Affiliated Government Employees' Distributing Co. v. Commissioner

Affiliated Government Employees' Distributing Company, a Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent Affiliated Government Employees' Distributing Co. v. Commissioner Docket No. 84190 United States Tax Court 37 T.C. 909; 1962 U.S. Tax Ct. LEXIS 194; February 12, 1962, Filed *194 Decision will be entered for the respondent. Petitioner, a California nonstock membership corporation, operates a group of department stores in the San Francisco Bay area for the exclusive use of its members and their guests. Membership is not open to the public but is restricted to active and retired government employees and widows of such government employees for a fee of $ 2 and to veterans for a fee of $ 3. Membership is for life, terminates automatically upon death, is nontransferable and nonassessable, and is represented by a wallet-sized passcard which is used to identify the holder for admittance to petitioner's stores. Held that the membership fees received by petitioner during its fiscal years ending June 30, 1956 and 1957, were paid predominantly for the privilege of shopping at petitioner's stores and constituted taxable income; they were not exempt either as capital contributions or as money received in exchange for stock under sections 118 and 1032 of the 1954 Code. Charles J. Leighton, Jr., Esq., and Edward L. Butterworth, Esq., for the petitioner. John O. Hargrove, Esq., for the respondent. Raum, Judge. RAUM *909 Respondent determined deficiencies in petitioner's income tax for the fiscal year ended June 30, 1956, in the amount of $ 26,718.64 and for the fiscal year ended June 30, 1957, in the amount of $ 46,188.48. The sole issue is whether so-called membership fees received by petitioner from its new members during the fiscal years ended June 30, 1956, and June 30, 1957, constitute taxable income. FINDINGS OF FACT. The facts stipulated by the parties are hereby incorporated by this reference. Petitioner, a so-called nonprofit membership corporation, was organized in 1953 and exists pursuant to the General Non-Profit Corporation *910 Law of the State of California. Its principal office is located*196 at 400 Hegenberger Road, Oakland, Alameda County, California. Petitioner's income tax returns for the fiscal years ending June 30, 1956, and June 30, 1957, were filed with the district director of internal revenue, San Francisco, California. Petitioner is a retail merchandising corporation which sells a broad line of consumer goods. It does not sell to the public at large but restricts its sales and the use of its premises and facilities to its members and their guests. Members are admitted to petitioner's stores only upon presentation of a membership card and upon signing a register. However, guests are admitted when accompanied by members, and may thus make purchases without restriction. Prior to July 23, 1956, petitioner had two classes of membership: Regular and honorary. Regular memberships were issuable to any active or retired employee of the Federal, State, or local government for an "initiation fee" of $ 2. Such memberships were for the life of the member and were nontransferable and nonassessable. Honorary memberships required no initiation fee and were issuable to any person at the discretion of petitioner's board of directors, but not in excess of five per calendar*197 year. On June 30, 1956, petitioner had 77,991 regular members and less than 10 honorary members. Under petitioner's bylaws in effect prior to July 23, 1956, both regular and honorary members possessed the right to vote for its board of directors and on other corporate matters. Any membership could be revoked by a two-thirds vote of the board of directors "for cause," and the membership fee paid was not refundable. Any member could resign his membership and be refunded his membership fee. In the fiscal year ended June 30, 1956, a total of 52 members either resigned or had their memberships revoked. All such members (including the revoked memberships, contrary to the bylaws) had their membership fees refunded. On and subsequent to July 23, 1956, when petitioner's bylaws were revised, petitioner had three classes of membership: Life, associate (class 1 and class 2), and honorary. Life memberships were the counterpart of the earlier regular memberships, issuable to any active or retired employee of the Federal, State, or local government for a "consideration" of $ 2. Associate memberships, class 1, were issuable to the widows of government employees, were for life, and cost $ 2; *198 associate memberships, class 2, were issuable to any person who had served at least 6 months in the Armed Forces of the United States, were also for life, and cost $ 3. Honorary memberships were issuable without cost to any person at the discretion of petitioner's board of directors, but not in excess of 15 per calendar year. At the dates indicated, the number of members in each class was as follows: *911 Dec. 31, 1956 June 30, 1957 Life members 90,950 98,107 Associate members 10,278 16,322 Honorary members Less than 10 Less than 10 Under the revised bylaws, only life members were entitled to vote and to attend annual or special membership meetings. In the event of petitioner's liquidation or dissolution or winding up, both life and associate members were to be entitled to a distribution pro rata of any assets remaining to be distributed among or paid over to the members. All classifications of membership were nontransferable and nonassessable. Any membership could be revoked by a two-thirds vote of petitioner's board of directors "for any cause deemed sufficient" by the board without refunding any consideration paid. Any member could resign his membership*199 and be refunded his membership fee. In the event of the death of a life or associate member, the consideration paid for his membership was payable to the member's estate upon request of his executor or administrator. On November 17, 1956, petitioner's bylaws were amended to provide that thereafter all refunding of membership fees, whether based on revocation, resignation, or death of the member, would be within the sole discretion of its board of directors. In the fiscal year ended June 30, 1957, a total of 57 members either resigned or had their memberships revoked. All such members (including those whose memberships were revoked, contrary to the bylaws until November 17, 1956) had their membership fees refunded. Revocation of membership in petitioner during the taxable years in issue was based on action by the member contrary to the interests of petitioner. Such action included cashing bad checks, shoplifting, and in a single case using the membership privilege for the purpose of obtaining information for use against petitioner in a fair trade pricing dispute. Prior to issuance of memberships to eligible persons, petitioner has at all times since its incorporation filed applications*200 for authorizing permits with the Division of Corporations of the Department of Investments of the State of California and has obtained responsive permits from the Commissioner of Corporations of the State of California authorizing the issuance and sale of such memberships as "securities." No memberships have been sold by petitioner except pursuant to authorizing permit of the commissioner of corporations. Eligible persons apply for membership either in person at one of petitioner's stores or by mail. Each is required to furnish proof of qualification, as well as to fill out and subscribe his or her name to an application card. During the years here in issue the application for life (regular) membership contained the following information about petitioner: *912 A.G.E. (Affiliated Government Employees) is a California NON-PROFIT corporation, not privately owned, but belongs to the membership and is managed and operated by a Board of Directors, the majority being members and Government employees. A.G.E. considers as eligible, any FULL TIME EMPLOYEE of a city, county, state, military, or Federal government, or receiving retirement pay from same, members of organized reserve of*201 U.S. Armed Forces and National Guard units. Lifetime Membership $ 2.00. NON-ASSESSABLE. NON-TRANSFERABLE. * * * * A.G.E. is a buying (not selling) organization for its members. Its purpose is to obtain merchandise and services at the lowest prices obtainable, and operating on a cost plus basis to cover overhead of operations. The receptionist who examines applicants' identification and assists them in filling out the required application card does not instruct applicants on the rights and privileges of membership. Those who apply in person for life memberships (called regular memberships prior to July 23, 1956) are also requested, though not required, to execute proxies to petitioner's management. Generally, the members who applied by mail did not execute proxies. The number of members entitled to vote and the number of proxies filed by such members were as follows at the dates indicated: Number of June 30 -- members Proxies entitled filed to vote [1956] 77,991 49,020 [1957] 98,107 66,833 Memberships in petitioner are represented only by small cards suitable for insertion in a wallet. The main function of such cards is to identify the holder as a member*202 in order that he may be admitted to petitioner's premises. All of petitioner's members, regardless of classification, are entitled to the following membership privileges: (a) They are privileged to enter into any of petitioner's store premises and to inspect the merchandise on display. (b) They are privileged to purchase merchandise at prices fixed by petitioner. (c) In certain cases and in respect of certain items of goods or merchandise not stocked by petitioner, members are referred to other stores or establishments where, under prior arrangements made by petitioner, its members are privileged to purchase such items at prices fixed by such stores or establishments. (d) They receive the A.G.E. Reporter, a pamphlet published monthly by petitioner which informs its members of petitioner's current sales events. In addition, any member is permitted to bring guests and guests are permitted to make purchases in petitioner's stores at the same prices that members pay. *913 Petitioner has at all times classified membership fees in a capital account on its books and records and in its balance sheets. At no time has petitioner charged or required payment of its members in respect of *203 renewal fees, dues, or other periodic charges, nor has petitioner received from its members any such fees, dues, or other periodic charges. Memberships in petitioner do not expire or require renewal at fixed intervals. At no time has petitioner paid dividends or otherwise made distributions of surplus to its members. Its articles of incorporation and the General Non-Profit Corporation Law of the State of California under which petitioner was formed prohibit the distribution of gains, profits, or dividends to its members and likewise prohibit the distribution of assets to its members except on dissolution or winding up. During the fiscal years ending June 30, 1954, through June 30, 1957, petitioner's annual, noncumulative receipts from membership fees and profits (not including such fees) after payment of income taxes were as follows: June 30 -- [1957] Membership fees $ 27,341 $ 73,271 $ 51,382 $ 89,186 After tax profits 10,213 50,378 91,259 171,625 Petitioner's accumulated earned surplus as of June 30, 1956, was $ 149,968 according to its books of account. As of June 30, 1957, it was $ 321,597. An annual meeting of petitioner's members was*204 regularly held pursuant to its bylaws. Typewritten notice of such meetings was posted on a bulletin board adjacent to the sole entrance to each store at least 15 days prior to the meetings. This was the only notice of the annual meetings during the taxable years in issue; however, in recent years notices have also been published in the A.G.E. Reporter which is sent to each of petitioner's members. During the fiscal years ending June 30, 1954, through June 30, 1958, meetings of petitioner's members entitled to vote were held on the dates and with members attending, in person or by proxy, as follows: Attendance Date By proxy In person May 17, 1954 3,291 4. July 14, 1955 33,154 Less than 25. July 23, 1956 49,020 Less than 25. July 22, 1957 66,833 Less than 25. *914 During the years ending June 30, 1956, and June 30, 1957, petitioner carried on its business in store and warehouse premises at the following locations: 6625 Foothill Boulevard, Oakland, California (until November 1955 when petitioner moved to its Hegenberger Road premises); 400 Hegenberger Road, Oakland, California (subsequent to November 1955); 124 Highway 40, Vallejo, California; 3330 Telegraph*205 Avenue, Oakland, California. During these years, petitioner's occupancy of the premises at each of the above locations was as lessee under leases with various lessors. The major portion of petitioner's main store and headquarters at 400 Hegenberger Road, Oakland, California, was leased under three separate leases from a stock corporation called A.P.C., Inc., which was organized on November 29, 1954, for the purpose among others of building and leasing the above-mentioned property to petitioner. At June 30, 1956, and June 30, 1957, there were 1,199.95 shares of A.P.C., Inc., stock issued and outstanding. At both dates these shares were held as follows: An aggregate of 294 (or 24.5 percent) of the total was held by petitioner, its officers, and directors; an aggregate of 819.95 (or 68.3 percent) of the shares was held by concessionaires, employees, and suppliers of petitioner or by relatives of such concessionaires, employees, and suppliers; an aggregate of 86 (or 7.2 percent) of the shares was held by shareholders who had no business relationship with petitioner or with petitioner's concessionaires or suppliers. Petitioner's warehouse adjacent to its main store and its premises *206 at its other three locations listed above were leased from lessors other than A.P.C., Inc.; none of these other lessors had any relation, direct or indirect, to petitioner other than that of lessor to lessee. Petitioner's officers and directors and their respective salaries during the fiscal years ending June 30, 1954, through June 30, 1957, were as follows: Position Name (1954-1957) Harvey C. Binns Board chairman and treasurer O. C. Reiersgaard Secretary and director P. B. Godkin 1 President and director J. W. Lance 1 Vice president and director I. D. Thompson 1 Vice president and director Salary Name [1957] Harvey C. Binns $ 9,525 $ 45,285 $ 59,710 $ 82,936 O. C. Reiersgaard 8,400 27,687 39,613 33,705 P. B. Godkin 1 1,156 2,730 5,960 9,726 J. W. Lance 1 1,056 3,976 5,960 8,670 I. D. Thompson 1 1,106 2,730 5,960 7,140 None of petitioner's officers and directors were related by blood or marriage to one another. Petitioner's board of directors met regularly and not less than twice each month during the taxable years in issue. *915 Harvey C. Binns, in addition*207 to being board chairman and petitioner's treasurer, was general manager of petitioner. He was in charge of petitioner's day-to-day operations. He was the moving force in organizing petitioner in 1953 and has dominated its affairs since that time, at least through the taxable years. It does not appear that Binns was a member of petitioner until May 17, 1954, when he and Orville C. Reiersgaard were made honorary members, no other honorary memberships having been issued up to that time. He was petitioner's highest paid officer and, as hereinafter indicated, petitioner's contributions on his behalf to a profit-sharing trust substantially exceeded its similar contributions on behalf of any other officer or employee. On April 13, 1957, he received a $ 25,000 personal loan from petitioner. Petitioner carried life insurance policies on its officers during the years in issue, paid the premiums on such policies, and was the designated beneficiary thereunder. Since the years in question, some of these policies have been sold by petitioner to the insured officers for their cash value. Petitioner has a profit-sharing trust in existence for the benefit of its officers and employees to which*208 it contributed $ 46,279.10 in the fiscal year ended June 30, 1956, and $ 66,961.84 in the fiscal year ended June 30, 1957. Petitioner's contributions to this trust in respect of its two highest paid officers, Harvey C. Binns and O. C. Reiersgaard, during these 2 years were as follows: [1957] Harvey C. Binns $ 8,956.63 $ 12,440.44 O. C. Reiersgaard 2,770.89 3,555,75 Contributions in respect of all other employees or officers were in smaller amounts. Petitioner's members are not participants in the profit-sharing trust. The trust lent A.P.C., Inc., $ 50,000 on April 30, 1957, for the purpose of building a restaurant adjacent to petitioner's main store. Petitioner has no direct interest in the restaurant, called The House of Harvey, but Harvey C. Binns (after whom the restaurant was named) is a stockholder in the corporation which operates the restaurant. During the fiscal year ending June 30, 1956, petitioner maintained an average inventory of $ 346,000 which it turned over 9.71 times in the course of the year. In the fiscal year ending June 30, 1957, it maintained an average inventory of $ 557,000 which was turned over 7.81 times. The sales at petitioner's*209 stores are made both by petitioner and by concessionaires operating on petitioner's premises. During the fiscal year ending June 30, 1956, petitioner made about 60 percent of the gross sales and 40 percent was made by concessionaires. During the *916 fiscal year ending June 30, 1957, petitioner made about 54 percent of such sales and concessionaires made 46 percent. Concessionaires are independent operators who occupy generally the position of tenants and conduct their merchandising business within the physical confines of petitioner's premises. Concessions are utilized for specialized merchandise in cases where a concessionaire can operate more efficiently than petitioner. Concessionaires own their own inventory and hire their own sales personnel. Their rent or concession fee is payable to petitioner and is based on a percentage of sales (approximately 6 percent in the years in issue); their tenancy may be terminated by petitioner at any time. Neither petitioner nor any of its officers or directors, either directly or indirectly, have any financial interest in any concession. During the years in issue petitioner had a wholly owned subsidiary, Selmor Company, which was created*210 primarily for the purpose of obtaining merchandise for petitioner from certain manufacturers and suppliers which, due to petitioner's pricing policies, did not want to sell directly to petitioner. The deficiency notice sent to petitioner explained the adjustments made by respondent as follows: It is determined that you realized income from membership fees in the amount of $ 51,382.00 during the taxable year ended June 30, 1956, and in the amount of $ 88,824.00 during the taxable year ended June 30, 1957, which amounts were credited to a capital account on your records, and excluded from taxable income. OPINION. Petitioner is a nonstock, membership corporation which during the taxable years in issue operated three department stores in the San Francisco Bay area. Only petitioner's members and their guests were allowed to shop at these stores, which sold a broad line of goods and services purportedly at reduced prices. Membership in petitioner was not open to the public; it was restricted to active and retired government employees (Federal, State, and municipal) and, beginning in the second taxable year before us, veterans and widows of government employees. Memberships were for the*211 life of the applicant, were issued for a fee of $ 2 (government employees and their widows) or $ 3 (veterans), and were nontransferable and nonassessable. The question before us is whether such fees, in the aggregate amounts of $ 51,382 and $ 88,824, 1 for petitioner's fiscal years 1956 and 1957, respectively, are taxable as income. We hold that they are. It is important to note preliminarily that although petitioner may be labeled as a "non-profit" corporation in California, it is not in fact *917 a nonprofit corporation. Indeed, such is petitioner's contention, as set forth in its brief: Petitioner's is a business and operation of general retail merchandising for profit, substantial profit. The most casual glance at petitioner's balance sheets and income statements discloses profits, retained earnings*212 and an annual rate of return on equity invested capital (memberships) which would be the envy of many conventional, profit seeking corporations. Accordingly, it is undisputed that petitioner itself is not exempt and that it is a taxable corporation under the Federal statute. The only matter in controversy is whether the so-called membership fees must be included in its gross income. At the outset, it must be remembered that in using the term "gross income" Congress has legislated so as to exercise its power within the full reach of its authority under the Constitution. As was stated in Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 429, 430: This Court has frequently stated that this language was used by Congress to exert in this field "the full measure of its taxing power." [Citing cases] * * *. And the Court has given a liberal construction to this broad phraseology in recognition of the intention of Congress to tax all gains except those specifically exempted. [Citing cases] * * * The so-called membership fees herein were plainly of a type of receipt that is regarded as taxable income. Cf. Teleservice Co. of Wyoming Valley, 27 T.C. 722,*213 affirmed 254 F. 2d 105 (C.A. 3), certiorari denied 357 U.S. 919; Keystone Automobile Club, 12 T.C. 1038, affirmed 181 F. 2d 402, 405 (C.A. 3); Chattanooga Automobile Club, 12 T.C. 967, affirmed 182 F. 2d 551 (C.A. 6); Automobile Club of Michigan, 20 T.C. 1033, affirmed 230 F. 2d 585 (C.A. 6), affirmed 353 U.S. 180; American Automobile Association v. United States, 367 U.S. 687; Automobile Club of New York, Inc., 32 T.C. 906; United Grocers, Ltd. v. United States, 186 F. Supp. 724 (N.D. Cal.), amended F. Supp. ; United Retail Grocers Association, 19 B.T.A. 1016; Jockey Club, 30 B.T.A. 670, affirmed 76 F. 2d 597 (C.A. 2). Petitioner contends, however, that its fees are exempt as "[contributions] to * * * [its] capital" under section 118 of *214 the 1954 Code 2 or as money received "in exchange for [its] stock" under section 1032(a). 3 We think neither of these provisions "specifically [exempts]" (Glenshaw Glass) the so-called membership fees before us. The mere fact that petitioner is theoretically a membership corporation or that its memberships may be designated as "securities" under *918 California law for certain purposes is not determinative of the issue under the Federal statute. The important consideration relates more to the real nature of these fees than to the theoretical status of the members. *215 We are satisfied that the dominant if not the only purpose for which members "joined" petitioner and paid the requisite fee was to be permitted to shop at petitioner's stores where they expected to obtain bargains. While it is true, as petitioner insists, that the members (or some classes of members) had a right to elect the board of directors and to share in the distribution of assets upon liquidation, these appear to be exceedingly minor considerations when examined in proper context. The $ 2 or $ 3 fee, though substantial in the aggregate to petitioner, was comparatively small to the individual. Members were not entitled to share in the profits of the enterprise nor to receive distributions of any kind during the life of petitioner. And since memberships were not assignable and terminated with death of the individual, neither the member nor his estate was assured of any share in a possible future distribution upon liquidation. It is difficult for us to believe that the remote possibility of participating in any such distribution upon liquidation was a factor of any consequence in relation to the payment of the comparatively small fees here in issue. Moreover, memberships were*216 subject to revocation by the board of directors "for cause" prior to July 23, 1956, and "for any cause deemed sufficient" by the board thereafter. No certificates of membership were issued other than a wallet-size card which in substance was little more than a pass to gain admittance to petitioner's stores. Although petitioner's bylaws granted the right to vote for the board of directors to all of its members (regular and honorary) prior to July 23, 1956, and to only one class (life) thereafter, such right in practice was more theoretical than real. It seems clear on this record that petitioner was organized, controlled by, and to a certain extent operated for the benefit of a small group of men, particularly Harvey Binns (a non-dues-paying "honorary member"), and that a realistic appraisal of all the facts could hardly justify treating the members as stockholders who had invested their capital in petitioner. We do not suggest that the membership fees were utterly lacking in any indicia of capital. But it does seem plain to us that they were paid predominantly for the privilege of shopping at petitioner's stores and using its facilities. As such they were not exempt under either*217 section 118 or section 1032. They were not a "contribution to the capital of the taxpayer" (sec. 118) and they certainly were not paid "in exchange for stock" (sec. 1032). What was said by the Court of Appeals for the Third Circuit in a somewhat different context in Teleservice Co. of Wyo. Val. v. Commissioner, *919 254 F. 2d 105, 112, affirming 27 T.C. 722, is also pertinent to any candid consideration of petitioner's membership fees: Analysis of the substance rather than the semblance of the relationship existing between the taxpayer and its customers in the light of the principle that "taxation is an intensely practical matter" inescapably discloses that the relationship was that of seller-customer * * *. The initial payment made by a customer was the admission price which he paid for his individual enjoyment of the taxpayer's facilities and in no sense could it be regarded as a contribution to community participation. Only he who bought a ticket could "go for the ride." In the instant case, only he who purchased a membership card could have the opportunity to shop for bargains, real or fancied, at petitioner's*218 department stores. We hold that the respondent correctly determined that the receipt of membership fees by petitioner constituted taxable income. Decision will be entered for the respondent. Footnotes 1. Not full time during entire period.↩ 1. This is the amount upon which the deficiency for 1957 was based. However, the stipulation of facts shows that the fees for that year were in the amount of $ 89,186; the difference remains unexplained.↩ 2. SEC. 118. CONTRIBUTIONS TO THE CAPITAL OF A CORPORATION. (a) General Rule. -- In the case of a corporation, gross income does not include any contribution to the capital of the taxpayer.↩ 3. SEC. 1032. EXCHANGE OF STOCK FOR PROPERTY. (a) Nonrecognition of Gain or Loss. -- No gain or loss shall be recognized to a corporation on the receipt of money or other property in exchange for stock (including treasury stock) of such corporation.↩