106 T.C. No. 11
UNITED STATES TAX COURT
OHIO FARM BUREAU FEDERATION, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 18614-93. Filed April 11, 1996.
P, a tax-exempt agricultural organization, engaged in activities to promote the use of agricultural cooperatives among farmers. In 1934, P formed L, a statewide cooperative. In 1949, P and L entered into a written contract, whereby P agreed to perform educational and promotional activities on behalf of L in exchange for a fee. Pursuant to the contract, P performed activities to promote cooperatives in general and L specifically.
In 1985, L merged into another cooperative. In connection with the merger, P and L formally terminated their contractual relationship pursuant to a written termination agreement. The termination agreement contained a nonsponsorship and noncompetition clause, whereby P agreed not to sponsor or promote a competing cooperative on an exclusive basis. In consideration for the nonsponsorship and noncompetition agreement, P received $2,064,500. - 2 -
Held: The fees received by P pursuant to its service contract with L were substantially related to its tax-exempt purpose and, therefore, did not constitute unrelated business taxable income.
Held, further: P’s fulfillment of the nonsponsorship and noncompetition clause did not constitute a trade or business as defined by sec. 513, I.R.C.; therefore, the payment did not constitute unrelated business taxable income taxable to P under sec. 511(a), I.R.C.
James R. King, Michael Dubetz, Jr., and Todd S. Swatsler,
for petitioner.
Robert D. Kaiser, for respondent.
RUWE, Judge: Respondent determined deficiencies in
petitioner’s Federal income tax in the amounts of $1,107,505 and
$40,192 for the taxable periods ending August 31, 1985, and
August 31, 1986, respectively.
After concessions, the issues for decision are: (1) Whether
the $292,617 received by petitioner pursuant to its service
contract with Landmark, Inc., during the taxable year ending
August 31, 1985, constituted unrelated business taxable income;
(2) whether a lump-sum payment made by Landmark, Inc., to
petitioner pursuant to the terms of a nonsponsorship and
noncompetition clause contained in their 1985 termination
agreement constituted unrelated business taxable income; and (3)
whether interest should be computed under the provisions of - 3 -
section 6621(c),1 dealing with large corporate underpayments, for
the taxable period ending August 31, 1985.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and attached exhibits are incorporated
herein by this reference. At the time the petition was filed,
petitioner’s principal place of business was in Columbus, Ohio.
Petitioner is the Ohio Farm Bureau Federation, Inc., a
nonprofit agricultural organization exempt from Federal income
tax under section 501(c)(5). Petitioner was formed in 1919 as an
unincorporated association and subsequently incorporated under
Ohio law on November 27, 1931. Petitioner is a statewide
federation of local county farm bureaus (county bureaus).
Individual farmers are not members of petitioner. Instead,
farmers (or other persons fulfilling certain eligibility
requirements) are members of the county bureaus, which, in turn,
are members of petitioner.
Petitioner’s stated purpose was generally to aid and assist
in the betterment of the conditions and welfare of those engaged
in agriculture. More specifically, petitioner engaged in
activities to educate Ohio farmers and to promote agricultural
1 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the taxable period in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. - 4 -
cooperatives and cooperative activity among Ohio farmers. An
agricultural cooperative is a business organization in which the
members, who are generally individual farmers, are both owners of
the organization and its customers. The farmer-owners sell
products to, and purchase products and supplies from, the
cooperative. A farmer’s ownership interest in the cooperative is
determined by the amount of business he or she does with the
cooperative. Petitioner has historically encouraged farmers to
join cooperatives, pointing out the benefits of ownership, the
availability of products or services that may not otherwise be
available to farmers, and the focus on keeping farmers’ needs and
interests primary. In fact, petitioner was the founder or
sponsor of most of the agricultural cooperatives in Ohio.
In 1934, petitioner formed an Ohio agricultural cooperative
by the name of the Ohio Farm Bureau Cooperative Association, Inc.
The name was later changed to Landmark, Inc. (Landmark).
Landmark was a regional cooperative organization. As such, it
did not generally sell products to or purchase products from
individual farmers. Instead, local Landmark cooperatives or
affiliated organizations (local Landmarks) purchased from or sold
to individual farmers.
From the time of Landmark’s formation until December 5,
1981, petitioner held a controlling interest in Landmark’s voting - 5 -
common stock and also held some preferred shares.2 Petitioner
and Landmark shared common management until 1955. During the
taxable year in issue, petitioner and Landmark shared office
space pursuant to a contract dated December 5, 1981, between
petitioner and Landmark.
During the year in issue, local Landmarks were located
throughout the State of Ohio, making Landmark the only regional
cooperative in Ohio that had local affiliates located throughout
the State. Landmark, as the regional organization, dealt
principally with petitioner, rather than with the county bureaus.
The local Landmarks worked with the county bureaus throughout the
State in a similar mutual and cooperative manner. Most of the
farmers who were members of the county bureaus were also members
of the local Landmarks.
On November 15, 1949, petitioner and Landmark (then known as
the Farm Bureau Cooperative Association, Inc.) entered into a
written service contract, whereby petitioner agreed to "perform
services on behalf of * * * [Landmark] in the fields of
education, promotion, organization, publicity and public
relations for the purpose of aiding in the purchasing and
marketing activities of * * * [Landmark]." Specifically,
petitioner agreed to (1) disseminate information to Ohio farmers
2 Petitioner continued to hold Landmark preferred shares until such shares were exchanged for Countrymark stock pursuant to a merger in 1985. See infra p. 9. - 6 -
with respect to economic and social conditions, results of
agricultural research, methods of producing, marketing, and
selling agricultural products, and methods for financing
agricultural operations; (2) provide education, including
education for the purpose of promoting the marketing and sale of
agricultural products handled by Landmark; (3) make available to
Landmark its mailing list; (4) maintain a publicity department to
encourage the handling of Landmark merchandise; (5) publish
advertisements of Landmark (at standard advertising rates) and
news items about Landmark (as offered and agreed upon) in its
news publication; (6) maintain a public relations program
relating to farm cooperatives; and (7) promote research in
agricultural fields and cooperatives generally. In consideration
of the performance of these services by petitioner, Landmark
agreed to pay the sum of 1/4 of 1 percent of its purchasing
volume and 1/16 of 1 percent of its marketing volume.
The November 15, 1949, contract represented the first
written agreement between the parties; however, the working
relationship memorialized in the agreement actually predated the
writing. The written service contract was amended on January 1,
1980, and again on December 5, 1981. The only material change
made by these amendments was in the calculation of the fee to be
paid to petitioner. The 1980 amendment changed the amount of the
fee to a percentage of Landmark’s gross margin, and the 1981
amendment changed the amount to correspond to a fixed payment - 7 -
schedule. The 1981 amendment was in effect during the taxable
year in issue.
Pursuant to the service contract, petitioner engaged in
various types of educational programs, which directly or
indirectly promoted cooperatives. For example, petitioner
conducted youth camps, where cooperatives and cooperative issues
were explained, and children were given the opportunity to
operate a small-scale cooperative. Petitioner also conducted
conferences for young couples dedicated to farming. These
conferences were jointly sponsored with Landmark and included
discussion about cooperatives. In addition, petitioner sponsored
advisory council meetings, in which small, voluntary groups of
farmers gathered to discuss farm topics. Petitioner would
suggest topics for discussion at these meetings, including
cooperative issues in general and assessment of the performance
of the local cooperative organizations.
Petitioner also engaged in various public relations
activities to promote cooperatives pursuant to the service
contract. For example, C. William Swank, petitioner’s executive
vice president and chief executive officer, and other staff
members of petitioner frequently spoke about cooperative issues
to farmer groups, university groups and classes, and service
clubs. Moreover, petitioner’s primary publication, the Buckeye
Farm News, included frequent editorial discussions about
cooperative ideas in general and about Landmark in particular. - 8 -
Petitioner made editorial space available to Landmark, so that it
could include its own discourse on cooperatives as well as
discussions of its general business. Petitioner also invited
representatives from Landmark and other cooperative organizations
to speak about cooperative issues at its farm bureau meetings.
In addition, pursuant to the service contract, petitioner
undertook various legislative efforts in cooperation with
Landmark. On several occasions, they were successful in securing
passage of legislation beneficial to Ohio farmers.
In conducting its activities pursuant to the service
contract, petitioner continuously emphasized the cooperative form
of doing business. In this connection, petitioner would often
mention Landmark specifically and permit Landmark representatives
to communicate with petitioner’s members through editorials in
the Buckeye Farm News and through appearances at youth camps and
other meetings. Petitioner would also refer its members to
Landmark. The nature of petitioner’s activities under the
service contract did not materially change from the time the
contract was executed in 1949 until the time it was terminated in
1985.
Petitioner had a similar service agreement with another,
much smaller agricultural cooperative, known as the Ohio
Agricultural Marketing Association. This agreement served
significantly fewer people and generated much smaller fees than
did petitioner’s service contract with Landmark. - 9 -
In 1985, Landmark merged into another agricultural
cooperative, the Ohio Farmers Grain and Supply Association, Inc.
(Ohio Farmers). The name of the surviving entity was changed to
Countrymark. Prior to the merger, Landmark had cooperative
facilities throughout the State of Ohio, whereas Ohio Farmers’
activities were limited to northwest Ohio. The two cooperative
organizations were competitive to the extent that Landmark
operated facilities in northwest Ohio; however, Ohio Farmers
coexisted with Landmark in only about 15 percent of the counties
in Ohio. The merger eliminated most of the cooperative
competition in Ohio.
In connection with the merger, petitioner’s relationship
with Landmark was formally terminated pursuant to a written
termination agreement, dated February 20, 1985. The preamble to
the agreement contained the following recital:
[Petitioner] and Landmark have had a close working relationship since 1934. Until 1955, they shared common management. Thereafter, the close relationship continued under a service/sponsorship agreement providing for [petitioner] to perform a wide variety of services in the promotion and advancement of Landmark, its products and services. During the duration of the relationship [petitioner] has been privy to many of Landmark’s business plans and programs, its trade secrets, customer lists of its members, price lists and other confidential trade practices and has promoted, exclusively, the Landmark system and its products and services.
Under the termination agreement, petitioner and Landmark agreed,
among other things, to terminate their service contract. The - 10 -
termination agreement also contained a nonsponsorship and
noncompetition provision, which provided in pertinent part:
Section 5. Non-Sponsorship/Non-Competition. [Petitioner], for and upon receipt of the consideration specified in Section 6.2 below, agrees that for a period of three (3) years from the Effective Date that (except for the benefit of Landmark or its successors) it will not participate in the ownership, management, operation, control, or sponsorship of any agri-business enterprise engaged in grain marketing, feed manufacturing, fertilizer manufacturing or distribution, or farm chemical or petroleum distribution at the "regional cooperative level" * * * nor will it, at the regional or local level * * * during such three year period, within the State of Ohio, sponsor or promote, on an exclusive basis, a specific competing enterprise or products or services of the type and character described above. Nothing herein shall be construed to prohibit or prevent [petitioner’s] support for and promotion of cooperatives and their products and services on a non- exclusive basis within the agri-business community; promotion of and education of the public about agriculture, its needs and concerns; the conduct of any programs or activities which [petitioner] now conducts * * *
In consideration for the covenants contained in this provision,
petitioner received $2,064,500.3
Since entering the termination agreement on February 20,
1985, petitioner has continued to conduct educational,
promotional, and other activities with respect to agricultural
3 Petitioner received an additional $633,600 under the termination agreement in consideration for certain rights to additional preferred stock of Landmark and for petitioner’s assignment of all its voting rights in Landmark to a voting trust provided for in the termination agreement. This payment is not in issue. - 11 -
and other cooperatives. Petitioner has also afforded some
visibility to Countrymark, the merged entity, by mentioning it in
the Buckeye Farm News and permitting Countrymark representatives
to appear at petitioner’s youth camps and annual meetings.
OPINION
The parties agree that petitioner is a "Labor, agricultural,
or horticultural" organization exempt from tax pursuant to
section 501(c)(5). Such organizations are described in the
regulations as those that (1) have no net earnings inuring to the
benefit of any member and (2) have as their objects the
betterment of the conditions of those engaged in agricultural
pursuits, the improvement of the grade of their products, and the
development of a higher degree of efficiency in their
occupations. Sec. 1.501(c)(5)-1, Income Tax Regs.
Notwithstanding this general exemption from taxation,
section 511(a) imposes a tax on the "unrelated business taxable
income" (UBTI) of section 501(c)(5) organizations. UBTI is
defined in section 512(a)(1) 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
* * * which are directly connected with the carrying on of such
trade or business". Section 513(a), in turn, defines "unrelated
trade or business" as "any trade or business the conduct of which
is not substantially related * * * to the exercise or performance - 12 -
by such organization of its charitable, educational, or other
purpose or function constituting the basis for its exemption".
The regulations and the case law have delineated the three
elements necessary for income from an activity to be UBTI: (1)
The activity from which the income is derived is a trade or
business, (2) the trade or business is regularly carried on by
the organization, and (3) the conduct of the trade or business is
not substantially related to the organization’s tax-exempt
purpose, other than through the need for or use of the funds it
produces. United States v. American Bar Endowment, 477 U.S. 105,
110 (1986); National Water Well Association v. Commissioner, 92
T.C. 75, 83 (1989); sec. 1.513-1(a), Income Tax Regs. UBTI
exists only if all three elements are found. Veterans of Foreign
Wars, Mich. v. Commissioner, 89 T.C. 7, 19-20 (1987). Petitioner
bears the burden of proving that one or more of the elements
above is lacking. Rule 142(a).
Payments Under the Service Agreement
The first issue we must decide is whether the $292,617
received by petitioner during 1985 pursuant to its service
agreement with Landmark constituted UBTI. There appears to be no
dispute that the services performed by petitioner pursuant to the
service agreement constituted a trade or business and were
regularly carried on. Thus, the focus of our discussion is
limited to whether or not petitioner’s performance of those - 13 -
services was substantially related to its tax-exempt purpose as
an agricultural organization under section 501(c)(5).
For a substantial relationship to exist, the activity that
produces the income “must contribute importantly to the
accomplishment of * * * [the organization’s exempt] purposes.”
Sec. 1.513-1(d)(2), Income Tax Regs. The regulations describe
the type of relationship that qualifies as substantial:
Trade or business is “related” to exempt purposes, in the relevant sense, only where the conduct of the business activities has causal relationship to the achievement of exempt purposes (other than through the production of income); and it is “substantially related,” for purposes of section 513, only if the causal relationship is a substantial one. * * * [Sec. 1.513-1(d)(2), Income Tax Regs.]
The substantial relationship requirement focuses upon the manner
in which the tax-exempt organization conducts its activities.
United States v. American College of Physicians, 475 U.S. 834,
848-849 (1986).
In cases involving business leagues, courts have identified
two factual elements that are important to the substantial
relationship determination: (1) Whether the activities in
question are “unique” to the organization’s tax-exempt function,
and (2) whether the activities benefit the common business
interest of an organization’s membership or the industry as a
whole and not just members in their individual capacities.
Professional Ins. Agents of Mich. v. Commissioner, 726 F.2d 1097, - 14 -
1103 (6th Cir. 1984), affg. 78 T.C. 246 (1982); Louisiana Credit
Union League v. United States, 693 F.2d 525, 535 (5th Cir.
1982).4
With respect to the uniqueness test, it has been stated that:
Such services as educational and training programs, legislative lobbying, and institutional advertising clearly satisfy this uniqueness test, because they advance the purposes of the * * * [organization] as an entity in itself. It is the institutional ends that must be served if the activity is to be deemed substantially related. Educational, legislative, and advertising services are peculiarly suitable activities for a business league because they further the common business interest that unites the association’s members. * * * [Louisiana Credit Union League v. United States, supra at 535; see also Professional Ins. Agents of Mich. v. Commissioner, supra at 1103.]
in the betterment of the conditions and welfare of those engaged
in agriculture. The affidavit upon which petitioner’s tax
exemption was based defined petitioner’s purposes to include “the
sponsorship of * * * Purchasing and Marketing cooperatives”. The
primary thrust of petitioner’s activities under the service
contract was to educate Ohio farmers about agricultural
cooperatives in general, and Landmark specifically, and to
4 While the cases cited deal with business leagues under sec. 501(c)(6), which are associations of persons having common business interests, we have stated that this substantial relationship analysis is relevant for purposes of sec. 501(c)(5) agricultural organizations as well. California Thoroughbred Breeders Association v. Commissioner, T.C. Memo. 1989-342. - 15 -
promote cooperative activity among the farmers. Petitioner
believed that the use of cooperatives was beneficial to farmers,
as evidenced by its historical involvement in the cooperative
movement in Ohio. We think that petitioner is in a unique
position to perform the activities under the service contract
given its distinctive relationship with Ohio farmers, and we find
the activities to be unique to petitioner’s tax-exempt function.
In evaluating the relationship between the activities and
the purposes of an agricultural organization, the capacity in
which benefits are received by the organization’s members is as
important as the unique character of the organization’s
activities. For a substantial relationship to exist, the
benefits flowing from the organization’s activities must inure to
the members as a group, rather than as individuals. Professional
Ins. Agents of Mich. v. Commissioner, supra at 1103-1104;
Louisiana Credit Union League v. United States, supra at 535-536.
Several factors are relevant in determining whether an activity
operates primarily to benefit individual members: (1) Whether
fees charged are directly proportionate to benefits received; (2)
whether participation is limited to members and, thus, is of no
benefit to nonmembers in the industry; and (3) whether the
service provided is one commonly provided by for-profit entities.
Illinois Association of Professional Ins. Agents v. Commissioner,
801 F.2d 987, 993 (7th Cir. 1986), affg. T.C. Memo. 1985-105;
Carolinas Farm & Power Equip. Dealers v. United States, 699 F.2d - 16 -
167, 171 (4th Cir. 1983).
In the present case, the only fees paid to petitioner by its
members were membership dues. The benefits that petitioner’s
members might receive from petitioner’s educational, promotional,
and lobbying activities performed pursuant to the service
contract could turn out to be negligible, or they could far
outweigh the amount of their dues. The benefits were not
directly proportional to the amount of the fees paid. Moreover,
petitioner’s activities in lobbying for and promoting cooperative
activity would benefit the entire agricultural industry, not just
its members, and it is a service not commonly provided by for-
profit entities.
Respondent argues that, pursuant to the service contract,
petitioner agreed to promote exclusively Landmark and its
products and services, and that the manner in which petitioner
conducted its activities was primarily for the commercial benefit
of Landmark, rather than for the purposes underlying petitioner’s
exemption. Respondent cites Illinois Association of Professional
Ins. Agents v. Commissioner, supra and National Water Well
Association v. Commissioner, 92 T.C. at 97-98, to support her
argument.
In Illinois Association of Professional Ins. Agents v.
Commissioner, supra, the Court of Appeals for the Seventh Circuit
held that the manner in which the taxpayer, a business league
exempt under section 501(c)(6), conducted its errors and - 17 -
omissions insurance activities indicated that the activities were
not substantially related to the taxpayer’s exempt purpose. The
court based its determination on the fact that the taxpayer
endorsed a particular errors and omissions program in a manner
that provided convenient marketing, advertising, and
administrative services to the insurance company and that
generated income for the taxpayer rather than educating the
taxpayer’s members, serving the public interest, or merely
advising of the need for such coverage. Illinois Association of
Professional Ins. Agents v. Commissioner, supra at 995. The
court further noted that the program benefited the individual
members in direct proportion to the fees they paid, rather than
benefiting the members as a group. Id.
Similarly, in National Water Well Association v.
Commissioner, supra, this Court held that the taxpayer’s
endorsement and sponsorship of a particular industry casualty
insurance program was not substantially related to its exempt
purpose. In so holding, we noted that had the taxpayer intended
to educate and advise its members of the need for casualty
industry insurance, it would have advised its members of various
types of insurance from which its members could select. National
Water Well Association v. Commissioner, supra at 98. Moreover,
only those individuals who paid premiums received insurance under
the industry casualty insurance program; therefore, the members
were not benefited as a group. Id. at 98-99. - 18 -
We find these cases to be distinguishable from the instant
case, because petitioner did educate its members and promote the
use of cooperatives in general. Unlike the promotion of a
particular commercial insurance program, petitioner’s promotion
of Landmark was uniquely related to its exempt purpose. Most
Ohio farmers who were members of county bureaus were also members
of local Landmark cooperatives. Landmark was the only statewide
regional agricultural cooperative in Ohio and was regularly held
up by petitioner as the exemplar of the successful cooperative.
Indeed, the only other regional agricultural cooperative, Ohio
Farmers, coexisted with Landmark in only about 15 percent of the
counties in Ohio. Petitioner’s promotion of Landmark was thus
done in conjunction with its promotion of cooperatives in
general. Indeed, petitioner continued to promote cooperatives
after it terminated its relationship with Landmark, and
petitioner often singled out Countrymark, the newly merged
statewide cooperative. Moreover, unlike the cases above, the
benefits received by petitioner’s members were not directly
proportional to the amount of the fees paid, and the members
benefited as a group from petitioner’s activities.
Payments under the Nonsponsorship Clause
In determining whether the payment made by Landmark to
petitioner pursuant to the terms of the nonsponsorship and
noncompetition clause contained in their 1985 termination - 19 -
agreement constituted UBTI, we must first decide whether the
income was derived from a trade or business.
Section 513(c) defines the term “trade or business” as any
activity that is carried on for the production of income from the
sale of goods or the performance of services. The regulations
provide that, as a general rule, an activity that qualifies as a
trade or business under section 162 also qualifies as a trade or
business under section 513. Sec. 1.513-1(b), Income Tax Regs.
In setting out the test for a trade or business under section
162, the Supreme Court has stated:
Of course, not every income-producing and profit- making endeavor constitutes a trade or business. The income tax law, almost from the beginning, has distinguished between a business or trade, on the one hand, and “transactions entered into for profit but not connected with . . . business or trade,” on the other. See Revenue Act of 1916, § 5(a), Fifth, 39 Stat. 759. Congress “distinguished the broad range of income or profit producing activities from those satisfying the narrow category of trade or business.” Whipple v. Commissioner, 373 U.S., at 197. We accept the fact that to be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity and that the taxpayer’s primary purpose for engaging in the activity must be for income or profit. A sporadic activity, a hobby, or an amusement diversion does not qualify. [Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987); emphasis added.]
Because the purpose of the unrelated business income tax was to
prevent tax-exempt organizations from unfairly competing with
businesses whose earnings were taxed, United States v. American
Bar Endowment, 477 U.S. at 114, we have considered the potential - 20 -
for unfair competition as a factor in determining whether a trade
or business exists. National Water Well Association v.
Commissioner, 92 T.C. at 86.
The question of whether noncompetition under a covenant not
to compete constitutes a trade or business appears to be an issue
of first impression. Respondent argues that the determinative
factor is whether the activity was engaged in with an intent to
earn a profit, and the allocation of $2,064,500 to the
nonsponsorship and noncompetition clause clearly shows
petitioner’s profit motive.
While profit motive is an important factor in the trade or
business analysis, the Supreme Court made it clear that the level
of activity remains an important component of the trade or
business standard. Commissioner v. Groetzinger, supra at 35; see
also Professional Ins. Agents of Mich. v. Commissioner, 726 F.2d
at 1102; National Water Well Association v. Commissioner, supra
at 84. We simply do not think that a one-time agreement not to
engage in certain activities constitutes the kind of continuous
and regular activity characteristic of a trade or business. Nor
does noncompetition involve a “sale of goods” or “performance of
services” as set out in the definition of trade or business in
section 513(c). Moreover, we simply do not see how an agreement
not to compete creates a potential for unfair competition with a
taxable entity.
We are aware that a negative covenant to refrain from - 21 -
performing services has been held to be the equivalent of
affirmative personal services. Patterson v. Commissioner, 810
F.2d 562, 569 (6th Cir. 1987), affg. T.C. Memo. 1985-53; Salvage
v. Commissioner, 76 F.2d 112, 113-114 (2d Cir. 1935), affd. 297
U.S. 106 (1936); Cox v. Helvering, 71 F.2d 987, 988 (D.C. Cir.
1934); Ullman v. Commissioner, 29 T.C. 129, 139 (1957), affd. 264
F.2d 305 (2d Cir. 1959). However, this rule has been applied
only for purposes of determining that a payment received for such
a covenant constitutes income to the recipient.5 Such
application is appropriate given the exceedingly broad definition
of income. The definition of trade or business, on the other
hand, is more narrow as noted by the Supreme Court in
Commissioner v. Groetzinger, supra at 35. We, therefore, decline
to treat the absence of activity resulting from a covenant not to
compete as equivalent to the affirmative performance of such
activity for purposes of applying the definition of a trade or
business in this context. Accordingly, we find that the payment
made by Landmark to petitioner pursuant to the terms of the
nonsponsorship and noncompetition clause contained in their 1985
5 Similarly, in Schaefer v. Commissioner, 105 T.C. 227 (1995), we sustained a Treasury regulation under which income from a covenant not to compete is not considered “passive” income for purposes of sec. 469. In Schaefer, we dealt only with the validity of a regulation that specifically classified income from a covenant not to compete as nonpassive income. We did not deal with the more narrow question of whether the income from such a covenant is derived from a trade or business regularly carried on within the meaning of the unrelated business income tax, which confronts us in the present case. - 22 -
termination agreement was not derived from a trade or business
and, therefore, does not constitute UBTI.
For similar reasons, we do not think that the nonsponsorship
and noncompetition clause met the second requirement for UBTI--
that the trade or business be “regularly carried on” by the
organization. The regulations provide guidance in deciding
whether an activity is regularly carried on within the meaning of
section 512:
regard must be had to the frequency and continuity with which the activities productive of the income are conducted and the manner in which they are pursued. This requirement must be applied in light of the purpose of the unrelated business income tax to place exempt organization business activities upon the same tax basis as the nonexempt business endeavors with which they compete. * * *
* * * * * * *
Certain intermittent income producing activities occur so infrequently that neither their recurrence nor the manner of their conduct will cause them to be regarded as trade or business regularly carried on. For example, income producing or fund raising activities lasting only a short period of time will not ordinarily be treated as regularly carried on if they recur only occasionally or sporadically. * * * [Sec. 1.513- 1(c)(1), (2)(iii), Income Tax Regs.; emphasis added.] - 23 -
The nonsponsorship and noncompetition clause was part of a
termination agreement entered into between petitioner and
Landmark. Such a one-time agreement is clearly not the sort of
frequent and continuous activity contemplated by the regulations.
Rather, it is a single, isolated event that occurred as a result
of the unique relationship between petitioner and Landmark.
Our conclusion is consistent with analogous cases involving
self-employment taxes. In Newberry v. Commissioner, 76 T.C. 441,
444 (1981), the issue was whether the proceeds from business
interruption insurance that the taxpayer received after his store
was destroyed by fire constituted “gross income derived by an
individual from any trade or business carried on by such
individual” pursuant to section 1402(a). We held that the quoted
language of section 1402(a) required a causal nexus between the
income and actual business activity and that such a requirement
had not been met.6 The statutory language in section 1402(a) is
quite similar to the definition of unrelated business income in
section 512(a),7 and we believe that the rationale in Newberry v.
Commissioner, supra, is equally applicable to the instant case.8
6 See also Milligan v. Commissioner, 38 F.3d 1094 (9th Cir. 1994), revg. T.C. Memo. 1992-655. 7 Sec. 512(a) defines “unrelated business income” as “gross income derived by any organization from any unrelated trade or business * * * regularly carried on by it”. 8 See also Barrett v. Commissioner, 58 T.C. 284, 289 (1972), wherein this Court noted: “Both parties agree that (continued...) - 24 -
Accordingly, we hold that petitioner did not have UBTI
during the taxable year in issue.9
Decision will be entered
under Rule 155.
8 (...continued) noncompetition does not constitute the carrying on of a trade or business.” 9 Because we have found that there was no underpayment of petitioner’s income tax, we need not address whether interest should be computed under the provisions of sec. 6621(c), dealing with large corporate underpayments.