Opinion ID: 411167
Heading Depth: 1
Heading Rank: 6

Heading: the final inquiry: substantially related to exempt functions?

Text: 49 Having ascertained that LCUL was regularly engaged in trade or business, we now approach the final inquiry. Unless the League's insurance, debt collection, and data processing activities are substantially related to its exempt function, the income they produce will be taxed as unrelated business income. See I.R.C. Sec. 513(a); Treas.Reg. Sec. 1.513-1(a). Section 513(a) plainly states that the need of an exempt organization for income does not constitute the necessary substantial relationship. Beyond that, however, the statute itself provides no definition of substantial relationship, and so we turn once again to the pertinent regulations. 20
50 Resolution of the substantial relationship issue requires an examination of the relationship between the business activities which generate the particular income in question ... and the accomplishment of the organization's exempt purposes. Treas.Reg. Sec. 1.513-1(d)(1). The regulations go on to describe the type of relationship that qualifies as substantial: 51 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. Thus, for the conduct of trade or business from which a particular amount of gross income is derived to be substantially related to purposes for which exemption is granted, the production or distribution of the goods or the performance of the services from which the gross income is derived must contribute importantly to the accomplishment of those purposes. 52 Treas.Reg. Sec. 1.513-1(d)(2). In determining whether activities contribute importantly to the accomplishment of an exempt purpose, the size and extent of the activities involved must be considered in relation to the nature and extent of the exempt function which they purport to serve. Treas.Reg. Sec. 1.513-1(d)(3). 53 The regulations make the League's tax-exempt function a critical factor in the substantial relationship equation. The stated purpose of the League is to promote the organization and development of credit unions in Louisiana, in order to bring about greater participation in the activities of such credit unions by way of attention to personal thrift, money management, and the prudent use of credit. This statement of purpose must be interpreted, however, in light of the League's underlying tax exemption as a business league under section 501(c)(6). Treas.Reg. Sec. 1.501(c)(6)-1 defines a business league as follows: 54 A business league is an association of persons having some common business interest, the purpose of which is to promote such common interest and not to engage in a regular business of a kind ordinarily carried on for profit .... Thus, its activities should be directed to the improvement of business conditions of one or more lines of business as distinguished from the performance of particular services for individual persons. 55 Thus the League's tax-exempt purpose, as illuminated by the business league regulations, is to promote the common business interest of its members in advancing the credit union movement. In order for the League's activities to be substantially related to this purpose, they must benefit its members as a group rather than in their individual capacities. 56 The substantial relationship determination is necessarily a fact-based inquiry. As this court has recently noted, the regulations under section 513 require a case-by-case identification of the exempt purpose, an analysis of how the activity contributes to that purpose and an examination of the scale on which the activity is conducted. Hi-Plains Hospital v. United States, 670 F.2d 528, 531 (5th Cir.1982); see also Treas.Reg. Sec. 1.513-1(d)(2). Two factual elements in particular are critical to finding the necessary substantial relationship between a business league's activities and its purposes: (1) the unique nature of the activities vis-a-vis the organizational function, and (2) the capacity in which benefits are received by the organization's members.
57 In order for the activities of a business league to be substantially related to its exempt function, those activities must be unique to the organization's tax-exempt purpose. It is the distinctiveness of the activity that cements the substantial relationship between the two. Such services as educational and training programs, legislative lobbying, and institutional advertising clearly satisfy this uniqueness test, because they advance the purposes of the business league 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. See Treas.Reg. Sec. 1.501(c)(6)-1. In the case at bar, the publication and maintenance by the League of a looseleaf library service compiling all the statutes, regulations, and other legal materials pertinent to the operation of a credit union would exemplify the sort of service unique to the League's tax-exempt function. Such a service, provided to League members for a subscription fee, would bear a unique relationship to the League's purpose of promoting the development of credit unions in Louisiana. Presumably alternative access to such a service would be limited, and its narrow scope would make it singularly useful to member credit unions. Any business league activity so distinctively oriented toward its members seemingly would bear a substantial relationship to its purpose.
58 In evaluating the relationship between the activities and purposes of a business league, 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, any direct benefits flowing from a business league's activities must inure to its members in their capacities as members of the organization. Thus, when a business league's uniquely relevant activities produce inherently group benefits that accrue to its members qua members, a substantial relationship exists within the meaning of section 513. 59 This distinction between inherently group benefits and individual benefits is analogous to the aggregate/entity concept familiar in partnership taxation. 21 Just as a member of a partnership may enjoy benefits in his separate capacities as partner and non-partner, so may a member of the LCUL enjoy benefits both as a League member and as an individual credit union. Only those activities that benefit the credit unions in their capacities as League members can be considered substantially related to the League's exempt function. This group benefit standard also accords with the requirement that a business league seek to improve the conditions of an entire line of business rather than perform discrete services for individuals. See Treas.Reg. Sec. 1.501(c)(6)-1. When the activities of a business league are directed toward the achievement of the common business interest of its members, the benefits that accrue to its members are inherently group benefits. 60 To distinguish benefits received by League members qua members from those accruing to the credit unions in their individual capacities, it is necessary to segregate the interests of the credit unions as a group from those of the credit unions as separate entities. Because educational programs, lobbying activities, and advertising services serve the common business interest of League members, and because the benefits resulting therefrom accrue to the members in their membership roles, a substantial relationship exists between such activities and the organization's purposes. Activities that serve the interests of the individual member credit unions produce individual benefits insufficient to fulfill the substantial relationship test. 61 To reiterate, a substantial relationship exists for purposes of the unrelated business income tax provisions when a business league engages in activities unique to its exempt purpose, and those activities generate inherently group benefits that redound to the advantage of its members qua members. With this standard in mind, we turn to the facts of the case at bar.
62 The League argues that each of the three activities at issue here--promotions of insurance, debt collection, and data processing--is intrinsically important to the furtherance of the credit union movement and therefore is substantially related to its exempt function. We will discuss each separately.
63 LCUL asserts that its endorsement of CUNA/CUMIS insurance coverage contributes importantly to the initiation, growth, and stability of credit unions in Louisiana and therefore is substantially related to its exempt function. Basically, the League's argument is that by encouraging the use and purchase of insurance by credit unions, it strengthens the credit union movement by reducing the likelihood of credit union failure from unforseen events. The district court found that the connection between the furtherance of the credit league movement and the selling of insurance is at best tangential. Louisiana Credit Union League v. United States, 501 F.Supp. 934, 941 (E.D.La.1981). We agree. Insurance endorsement and administration is not the sort of unique activity that satisfies the substantial relationship test, nor are its benefits inherently group-related. Rather than merely advising its members of the availability and desirability of insurance coverage to credit unions generally, LCUL promoted the purchase of policies from a particular carrier, CUNA/CUMIS. The district court observed that LCUL's insurance activities did little more than generate revenue for the League and provide CUNA/CUMIS with convenient services in the marketing and administration of its programs. Because the League's insurance endorsement is basically a fundraising activity, it is by definition unrelated business activity under section 513(a). We therefore affirm the holding below that LCUL's trade or business of insurance endorsement and promotion was not substantially related to its exempt function. Accord, Professional Insurance Agents v. Commissioner, 78 T.C. 246 (1982); Long Island Gasoline Retailers Association v. Commissioner, 43 T.C.M. (CCH) 815 (1982); Rev.Rul. 60-228, 1960-1 C.B. 200. 22
64 LCUL argues that its involvement in debt collection protects the integrity of member credit unions and therefore is substantially related to its exempt purpose. 23 The district court found that the primary purpose of the debt collection service was to earn money for the League. The court further observed that because only certain members utilized the League's debt collection services, the benefits produced were not inherently group benefits. We believe these findings to be correct. We have no doubt that the individual credit unions that assign their claims to LCUL for collection benefit greatly from the League's services. Nevertheless, LCUL's tax exemption is based on the notion that a business league promotes a common business interest of all its members and does not perform particular services for individual persons. Treas.Reg. Sec. 1.501(c)(6)-1. Because the benefits of LCUL's debt collection activities accrue only to certain credit unions, these activities constitute the performance of services of a commercial nature for individual members rather than the promotion of a common business interest with inherently group benefits. See also Rev.Rul. 73-386, 1973-2 C.B. 191 (exempt business league that provided job injury histories to prospective employers is engaged in unrelated trade or business); Rev.Rul. 68-267, 1968-1 C.B. 284 (exempt business league that operated a coupon redemption service for members is engaged in unrelated trade or business). Accordingly, we affirm the district court's holding that the League's debt collection activities are not substantially related to its exempt purpose.
65 Finally, the League asserts that by providing credit unions with data processing services it fosters the growth of the credit union movement and thereby contributes importantly to its exempt function. The district court held that the League's data processing services were not substantially related to its exempt function because the benefits flowing from those services were restricted to the participating credit unions. This holding must be affirmed. It appears from the record that some but not all LCUL members utilize the League's data processing services. New and small credit unions have no need for electronic accounting systems and generally use hand-posting methods. Credit unions large enough to support an in-house processing system generally do so. Thus, as with debt collection, only certain members of the League derive the benefits of the data processing services, and these benefits accrue to them as individual participants rather than as League members. We note further that the League charges the credit unions according to the amount of use they make of the program. When each member contributes in proportion to what he receives, it is a strong indication that the benefits received are not ... 'inherently group benefits.'  Evanston-North Shore Board of Realtors v. United States, 320 F.2d 375, 379 (Ct.Cl.1963). Because the data processing program operates for the primary benefit of participating credit unions, we affirm the district court's holding that it is not substantially related to LCUL's exempt function for purposes of section 513(a). See also Rev.Rul. 81-75, 1981-1 C.B. 356 (income received by tax-exempt business league from language translation service is unrelated business taxable income); Rev.Rul. 56-466, 1957-2 C.B. 311 (income received by tax-exempt organization from sale of supplies and equipment to members is unrelated business taxable income).
66 The question whether a particular trade or business is substantially related to the exempt function of a tax-exempt business league necessitates an examination and a comparison of the services it renders and the purpose it proclaims. In this case, each of the three challenged activities is related to the League's purpose primarily, if not entirely, by virtue of its revenue-raising potential. Such a financial relationship is by definition not substantial. Furthermore, our review of the record convinces us that the district court was correct in finding that the League's activities were not unique in character and that the benefits produced thereby were not inherently group benefits. According, we affirm the district court's holding that the activities were not substantially related to its tax-exempt purpose. 24 67