Medical Diagnostic Asso. v. Commissioner

MEDICAL DIAGNOSTIC ASSOCIATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Medical Diagnostic Asso. v. Commissioner Docket No. 96563. United States Board of Tax Appeals 42 B.T.A. 610; 1940 BTA LEXIS 975; August 27, 1940, Promulgated *975 The petitioner is a nonprofit corporation organized under the laws of the State of California for furnishing laboratory facilities at cost to its members. Held, not exempt from income tax. J. Marion Wright, Esq., and Wm. C. Kottemann, C.P.A., for the petitioner. E. A. Tonjes, Esq., for the respondent. C. Arden Gingery, Esq., as amicus curiae. SMITH *611 The respondent has determined deficiencies in income and excess profits taxes for the years 1936 and 1937 as follows: Year Income tax Excess profits tax [1936] $274.92 $259.62 [1937] 304.53 285.17 The petition alleges that the respondent erred (1) in determining that the petitioner is liable to income and excess profits taxes for the years in question; in the alternative, (2) that he erroneously disallowed deductions for salaries of $165 for 1936 and $405 for 1937; (3) that he erroneously disallowed the addition to a reserve for bad debts of $648.73 for 1936 and $841.58 for 1937. The respondent admits error in the disallowance of any part of the salaries paid. FINDINGS OF FACT. The petitioner is a corporation, organized under the laws of the*976 State ofCalifornia as a nonprofit corporation without capital stock and with its office and place of business in Los Angeles. The petitioner filed income and excess profits tax returns for the years 1936 and 1937 with the collector at Los Angeles. No tax is calculated on the returns, but a statement containing the following is attached to each of the returns: The tax has not been calculated and no tax is being paid for the reason that it is believed that no tax is payable due to the fact that the corporation is a nonprofit cooperative organization and the only reason the return is being filed is because in a communication from the Department dated November 2, 1934 the Commissioner of Internal Revenue agreed that it was a nonprofit organization but insisted that returns should be filed as there was no provision of law granting the exemption. The respondent determined that the petitioner is a taxable corporation and mailed notice of deficiency to the petitioner asserting deficiencies as above for the years 1936 and 1937. Petitioner's articles of incorporation disclose that it was organized as "a non-profit co-operative corporation", under the laws of the State of California. *977 It was organized under the name of "Los Angeles County Medical Laboratories." By amended articles of incorporation filed February 20, 1926, the name was designated as "The Co-operative Diagnostic Laboratories." The name was changed back to "Los Angeles County Medical Laboratories" on September 24, 1931, and the name again changed on January 26, 1932, to "Medical Diagnostic Association." The chief purposes of the corporation *612 are set forth in paragraph 2(a) of the articles of incorporation as follows: (a) To establish and maintain a co-operative diagnostic laboratories for the use and benefit of licensed physicians and surgeons in the City of Los Angeles, County of Los Angeles, State of California. That said laboratories will be operated at cost and that no profit or profits are to be made or derived from the operation of the same and that no dividends are to be declared, and if any surplus is accumulated that the same shall be used for the betterment and upkeep of said laboratories, and for that purpose only. That all work and services to the medical profession by said laboratories shall be done at actual cost and that any and all licensed physicians and surgeons who*978 hold membership in this corporation shall be entitled to have and receive their laboratory and other work of similar nature done in said laboratories operated by this corporation at actual cost. The corporation is given broad powers to own, control, manage, and operate real and personal property in connection with the conduct of its business. The articles of incorporation provide that the number of directors of the corporation shall be three and the three incorporators, namely, Dr. Karl L. Dieterle, William Dieterle, his father, and R. Dieterle are named directors for the first year and to serve "until the election of such officers by the stockholders." Paragraph 6 of the articles of incorporation discloses the following with respect to voting powers and property rights: 6. That the voting power and property rights and interest of the members shall not be equal but shall be as follows: (a) The incorporating members and their successors shall not be confined to licensed physicians and surgeons but their property rights and interests shall be equal and they shall have the full control and management of said corporation and its property and shall exercise and have the sole*979 and full voting power of the memberships of said corporation and all directors of said corporation shall be elected from this class of memberships. (b) All other members except as set forth in the preceding paragraph designated in paragraph (a) shall be known as Associate Members and shall be confined to regularly licensed physicians, surgeons and dentists; said members shall be the owners of all the property and assets of the corporation, subject to the management and control thereof, by the incorporating members and their successors; the Associate Members shall not have any right or power to vote on any proposition or propositions concerning said corporation, but during the life of said corporation, each of said Associate Members shall have the right and privilege of having the use and benefit of any and all services performed by said corporation furnished to him at the costs of any such services so rendered at his request; the Associate Membership shall be limited to One Thousand (1000) and shall be governed by and controlled as set forth in the By-laws of said corporation. (c) The membership described in paragraph (a) shall select from the class of memberships described in*980 paragraph (b) last above written an Advisory Board of not less than nine (9) members as may be provided in the corporation's By-laws from time to time, which said Advisory Board shall meet with and advise with the Board of Directors, at each annual meeting and at such other *613 meetings as the Board may deem advisable, but said Advisory Board shall not have any voting power or any other rights except herein expressly set forth or as may be provided in the corporation's By-laws. The corporate powers of the association are further set forth in articles III and VI of the bylaws as follows: Article III - CORPORATE POWERS. The corporate powers of this corporation shall be vested in a Board of three (3) directors, who shall be incorporating members in good standing, holding incorporating membership certificates in the corporation, and two (2) directors shall constitute a quorum for the transaction of business. Article VI - MEMBERSHIPS. The memberships of this corporation shall be of two kinds: First. INCORPORATING MEMBERSHIPS, which shall be held by the three (3) original incorporators or their successors, who shall constitute the Board of Directors of the corporation*981 and shall manage and control the business of the corporation for the sole use and benefit of the associate members. Second. ASSOCIATE MEMBERSHIPS, which shall be held by not more than one thousand (1000) associate members and shall be restricted to regularly licensed physicians, surgeons, and dentists who are eligible to membership in their respective professional societies. The associate members shall be the sole and equal owners of all of the assets and properties of the corporation as provided in paragraph (b), Subdivision 6 of the Articles of incorporation. The bylaws provide that the services of the association may be rendered on the order of any regularly licensed physician or dentist, other than members of the association, and that all profits arising from work done for nonmembers shall be retained by the association and shall be used to reduce the cost of the operation of the laboratories for the members as provided by section 653 of the Civil Code of California. In article VIII, B. 3., of the bylaws it is provided: Upon the recommendation of a two-thirds (2/3) vote of the Advisory Board, the Board of Directors shall appoint or discharge any employees in its service*982 provided good cause be shown therefor. Article IX of the bylaws provides in part: OFFICERS 1. The officers shall consist of President, Vice-President, Secretary-Treasurer and Assistant Secretary-Treasurer. All of said officers shall be elected at the first meeting of the Board of Directors and sall hold office for and during the will and pleasure of the Board of Directors. 2. All of the above-named officers shall be elected from among the owners of the incorporating memberships or their successors except the Assistant Secretary-Treasurer who need not be a member of said corporation at all. Article XI of the bylaws provides that the associate members shall pay the sum of $100 each to the association for such memberships; that they shall not be subject to any dues; that they shall not be liable for any of the liabilities of the association, and in the event the association should be dissolved or the affairs of the association are otherwise would up, after all just and proper expenses and liabilities of *614 the association have been paid, the balance remaining shall be distributed pro rata among the associate members. Article XII provides: PROFITS Should any*983 surplus or profits arise from any source whatsoever in the operation and conduct of the business of the corporation the same shall be used accordingly to their discretion by the Board of Directors for the sole purpose of increasing the scope of the work of the corporation and the betterment of the laboratories and its properties, but in no event, nor under any circumstances, except a dissolution of this corporation shall any surplus or profits be used for the paying of any dividends to any member of this corporation whether he be incorporating member or associate member; and in the event of dissolution all surplus and proceeds from the winding up of the affairs of the corporation shall be distributed pro-rata among the associate members only, as provided in the Articles of Incorporation. Patients are referred to the petitioner for the particular service which the petitioner performs and for which service it charges the referring physician. On some occasions the petitioner collects a fee from the patient directly in an amount fixed by the referring physician in which event the amount collected is credited to the physician's account. All reports are made to the referring physician. *984 In those cases where the petitioner does not collect any fee from the physician, the physician may charge the patient whatever he chooses. The gross receipts of the petitioner for the fees for services rendered amounted to $86,084.25 and $101,629.28 for the years 1936 and 1937, respectively. The receipts are used to pay general operating expenses, salaries, etc. Upon any dissolution of the corporation total assets of the petitioner are to be divided among the petitioner's associate members. The memberships of the petitioner are transferable with the consent of the advisory board. The petitioner had between 600 and 700 associate members during the taxable years 1936 and 1937. There are other laboratories in Los Angeles which furnish to physicians, surgeons, and dentists the same services as are furnished by the petitioner. The petitioner is regarded as a competitor. Since under the petitioner's articles of incorporation and bylaws services are rendered to members at cost as nearly as may be determined the members in many cases obtain the services of the petitioner at a smaller cost than they could obtain like services from other laboratories. In returns filed for the*985 years 1936 and 1937 the petitioner claimed deduction from gross income of additions to a reserve for bad debts of $1,079.15 for 1936 and $1,349.73 for 1937. Of these amounts the respondent in his notice of deficiency disallowed $648.73 of the amount claimed for 1936 and $841.58 of the amount claimed for 1937. A reasonable addition to the reserve for bad debts for 1936 is $860.84 and for 1937 is $1,016.29. *615 OPINION. SMITH: The petitioner claims to be exempt from income tax under section 101 of the Revenue Act of 1936. It is unable to point to any class of exempt corporations which expressly comprehends it. At the hearing of this proceeding counsel for the petitioner was asked: What provisions of Section 101 of the Revenue Act of 1936 are you particularly relying upon in your claim that the Association here is exempt from filing any income tax returns? He replied: * * * the Medical Diagnostic Association does not come under the provisions of any specific class of organizations specifically exempt and yet, it savors of tests that are made for all of the associations. It has some of the characteristics of a scientific educational organization. It is similar*986 to a business league in that it is an association of doctors. It is somewhat similar to what we might say, to a board of trade, although confined to professional men. It is - in a way, it has a scientific purpose and is sort of a civic league. * * * Section 101 of the Revenue Act of 1936 provides in part as follows: SEC. 101. EXEMPTIONS FROM TAX ON CORPORATIONS. The following organizations shall be exempt from taxation under this title - * * * (6) Corporations, * * * organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, * * *, no part of the net earnings of which inures to the benefit of any private shareholder or individual, and no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation. It is not material that the petitioner is organized as a nonprofit corporation under the laws of the State of California; that it aims to perform its services for its members at cost; or that it can not and never has declared any dividends to its members. In this connection it may be noted that the Civil Code of the State of California provides for nonprofit corporations*987 and states in section 593 thereof the formation and purposes for which a nonprofit corporation may be formed. It provides: Formation and purposes. - A nonprofit corporation may be formed by any number of persons, not less than three, for any lawful purposes, such as religious, charitable, social, educational, recreational, cemetery or for rendering services which do not contemplate the distribution of gains, profits or dividends to the members thereof, and for which individuals lawfully may associate themselves, subject to laws and regulations applicable to particular classes of nonprofit corporations or lines of activity. The carrying on of business at a profit incidental to the main purposes of the corporation and the distribution of assets to members on dissolution shall not be deemed forbidden to nonprofit corporations. It can not be denied upon the evidence in this case that it was the thought and expectation of the three incorporators that laboratory *616 services could be performed for members of the petitioner corporation at prices less than those charged by the commercial laboratories. This was undoubtedly one of the objects in the organization of the petitioner. *988 It enabled the physicians and surgeons and dentists who were members of the association to obtain laboratory services at such a price as would enable them to serve patients of the lower income groups at prices less than they would have to charge if the laboratory services were paid for at higher prices. If the physicians and surgeons were disposed to reduce their charges to such low income groups, they could do so. By reason of this fact, counsel for the petitioner states that the organization of the petitioner was for a semialtruistic or semicharitable purpose. It is to be noted, however, that charitable corporations are not exempt from income tax under section 101(6) of the Revenue Act of 1936 except where "organized and operated exclusively for * * * charitable" purposes. Even if it might be assumed that the petitioner is semicharitable, it is not within the class of exempt charitable organizations; it is not "exclusively" charitable. The petitioner was also authorized to perform laboratory services for others than members, and the evidence shows that some such services were rendered. Charges for such services were made at commercial rates. Profits from such services inured*989 to the benefit of all the members. It can not therefore be said that no part of the earnings inured to the benefit of the members. The claim of the petitioner that it is exempt as a "business league" does not stand upon a better foundation than its claim for exemption as a charitable corporation. In article 518 of Regulations 62, 65, and 69 a business league is defined as "an association of persons having some common business interest, which limits its activities to work for such common interest and does not engage in a regular business of a kind ordinarily carried on for profit." In applying a provision of the Revenue Act of 1928 to a corporation which claimed to be exempt from income tax as a chamber of commerce this Board, in Produce Exchange Stock Clearing Association, Inc.,27 B.T.A. 1214; affd. (C.C.A., 2d Cir.), 71 Fed.(2d) 142, held that under the doctrine noscitur a sociis a business league must have the general characteristics of a chamber of commerce, real estate board, or board of trade in order to be exempt from tax. In affirming the Board's decision the United States Circuit Court of Appeals said: *990 Were the construction of the statutory provision in question a matter res integra, we should find little difficulty in holding that a corporation formed for the purpose of affording clearing house facilities to a limited group of traders in securities was not a "business league" entitled to exemption from taxation. The numerous subdivisions of section 103 of the Revenue Act of 1928 (26 USCA § 2103) and the corresponding provisions in the earlier acts, specify organizations which, in the great majority of instances, are evidently granted exemption because of *617 the benefit to be derived by the public from their activities. Cf. Trinidad v. Sagrada Orden,263 U.S. 578, 581, 44 S.Ct. 204, 68 L.Ed. 458. There is reason why these should be favored, but none is apparent for exempting an association which merely serves each member as a convenience or economy in his business. This is the distinction which the Board of Tax Appeals and the courts have taken in applying the provision in question to somewhat analogous situations. *991 Uniform Printing & Supply Co. v. Commissioner,33 F.(2d) 445 (C.C.A. 7), affirming 9 B.T.A. 251; Crooks v. Kansas City Hay Dealers' Ass'n,37 F.(2d) 83 (C.C.A. 8); Northwestern Jobbers Credit Bureau v. Commissioner,37 F.(2d) 880 (C.C.A. 8), affirming 14 B.T.A. 362; Louisville Credit Men's Adjustment Bureau v. United States,6 F.Supp. 196 (D.C.W.D. Ky.); A - 1 Cleaners & Dyers Co. v. Commissioner,14 B.T.A. 1314; Growers Cold Storage Co. v. Commissioner,17 B.T.A. 1279. A well founded claim for an exemption from income tax under any of the classes of corporations exempt under section 101 of the Revenue Act of 1936 must be predicated upon evidence which shows that the corporation falls fairly within the exempt class. The evidence in this case does not show that fact. The petitioner corporation was promoted by the Dieterles, only one of whom, Karl L. Dieterle, was apparently a physician. The father was not a physician and there was no requirement that the incorporators or directors should be physicians. Karl L. Dieterle testified*992 that his father was the clerical or business executive officer of the corporation. So far as appears their salaries were fixed by themselves. The income tax returns show that father and son each received a salary from the petitioner for 1936 of $5,400, and for 1937 of $6,600. The question of the reasonableness of these salaries paid is not before us. But we think it clear that the corporation was organized in the manner in which it was organized for the purpose of obtaining business in volume for the laboratory by the Dieterles. The determination of the respondent that the petitioner is not exempt from income tax is approved. Much evidence was introduced with respect to the correct net addition to the bad debt reserve for each of the years 1936 and 1937. It appears that there were some old accounts on the books of the petitioner corporation that were properly known to be worthless prior to 1936. They had not been charged off, however, and no reserve had been set up against them. The addition to the reserve made by the petitioner for 1936 was $1,079.15, and for 1937 was $1,349.73. From a careful consideration of the evidence the Board is of the opinion that the net addition*993 to the reserve should be one percent of the volume of business for each year and that the correct net addition to the bad debt reserve for 1936 is $860.84 and for 1937 is $1,016.29. Decision will be entered under Rule 50.