West Side Tennis Club v. Commissioner

WEST SIDE TENNIS CLUB, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. West Side Tennis Club v. Commissioner Docket No. 83338. United States Board of Tax Appeals 39 B.T.A. 149; 1939 BTA LEXIS 1062; January 20, 1939, Promulgated *1062 1. The petitioner, a New York corporation organized to operate a tennis club, for many years has held national tennis tournaments awarded to it by the United States Lawn Tennis Association, of which it was a member. Admission to the matches was by tickets sold at a profit each year, with one exception, to members of the club and to the public without any preference to the former. Held, that during the taxable years petitioner was not a club operated exclusively for pleasure, recreation and other nonprofitable purposes, no part of the earnings of which inured to the benefit of its shareholders. 2. Petitioner being subject to liability for tax on its income as a corporation, the amount of dues and initiation fees received by it constitutes taxable income. 3. Penalties imposed for failure to file timely returns are sustained in the absence of proof that the delay was due to reasonable cause. Lawrence A. Baker, Esq., for the petitioner. Clay C. Holmes, Esq., for the respondent. DISNEY *149 This proceeding involves the redetermination of the following deficiencies in taxes and penalties: [1934] Tax: Income $2,982.90 $870.44 Excess profits 459.69 Penalty: Income tax 745.73 217.61 Excess profits 114.92 *1063 The issue is whether the petitioner is exempt from income and excess profits taxes. In the alternative, the petitioner alleges that *150 the respondent erred in including in its income amounts for dues and initiation fees collected from its members and in proposing delinquency penalties. The stipulation of facts filed by the parties is adopted by reference as part of our findings of fact. FINDINGS OF FACT. In 1892 thirteen members of a group meeting regularly to play tennis on municipal courts in Central Park, New York City, formed an association and obtained a lease on property on Central Park West, where tennis courts were laid out. As the group increased and dues accumulated, expansion became possible and in 1902 more adequate facilities, including courts and club quarters, were obtained by lease at Amsterdam Avenue and 117th Street. The group incorporated the petitioner in 1902 under the Membership Corporations Law of the State of New York. The certificate of incorporation, which has never been amended or changed, provides that "The particular objects for which the corporation is to be formed are to provide and maintain Lawn Tennis Courts and the buildings*1064 and accommodations appertaining thereto, for the use of its members, and to promote social intercourse among the members thereof." In addition to the certificate of incorporation, the petitioner has always operated under a constitution and bylaws. The petitioner has never issued bonds or certificates of stock of any kind. Its members have at all times become such through election and payment of initiation fees and dues. By 1908, when the membership of petitioner was in excess of 500, the petitioner acquired new facilities by lease on the Van Cortlandt Estate north of 238th Street. In 1912, due to litigation among the Van Cortlandt heirs, the petitioner was forced to abandon its facilities and purchased land at Forest Hills, Long Island, where it was during 1933 and 1934 and is now located. The deed for the land acquired contained certain restrictive covenants concerning the use of the property and other restrictions were suspended so long as petitioner used the premises for club purposes. Since 1881 the supervision of national tennis championships, international matches, and participation of the United States in competition for the David Cup has been vested in the United*1065 States Lawn Tennis Association, a voluntary association of recognized tennis clubs and sectional tennis associations, hereinafter referred to as the Association. The Association fixes not only the time that such competitions shall be played, but also the place. As a matter of uniform policy and invariable practice it has designated as the place of play for such competitions a recognized tennis club having membership in the Association and having facilities adequate for the *151 holding of such an event. The Association has at no time in the past sanctioned the holding of a national championship or competition for a recognized international trophy under circumstances which would permit any private individual or nonmember organization to participate in the profits of such event. The championship matches sanctioned by the Association were held at Newport, Rhode Island, from about 1881 to 1914. The facilities for entertaining and housing players at that place were unsatisfactory and the Association desired to hold them at another club. In 1914 the petitioner had two grass courts suitable for the playing of championship matches, and held its first major championship match*1066 under an award by the Association. The public reaction from holding the event at the new location was so favorable, about 14,000 persons having attended the three days of play, that the petitioner petitioned those who had sponsored the moving of the match from Newport to award similar matches to it in future years. Thereafter until 1922 many events held under the supervision of the Association were played on petitioner's courts. The matches were held on the turf in front of the club house. To accommodate spectators it was necessary to erect temporary stands in advance of the events to the inconvenience of club members and injury to the grounds. The temporary stands had a seating capacity of from 8,000 to 10,000 and were not adequate in either size or safety to fulfill the demand of the public who wanted to attend the matches. It cost about $10,000 to erect the stands and the work interfered with normal activities of the club each year for a period of about three months. The petitioner concluded that if those conditions continued it would not hold any of the matches in the future. The Association recognized the situation and appointed a committee to meet with a committee of*1067 petitioner to devise a plan to eliminate the objection of petitioner. Pursuant to a desire of the Association for a convenient, safe, and permanent stadium for the matches and willingness of the petitioner and its members to cooperate therein, on February 20, 1923, the Association and the petitioner entered into an agreement under the terms of which the former awarded to the latter the Challenge Round of the Davis Cup Matches for 1923, the National Singles Championship Tournament each year from 1924 to 1928, inclusive, and either of these events or the National Doubles Championship Tournament each year from 1929 to 1932, inclusive, upon condition that the petitioner cause to be erected on land owned or acquired by it at Forest Hills, a suitable permanent stadium with a seating capacity for not less than 12,000 spectators, with provision for increasing the seating capacity to 21,000. The parties to the agreement agreed upon a division of the net proceeds of the events. In accordance with this agreement *152 the petitioner purchased some adjoining land and constructed thereon a permanent stadium at a cost of about $269,000, including equipment, and exclusive of the cost of*1068 the land in the stadium area, and paid for it out of funds on hand, borrowed money, and advance subscriptions for seats. The deeds restricted the use of the land prior to January 1, 1950, to private residences and club purposes. In May 1925 the Association and the petitioner entered into an agreement by the terms of which the former, in view of the additional cost of the stadium, agreed to lend the petitioner without interest until November 15, 1932, $6,000 yearly for eight years, less each year the petitioner's share of net proceeds of the tournaments awarded by the association in excess of $24,000. The petitioner agreed to repay the loan in installments out of the net receipts of tournaments sanctioned by the Association commencing in 1933. In October 1932 the petitioner requested the Association to enter into an agreement with it for a ten-year period similar to the agreement of February 20, 1923. The Association felt that the petitioner had not had an opportunity to recover the cost of the stadium during the life of the 1923 agreement and should be given a further guarantee of tournaments for a like period to enable it to pay off the remainder of the debt incurred in connection*1069 with the construction of the stadium. Accordingly, in January 1933 an additional agreement was entered into, awarding the petitioner the Men's National Singles Championship or the Davis Cup Challenge Round each year for ten years commencing in 1933 and altering the terms of the previous agreement respecting repayment of the loan. The agreement provided that in computing the net receipts from conducting the Men's National Singles Championship each year there should be deducted from gross receipts, in addition to usual expenses, the sum of $6,000 in lieu of rental for the stadium and a reasonable amount for charges necessarily incurred for the upkeep of the stadium during the year. The net receipts up to $30,000 were to be divided equally between petitioner and the Association and, of any amount in excess thereof, 75 percent was to go to the Association and the remainder to petitioner. The net receipts of the Davis Cup Challenge Round Matches were to be computed and divided in accordance with the Davis Cup regulations. The contract also contained an acknowledgment by the petitioner of an indebtedness to the Association of $48,000 arising from loans made under the May 5, 1925, agreement, *1070 and agreement to repay it by payment of one-half of advance sale of seats for matches to be held during the life of the contract, and any balance in ten equal annual installments, with interest at the rate of 5 percent per annum from November 15, 1932. The provisions of the agreement were and are being carried out by the parties thereto. *153 Except interest on investments, all of the petitioner's income consisted of dues, locker rentals, initiation fees, guest fees, profit on the sale of tennis equipment and food, and its share of tournament profits. At no time since its incorporation has petitioner used any of the funds received by it from the members or as the result of holding the tournaments except for the purposes of its operation and maintenance and the payment of its debts. It has never paid in cash or property any part of its income to the members or to any individual or corporation except for purposes of operation or maintenance or the payment of its debts. During the taxable years the facilities of the petitioner, available only to members and their guests, consisted of 28 grass tennis courts, 32 ordinary clay tennis courts, 5 so-called fast drying courts, *1071 and a club house, with the usual recreational, dining, locker, and shower rooms. The general public was not admitted to any part of the property of the petitioner during 1933 and 1934 except during the playing of events awarded by the Association. In each of the taxable years the events played on tennis courts of the petitioner were the Men's National Singles Championship and the Women's National Singles Championship, each event consuming one week. The Wightman Cup Matches, consuming two days, were also played in 1933 on petitioner's property. During the holding of these five events the public, upon presentation of tickets, for which they paid, were admitted at the public entrances to the stadium and had access to such surrounding courts as were being used for matches incident to the event, but at no time to the club house or to that part of the grounds not set aside for the event. At all times the club house and its immediate facilities and surrounding grounds have been reserved for members of the club and their guests, who are admitted only by guest cards obtained through members. During the playing of tournaments among its members, team matches with other clubs and national*1072 or international competitions, certain courts are set aside for use in such competitive events. While the members may lose the use of some of the courts during the playing of such events, adequate facilities are at all times available for play by members. During the holding of a national championship they were deprived of the use of petitioner's 28 grass courts almost exclusively. All of the matches awarded to petitioner by the Association were grass court events. Only two other clubs in the United States having membership in the Association have facilities for conducting such events. The petitioner had 790 members in 1933 and 751 in 1934. The annual turn-over of membership is about 10 percent. Except "Army and Navy" membership dues of $10 a year, petitioner's dues in 1933 *154 and 1934 ranged from $20 to $65 a year, the amount for each member depending upon the class of membership held. All of the activities of the petitioner, including those incident to the tournaments, could not have been carried on without the income from the stadium. In 1933 and 1934 the petitioner had a surplus of $225,720.83 and $219,140.74, respectively, after deducting amounts as a reserve*1073 for depreciation on its exhaustible property. Its loss from club operations (not including major tournaments) was $11,879.53 in 1933 and $17,467.66 in 1934. In each year the amount was reached by deducting about $10,000 for depreciation. Its income consisted of the following: [1934] Dues $35,565.00 $33,878.50 Locker rentals 4,335.00 3,976.25 Initiation fees 3,965.00 2,660.00 Guest fees 925.00 $44,790.00 1,528.00 $42,042.75 Other sources (net) - Bar 1,307.82 Supplies 1,886.30 Restaurant 1,120.03 1 254.34 Interest 363.04 3,309.37 666.71 1,720.19 Total income from club operations 48,159.37 43,762.94 The petitioner computed gains during the taxable years from major tournaments as follows: Income (net) Expenses [1934] Rental stadium $6,000.00 $6,000.00 Expenses players $1,375.15 Tennis matches 32,423.89 19,160.18 Seat subscription sale expense 828.00 $152.50 Catering 3,982.80 3,897.64 Taxes 1,430.30 1,477.60 Parking 1,033.95 743.85 Interest 7,765.00 5,565.00 Ticket adjustments 324.00 320.32 43,764.64 30,121.99 Total 11,398.45 7,195.10 Profit before depreciation 32,366.19 22,926.89 Depreciation 11,933.42 12,039.32 Profit after depreciation 20,432.77 10,887.57 *1074 The following statements appear under the heading "Annals of the U.S.L.T.A. Chronological notes on the development of the United States Lawn Tennis Association" in a publication of the Association entitled "Fifty Years of Lawn Tennis in the United States": Though the Davis Cup was lost, the exciting play of McLoughlin against Brookes and Wilding for the international matches at the West Side Club *155 yielded a heavy profit and indicated what could be done in the way of gate receipts at big games near New York City. [This has reference to the match held in 1914.] * * * This [referring to action taken at the annual meeting of the Association of 1915 to move the national tournament from Newport to New York] marked an epoch in the popularization of tennis and its development as a major sport and, we may add, as big business. * * * The finances of the Association were reported [in 1926] in excellent condition, owing to the receipts from both the Davis Cup challenge round and from the national tournament. The treasurer's report appearing in the annual statement of petitioner for 1933 includes the following statement: In my report for the year 1933 I wish*1075 to stress the benefit derived by the Club from major tournament operations and from the sale of stadium seat subscriptions. The income from major tournaments was sufficient to absorb a loss after depreciation of $11,879.53 from club operations and leave a balance of $8,553.24 which has been transferred to the credit of surplus. * * * The bylaws of petitioner provided that of its classes of members only resident, veteran, and life members should have any interest, equity, or claim in or to property or assets of the club. An admission fee always has been charged members of petitioner's club and the public to witness major tournaments held at the stadium. Petitioner's members were required to pay the same price for tickets as nonmembers. The prices charged in 1933 and 1934 for the Men's National Singles Championship ranged from $1.65 to $5.50 for single tickets and from $9.90 to $15 for series tickets. The prices charged in 1933 and 1934 for the Women's National Singles Championship ranged from $1.50 to $4 for single tickets and from $6.60 to $11 for series tickets. The prices include admission tax. No tennis club in the United States has facilities for the holding of major*1076 tennis tournaments equal to those of petitioner. The stadium has a seating capacity of about 13,000. At times from 10,000 to 13,000 spectators have attended play of an attractive event, only a small percentage of whom were members of petitioner's club. It is not feasible to hold a national or international tennis match at a ball park or a stadium as operated by various colleges. The Association does not sanction the holding of events under its auspices at places other than those of members of the Association. Except on three occasions, one of which was in 1938, when it was used for a religious service, the stadium has never been used for other than tennis and club purposes. The petitioner holds many purely club events annually and, through a team selected from club members, engages in interclub *156 competition. The members of the club assist in making arrangements for and managing the club and its facilities, including the management of special competitions. During the taxable years no member of petitioner's club received compensation for services rendered for the club. The petitioner has always collected and transmitted to the collector of internal revenue the*1077 required tax on initiation fees, dues, and tickets for the competitions held on its property. Prior to 1934 the officers and directors of the petitioner believed that petitioner was exempt from paying Federal income taxes. Upon being notified by the respondent that he considered it liable for taxes, the petitioner caused to be prepared, and on August 2, 1935, filed under protest, income tax returns for 1933 and 1934, in which it claimed exemption and did not admit liability for tax. OPINION. DISNEY: The Revenue Acts of 1932 and 1934 exempt from taxation: Clubs organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes, no part of the net earnings of which inures to the benefit of any private shareholder. [Sec. 103(9), 1932 Act; sec. 101(9), 1934 Act.] The applicable provisions of the statute must be strictly construed and the petitioner had the burden of showing clearly that it comes within their terms. Waynesboro Manufacturers Association,1 B.T.A. 911; Farmers' Co-Operative Milk Co.,9 B.T.A. 696; *1078 Northwestern Drug Co.,14 B.T.A. 222. The purpose for which a club was organized may be within the statute, but if it is not operated exclusively for nonprofitable purposes or if part of its net earnings inure to the benefit of a private shareholder, the statute does not operate to give exemption from tax. The Associates,28 B.T.A. 521; The Jockey Club,30 B.T.A. 670; Farmers Union Co-Operative Co. v. Commissioner, 90 Fed.(2d) 488. Under the statute a corporation may be exempt even though it derives earnings as an incident to its general nonprofitable purpose. Trinidad v. Sagrada Orden de Predicadores,263 U.S. 578; Roche's Beach, Inc. v. Commissioner, 96 Fed.(2d) 776; Santee Club v. White, 87 Fed.(2d) 5. In the Santee Club case it was said that "The purpose for which the corporation, if otherwise exempt, engaged in the transaction in question is the test." The profit realized from an isolated sale is not exempt from tax if the transaction, instead of being merely incidental to the activities of the club, was entered into with gain as the primary*1079 object in view. Juniper Hunting Club, Inc.,28 B.T.A. 525. In Jockey Club v. Helvering, 76 Fed.(2d) 597, affirming *157 The Jockey Club, supra, the court, in discussing the meaning of identical provisions of 1926 and 1928 Acts, said: * * * This does not of course mean that a club may on no occasion make a profit without losing its exemption, but it does mean that the returns from transactions with outsiders, taken by and large, shall be no more than a reimbursement of their cost to the club; shall not be a source of income. If it turns out upon computation that they are such a source over a substantial enough period to justify the conclusion that this is deliberate, we agree with the Board that the club is making earnings which "inure to the benefit" of the members, though they are not distributed. * * * The respondent does not contend that the petitioner was not organized for purposes within the statutes. He argues that it was not operated exclusively for pleasure, recreation, and other nonprofitable purposes and that part of its net earnings inured to the benefit of its members. He points to the profits realized from major*1080 tennis tournaments to show that during the taxable years a part of the activities of petitioner were deliberately entered into for profitable purposes. The petitioner argues that the profits derived from tournaments awarded to it by the Association were in connection with "an activity clearly incidental to and in furtherance of the essential purpose of an otherwise exempt social club" and that the activity is "directly related to and in keeping with the objects" for which it was organized and has been exclusively operated. In 1923 the petitioner and the Association were in agreement that the facilities then in use at the club for accommodating all who desired to witness the matches were not only inadequate but were of such a nature as to cause considerable inconvenience to members each year for about three months and damage to the grounds. Committees were appointed by each to consider the existing condition at petitioner's club. Their action resulted in a contract under the terms of which the Association awarded petitioner a major tennis tournament each year for ten years, subject to the construction by it on its grounds of a permanent stadium of a specified seating capacity*1081 and an agreement for dividing the net proceeds of the matches. Upon the termination of the agreement in 1933, another contract, with similar provisions, was entered into for a like period. The petitioner claims that these tournaments stimulated interest among its members to use the normal facilities of the club and had the effect of retaining membership and encouraging others to join. It claims that this is the primary purpose it had in seeking awards of major tennis tournaments from the Association and that the continuation of the attraction over a long period of time is not enough to make the undertaking a business. A purpose of that nature, when properly limited, may not carry a club, otherwise exempt, into the field of taxation. There was no such limitation here as we view the facts. *158 The financial result of tournaments held prior to 1933 is not in evidence, but upon brief the petitioner admits that, with the exception of 1917, when a small loss was sustained, and in 1918, when no event was held, since 1914 the matches resulted in net profits each year. By 1923 the petitioner had had sufficient experience in conducting major tournaments awarded to it by the*1082 Association to be able to predict with a reasonable degree of certainty the financial outcome of any like events held in the future. With this knowledge in its possession, in that year it provided permanent facilities to continue the venture for ten years and then sought, and received, an award of matches for a like term. The stadium erected under the plan to hold major tournaments annually for ten years has a permanent seating capacity considerably in excess of the temporary stands previously used each year, and the agreement with the Association was to make provision for increasing the normal capacity about 50 percent, or to more than twice the seating capacity of the temporary stands. This action of the petitioner is strong evidence of a desire at least to be in a position to offer to the Association for many additional years adequate facilities for holding major championship matches at terms to be agreed upon. The members of the club were obliged to forego some of the facilities of petitioner during the tournaments. It is apparent that the tournaments were not an activity conducted solely for the benefit of the membership of the club, but rather to their inconvenience, and*1083 the rule set forth in G.C.M. 2867, C.B. VII-1, p. 115, cited by the petitioner, may not be applied here. In view of the small membership of the club in comparison with the attendance at the matches, the petitioner's new venture was of such an extent and the financial burden so large that it was obviously necessary to draw upon the general public for most of the patronage to avoid risk of large deficits. Support by outsiders was received. The major matches held at the stadium in each of the taxable years under an award of the Association resulted in profits, substantially all of which were derived from outsiders in the form of admission fees and from sources characterized in the report of petitioner's treasurer as catering and parking. It was not necessary for an applicant for admission to the tournaments, in order to be in a position to qualify as a spectator, to manifest the same interest in tennis or the normal social and recreational activities of the club which was requisite to membership. The only requirement was that he present a ticket for admission in the same manner as is required in any other form of public entertainment. Considering the admission that*1084 the activity in question was conducted over a long period at a profit and facts of record, there is *159 justification for holding, and we do hold, that the tournaments were deliberately entered into for profit. If profits were not the primary object in view, steps would have been taken, after many years of profitable operation as a guide, to fix prices for permission to witness the matches that would not have resulted in profit from outside sources. The petitioner cites Trinidad v. Sagrada Orden de Predicadores, supra, to support its contention. There, as we pointed out in The Associates, supra, the Supreme Court considered the benefit the public derived from the activity and the "beneficent purpose of Congress' in allowing exemption to charitable organizations." The public received no benefit from the income derived from the tournaments. In 1933 the earnings were sufficient to offset a deficit in normal club operations and leave about $8,500 as a credit to surplus. In 1934 the profit of about $11,000 from the tournament operations was less than the loss from other activities, but the amount served to reduce the deficit. In each*1085 year the earnings were used to pay debts of petitioner. We are unable to distinguish the present proceeding in principle from Jockey Club v. Helvering, supra.Therein the corporation was vitally interested in the improvement of the breed of horses and expended large sums upon, and obviously contributed materially to, that laudable objective. It received substantial income from various sources such as fees from registrations, fees for issuance of licenses, fines and penalties, percentages of prize moneys, etc. These characteristics prevented the allowance of a claim of exemption from tax. Yet the Jockey Club did not own, lease, or operate race tracks; whereas herein the petitioner does own, operate, and derive profit from, a stadium, an institution somewhat analogous to a race track. See also Uniform Printing & Supply Co. v. Commissioner, 33 Fed.(2d) 445; certiorari denied, 280 U.S. 591. Under the circumstances present here, it can not be said that the earnings did not inure to the benefit of petitioner's members even though they were not distributed. We conclude that the petitioner has failed to establish its right to*1086 exemption and accordingly sustain the action of the respondent in holding it to be subject to tax. The petitioner contends in the alternative that the amounts it collected for dues and initiation fees do not constitute taxable income on the ground that they represent capital contributions. The revenue was reported as income in returns filed for the taxable years, and there is no indication in the record that the petitioner ever entered the amounts in his books as capital items. Neither does it appear that the petitioner was denied the use of the income for general operating purposes. In The Jockey Club, supra, the tax of 10 percent *160 on dues paid by members had been paid to the collector of internal revenue for a number of years. The amounts in question represent taxable income of the petitioner. The Jockey Club, supra; Pontiac Employees Mutual Benefit Association,15 B.T.A. 74; United Retail Grocers Association,19 B.T.A. 1016. The respondent imposed a 25 percent penalty for petitioner's failure to file returns within the time prescribed by law. The Revenue Acts of 1932 and 1934 provide for a penalty equal to 25 percent*1087 of the tax in cases, as here, where the return is filed after the due date thereof unless "it is shown that the failure to file it was due to reasonable cause and not due to willful neglect * * *." Sec. 291. The evidence before us on the issue is limited to facts set forth in the stipulation. These are merely that prior to 1934 petitioner's officers and directors believed that it was exempt from payment of Federal income taxes. Thereafter, at some undisclosed date, the petitioner received a notice from the Commissioner that he considered it subject to payment of income taxes, and on August 2, 1935, the petitioner filed returns for the taxable years accompanied by claims for exemption. The respondent does not claim that petitioner willfully neglected to file timely returns for the taxable years, but contends that its failure in that regard was not due to reasonable cause. We have said that the term "reasonable cause" used in the statute means "such a cause as would prompt an ordinarily intelligent and prudent business man to have so acted under similar circumstances." *1088 Charles E. Pearsall & Son,29 B.T.A. 747. We do not know the steps taken by petitioner to ascertain its status as a taxpayer and, without knowledge of the basis for the belief of its officers and directors that it was exempt from tax, we are in no position to test the reasonableness of the conclusion. We can only speculate on the reason for the belief and such speculation would not in the final analysis help petitioner's cause. Nothing more than belief that one is not required to file a return is not enough to discharge the penalty. Eagle Piece Dye Works,10 B.T.A. 1360; Rafael Sabatini,32 B.T.A. 705; affd., 98 Fed.(2d) 753, in which the court said: "The taxpayer may well have believed that he was liable for no tax and yet have had no reasonable cause for not filing timely returns." In The Jockey Club, supra, relied upon by the petitioner, the taxpayer filed blank returns within the time prescribed by law and claimed exemption. We think that feature of the case is sufficient to distinguish it from the instant proceeding. The respondent committed no error in imposing the 25 percent penalty for failure to file*1089 timely returns. Decision will be entered for the respondent. Footnotes 1. Loss. ↩