Court Opinion

ID: 4481156
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:14:44.065686+00
Date Added: 2024-06-11T14:54:00.329508
License: Public Domain

Sterrett, /., dissenting: I dissent from the holding of the majroity in this case and would hold that the amounts in question represent taxable income to the petitioner on the basis, in effect, that petitioner has not made a showing that the rental payments in question represent rent from “real property (including personal property leased with the real property) ” as that phrase is used in section 502 of the Code. The failure to make such a showing means that petitioner cannot rely on the exception in section 502 from the term “trade or business” for those organizations who rent their “real property, etc.” Since I would hold that the petitioner was clearly engaged in a trade or business, Cooper Tire & Rubber Co. Employees’ Retirement Fund, 36 T.C. 96 (1961), affd. 306 F. 2d 20 (C.A. 6, 1962), by reason of the magnitude of its leasing activities, section 502 would then prevent the petitioner from claiming exemption from tax by reason of the fact that its income is distributable to exempt organizations. As it has shown no reason other than the character of the recipients of its income distributions as a basis for exemption, petitioner would then lose its exempt status, thus rendering all its income taxable. The view that the rental payments involved here qualify as rent from “real property (including personal property leased with the real property) ” is obviously basic to the petitioner’s claim for exemption and hence a few words of discussion on that point are in order. The term “real property (including personal property leased with the real property)” also appears in section 512(b) (3) of the Code as an exclusion from “unrelated business taxable income.” The predecessors to sections 502 and 512 were added to the 1939 Code by the Eevenue Act of 1950 and bore the section Nos. 101 and 422(a) (3), respectively, of that Code. These sections were then carried over into the 1954 Code as sections 502 and 512. Since the words “real property, etc.,” must be deemed to have the same meaning in each section, the legislative history of each section is pertinent and hence reference will be made to both. Investment in real property has been a historical source of income for exempt organizations of all kinds along with dividends and interest. As the Senate Finance Committee put it in its report No. 2375 (p. 31), accompanying H.E. 8920, which on enactment became the Eevenue Act of 1950: “Moreover, investment-producing income of these types have long been recognized as a proper source of revenue for educational and charitable organizations and trusts.” Congressman Lynch had made a comparable statement on the floor of the House during the debate on H.E. 8920 when he stated: “The receipt of interest, dividends, and royalties does not constitute carrying on an active business. In general, the receipt of rent is also considered a proper activity for these organizations and is not taxed. Historically, the colleges and other exempt organizations have often invested their endowments in rental property — and the bill does not tax this.” (9G Cong. Eec. 9366.) The Treasury Department has long put its stamp of approval on the receipt of such income by exempt organizations. See Eegs. 86, art. 101 (6)-1, and successor regulations through Eeg. 118. .'Significant, though, was the constant grouping of rental income with dividends and interest. All represent passive income, the type of income that could be received without the recipient becoming engaged in a trade or business, as that term is normally understood. It developed, however, as the majority opinion has noted, that the commercial activities of some exempt organizations increased and with that increase came a corollary complaint from competitive taxpaying businesses. The hearings referred to by the majority did in fact disclose the abuses and the need for corrective measures. Consequently, the Eevenue Act of 1950 was enacted and one of its provisions (now denoted as section 502 of the 1954 Code) is here in question. It is clear from the hearings, from the entire legislative history of the 1950 Act, that its purpose was to correct the excesses that had crept into the activities of charitable organizations and to return to the status quo where passivity was the principal characteristic of an exempt organization’s income. The Ways and Means Committee summarized its purpose on this score in reporting out favorably H.E. 9420 as follows r The tax applied to unrelated business income does not apply to dividends, interest, royalties (including, of course, overriding royalties), rents (other than certain rents on property acquired with borrowed funds), and gains from sales of leased property. Your committee believes that such “passive” income should not be taxed where it is used for exempt purposes because investments producing incomes of these types have long been recognized as proper for educational and charitable organizations. [H. Rept. No. 2319, 81st Cong., 2d Sess., p. 38.] Further illustrating the restriction which Congress sought to impose upon the receipt of income, insofar as rental income is concerned, is the following statement from the Senate Finance Committee in its report on the same bill: (b) * * * The term “rents from real property” does not include income from the operation of a hotel but does include rents derived from a lease of the hotel itself. 'Similarly, income derived from the operation of a parking lot is not considered “rents from real property.” Income received from a business of renting personal property is excluded under section 422(a) (3) only if the personal property is leased with real propery [S. Rept. No. 2375, 81st Cong., 2d Sess., p. 108.] The illustrative restriction on the type of qualifying rent from real property is pertinent; Congress was intent on not granting exemption to the operator of property. What we have here is not even the mere operation of property, but in fact the carrying on of an extensive primary business of leasing a large number of varied active business enterprises in which real estate played (for all we know) but an incidental role. The fruits of that primary business surely are not within the contemplation of the term “rents from real property” as explained above in the Senate Finance Committee report.1  Eelevant also in the above quotation is the reference made by the Senate Finance Committee to the fact that rent from personal property is excluded only to the extent that the personal property is leased with real property. The leasing of personal property almost inevitably involves the lessor more actively in the rental business than the rental of real property does. Cf. Cooper Tire & Rubber Co. Employees' Retirement Fund, supra. The committee’s language seems to make it perfectly clear that the committee intended to exempt rent from personal property only when such property was leased as a necessary incident of the real property. Had .they intended to grant coequal exemption status it would have been perfectly simply for it to provide for an exemption for rental income “from real and personal property.” The petitioner here involved engaged in the renting of going businesses on an extensive scale. The going businesses were made up of an admixture of assets, real property, personal property, tangibles, intangibles, goodwill, etc. The rent payable was based upon a percentage of net income, thus subjecting its very receipt to the risks of the business, unlike the familar percentage lease based upon gross receipts. The petitioner made no satisfactory showing that the rent it received was attributable, at the very least, in any substantial degree to any real property included in the composite of assets of the leased enterprises, rather than to other assets. Indeed, the majority itself has found that “There was no correlation between the cost or value of the fixed assets acquired by the Foundation and the rentals paid by the lessees.” I think petitioner should fail in its claim of exemption from the effects of section 502. Baum, Withe y, Atkins, and Irwin, JJ., agree with this dissent.   It is interesting to note that -when Congress added see. 856 to the Code, which permits prescribed real estate investment trusts to receive and distribute certain rental income, without paying a tax thereon at the trustee level, it was careful to insure that rents from the active conduct of a trade or business would not be accorded the favored “pass-through” treatment. ‘'Section 856(d) defines “rents from real property.” Restrictions and limitations are provided in the definition to prevent income from active business operations from being included therein. This is designed to insure that active business income is not to be given “conduit” tax treatment * * * ******* “Furthermore, section 856(d)(1) excludes from the definition of “rents from real property” any amount derived from real property if the determination of such amounts depends in whole or in part on the income or profits derived by any person from such property. An exception is provided for amounts based on a fixed percentage or percentages of receipts or sales of the lessee (whether or not adjusted for such items as returned merchandise, or Federal, State, or local sales taxes). * * * [H. Rept. No. 2020, 86th Cong., 2d Sess., pp. 9,10.]” Rent from the leases here at issue would not qualify for sec. 856 treatment since it is based upon a percentage of net income.