directing them to low-cost or high-quality vendors,
petitioner was not serving “the convenience of * * * [its] members in their capa-
city as members.” Am. College of Physicians, 3 Cl. Ct. at 535. The members’
interests as members may include attending petitioner’s educational functions and
participating in its research programs. Petitioner might serve its members’ con-
venience in their capacity as members (for example) by providing travel services
in connection with its conferences or by contracting with research or consulting
firms. Although helping its members save money might improve the hospitals’
balance sheets, it would not provide a convenience to them in their capacity as
members of petitioner. Nor would it enable petitioner to advance its own educa-
tional purposes, as a university does by serving the convenience of its students in
their capacity as students.
Second, petitioner has not established that its activity benefitted its members
in any meaningful way. Petitioner did not track or assess, and cannot now quan-
tify, the extent to which its members saved money (in absolute terms or in compar- -27-
ison with other programs available to them) as a result of discounts or favorable
prices offered by GNYHA or OSI. Hospitals were not required to belong to an
association like petitioner in order to participate in GNYHA’s group purchasing
programs, and they received essentially the same vendor discounts regardless of
whether they joined individually or through an association. Petitioner insists that
it served its members’ convenience, “if only in terms of saved time and effort,” by
vetting OSI through a request for proposals. But this alleged vetting was conduct-
ed in 1991, more than a decade earlier. And only a third of petitioner’s members
signed up for the OSI program, suggesting that its benefits were not obvious. Peti-
tioner cannot show that these activities were conducted “primarily for the conveni-
ence of its members” without showing that the activities plausibly benefitted its
members in some way.
Third, even if petitioner’s business activity saved its members money, there
is no legal support for the notion that saving money, without more, is enough to
qualify for the “convenience” exception in section 513(a)(2). There is nothing in
the statute or its legislative history, in the regulations promulgated by the Secre-
tary, or in the rulings issued by the Commissioner, to suggest that saving money is
an important (or even a relevant) consideration. A university’s operation of on-
campus cafeterias and laundromats might save students (or their parents) money -28-
by offering lower prices than those available commercially. But there is no evi-
dence that considerations of this sort played any role in Congress’ enactment of
the “convenience” exception. Indeed, petitioner’s “money saving” theory is hard
to reconcile with Congress’ overall purpose in enacting the UBIT provisions,
which was to eliminate unfair competition between tax-exempt and taxpaying bus-
inesses.
Petitioner’s “money saving” theory also proves too much. Tax-exempt or-
ganizations could engage in a wide array of businesses that might save time or
money for their members, students, patients, officers, or employees, by selling
directly to those individuals or by directing them to low-cost or high-quality vend-
ors. Were section 513(a)(2) construed as petitioner urges, it “would significantly
undercut the purpose of the UBIT” because “there would be no end to the types of
goods and services an organization could provide its members while avoiding tax
on the income so derived.” Am. College of Physicians, 3 Cl. Ct. at 535.8
8 Insurance programs are one example of a business that might qualify under petitioner’s interpretation of the “convenience” exception. Many tax-exempt or- ganizations sponsor or endorse insurance plans for their members, receiving fees from the insurance companies when their members sign up. Such organizations may plausibly contend that these plans have been well vetted and may save their members time or money. But it is well established that this activity generally con- stitutes an “unrelated trade or business” the revenues from which are subject to UBIT. See, e.g., United States v. Am. Bar Endowment, 477 U.S. 105, 119 (1986); (continued...) -29-
Fourth, even if petitioner’s business activity were thought to provide a con-
venience to its members by saving them time or money, petitioner has not shown
that it conducted this activity “primarily for the convenience of its members,” as
the statute requires. Sec. 513(a)(2) (emphasis added). In another tax context, the
Supreme Court has interpreted the term “primarily’ to mean “of first importance”
or “principally.” Malat v. Riddell, 383 U.S. 569, 572 (1966) (construing section
1221(1)). As the Claims Court concluded in Am. College of Physicians, “[t]here
seems to be no reason to depart from this common sense definition in interpreting
section 513(a)(2).” 3 Cl. Ct. at 536.
During 2004-2007 petitioner derived aggregate fees of $2,266,874 (approxi-
mately 23% of its total revenue) under its contracts with OSI and GNYHA. As
petitioner’s president emphasized to his fellow board members, these revenues
were important to petitioner. Petitioner’s annual expenditures substantially ex-
ceeded the dues its members paid; in 2007, the gap between expenditures and dues
was more than $700,000. See supra p. 5. Without the fees it received from OSI
and GNYHA, petitioner would have been forced to curtail its activities (or raise its
dues) significantly. Even if petitioners’ members were thought to have derived
8 (...continued) Texas Farm Bureau, 53 F.3d at 126; Am. Postal Workers Union, AFL-CIO v. United States, 925 F.2d 480, 483-485 (D.C. Cir. 1991). -30-
some incidental benefit from the conduct of these two businesses, it seems clear
that petitioner’s primary purpose for engaging in these activities was to raise reve-
nue for itself. See Am. College of Physicians, 3 Cl. Ct. at 536.9
If raising revenue were deemed its primary purpose, petitioner asserts that
its fee-generating activity nevertheless served its members’ convenience by en-
abling it to conduct a broader range of charitable activities or by reducing the dues
its members would otherwise have had to pay. But this is simply a variation on
the “money saving” theory we have already rejected. See supra pp. 27-29. Peti-
tioner offers no legal authority, and we have found none, to support the proposi-
tion that a desire to raise revenue (whether rebated to members or not) is sufficient
to meet the requirements of the “convenience” exception.
The UBIT provisions adopt the general rule that an organization’s business
revenues are taxable unless the underlying activity is “substantially related” to its
exempt purposes “aside from the need of such organization for income or funds or
the use it makes of the profits derived.” Sec. 513(a). Adoption of petitioner’s
premise--that raising revenue to support its operations is sufficient to meet the
9 Hospitals were not required to belong to an association like petitioner in order to participate in GNYHA’s group purchasing programs. But if petitioner’s members participated through it rather than individually, GNYHA would pay peti- tioner substantial fees. This makes it clear that petitioner operated this business, not for its members’ convenience, but primarily to raise revenue for itself. -31-
“convenience” exception--would cause that exception to swallow this general rule.
“In construing provisions * * * in which a general statement of policy is qualified
by an exception, we usually read the exception narrowly in order to preserve the
primary operation of the provision.” Commissioner v. Clark, 489 U.S. 726, 739
(1989).
For all these reasons, we find that the business activities giving rise to peti-
tioner’s fees from OSI and GNYHA were not “carried on * * * primarily for the
convenience of its members” within the meaning of section 513(a)(2). Those rev-
enues were thus derived from an “unrelated trade or business” that petitioner reg-
ularly carried on. The royalty exclusion of section 512(b)(2) being inapplicable,
petitioner’s fees constitute UBTI under section 512(a)(1) that is subject to UBIT
under section 511(a)(1).
To implement the foregoing,
Decision will be entered for
respondent.