USCA1 Opinion
_________________________
No. 97-1319
STATE POLICE ASSOCIATION OF MASSACHUSETTS,
Petitioner, Appellant,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent, Appellee.
_________________________
APPEAL FROM THE UNITED STATES TAX COURT
[Hon. Thomas B. Wells, Judge]
_________________________
Before
Selya and Lynch, Circuit Judges,
and Pollak,* Senior District Judge.
_________________________
Alfred J. O'Donovan, with whom Michelle H. Blauner and
Shapiro, Haber & Urmy were on brief, for appellant.
Teresa T. Milton, Attorney, Tax Division, U.S. Dep't of
Justice, with whom Loretta C. Argrett , Assistant Attorney General,
and Kenneth L. Greene, Attorney, Tax Division, were on brief, for
appellee.
_________________________
August 20, 1997
_________________________
__________________
*Of the Eastern District of Pennsylvania, sitting by designation.
SELYA, Circuit Judge . In this case, the Commissioner of
the Internal Revenue Service (the Commissioner) issued a deficiency
notice to the State Police Association of Massachusetts (the
Association) for income taxes allegedly due but unpaid. When the
Association protested, the Tax Court sided with the Commissioner.
See State Police Ass'n of Mass. v. Commissioner, 72 T.C.M. (CCH)
582 (1996) (Tax Ct. Op.). The Association appeals, contending that
the Tax Court erred both in finding that the deficiency assessment
was timely and in holding that certain of the Association's
activities gave rise to liability for unrelated business income
tax. We affirm.
I. BACKGROUND
The Association is a labor organization, and, as such, is
exempt from income taxes under 26 U.S.C. S 501(c)(5) (1994). The
purpose of the organization is to represent its members in
bargaining over the terms and conditions of their employment and to
promote a fraternal spirit among members. Virtually all the
troopers who are eligible to join the Association do so.
During the years at issue, the Association published an
annual yearbook, known as The Constabulary. The yearbook consisted
of photographs, articles, display advertisements, and a business
directory. We describe infra the sales effort (which the
Association in more salubrious times called the "earnings program")
From this point forward, we will refer to the applicable
provisions of the Tax Code, as they appeared on the date(s) in
question, by using the preface "IRC." To illustrate, 26 U.S.C. S
501(c)(5) will be cited as IRC S 501(c)(5), and so on and so forth.
2
and the mechanics of publication and distribution. It is enough
for now to say that the earnings program proved to be aptly named:
gross receipts related to the publication of The Constabulary for
the years at issue totalled $8,788,211. Of this amount, the
Association retained somewhat over 40% (the precise percentage
varied from year to year, and is of no consequence here). The
Association paid no tax on the income.
It is said that all good things come to an end. Federal
law requires that an otherwise tax-exempt organization must pay
federal income tax on income derived from business ventures which
are not substantially related to its tax-exempt purpose(s). See
IRC S 511. After due investigation, the Commissioner concluded
that the Association had violated this stricture because the sale
of advertising in The Constabulary yielded taxable income. Acting
on this conclusion, the Commissioner issued a deficiency notice
seeking $1,352,433 in taxes due for the tax years ended April 30,
1986 through April 30, 1989, the three months ended July 31, 1989,
and the tax years ended July 31, 1990 and 1991, along with
additions to tax and penalties totalling $711,075.
Displeased by this turn of events, the Association
brought suit in the Tax Court under IRC S 6213(a) to obtain a
redetermination of the taxes allegedly due. It claimed that, for
certain tax years, the notice of deficiency had been issued beyond
the applicable limitation period; and that, on a broader plane, the
activity cited by the Commissioner _ the solicitation, sale, and
publication of display ads and listings in The Constabulary _ did
3
not constitute an unrelated trade or business regularly carried on,
and that, therefore, the income derived from that activity was
exempt from tax. The Tax Court rejected both of these theses and
sustained the Commissioner's determination of the existence and
extent of the deficiency (although it eliminated the additions to
tax and the penalties). See Tax Ct. Op. at 589, 594. This appeal
ensued.
II. THE PUTATIVE TIME BAR
The Association claims that the statute of limitations
bars the collection of taxes as to some or all of the affected
periods. The relevant facts are not in dispute. On August 3,
1992, the Association and the Commissioner, through their
authorized representatives, executed a form entitled "Consent to
Extend the Time to Assess Tax" (the Form). The Form, a copy of
which is reprinted in the appendix, permitted the Commissioner to
assess income tax on or before April 30, 1993, for the contested
periods through July 31, 1989. The Commissioner assessed the taxes
allegedly due for these periods by issuing a deficiency notice on
April 22, 1993. The applicable limitation period is three years.
See IRC S 6501(a). If the Form sufficed to extend the limitation
period, then the deficiency notice was timely as to all the tax
years at issue; if not, the Commissioner's claim for certain
periods is probably time-barred.
The Association advances a purely linguistic argument on
this point. It notes that the text of the Form provides for an
extension of the limitation period solely with respect to tax due
4
on "any return(s) made" by the Association during the periods in
question. The only returns so made were information returns, on
Form 990, entitled "Return of Organization Exempt from Income Tax."
By definition, no tax could possibly be due on an information
return. Taking this literal view, the Association contends that
the Form did not extend the limitation period at all.
The Tax Court refused to swallow this slippery syllogism.
It impliedly found the language of the Form ambiguous and construed
it as broad enough to include not only taxes due on returns made
but also taxes due on returns deemed to be made. See Tax Ct. Op.
at 589. Ascertaining the ambiguity vel non of a writing requires
a court to ask and answer a question of law, and, therefore, we
review this conclusion de novo. See IRC S 7482(c)(1); see also RCI
Northeast Servs. Div. v. Boston Edison Co. , 822 F.2d 199, 202 (1st
Cir. 1987).
The Tax Court's rendition withstands scrutiny. Tax forms
are rarely models of syntactical clarity, and the Form signed by
the parties is no exception. The Tax Court read the phrase
"return(s) made" as encompassing returns deemed to be made. This
construction strikes us as reasonable.
Words must be read in context. Though a plain vanilla
reading of the Form would support an inference that the parties
wished to extend the limitation period for assessing taxes due on
actual returns filed for the applicable periods, the context casts
a different light on the phrase "return(s) made." When one takes
into account that the only "returns made" were information returns
5
on which no tax could conceivably be due, and that the signatories
to the Form knew as much, the ambiguity of the phrase becomes
apparent.
Our thinking runs along the following lines. It would be
nonsensical to extend the limitation period for assessment of taxes
due on a return on which, by operation of law, no tax conceivably
could be due. The law, in turn, should be reluctant to insist that
courts construe a document in a way that leads to an absurd or
nonsensical result. Indeed, the maxim ut res magis valeat quam
pereat teaches that a written instrument ordinarily should be given
a meaning that will make it legally functional rather than a
meaning which will render it legally dysfunctional. See 3 Arthur
Linton Corbin, Corbin on Contracts S 532 (1960); see also Blackie
v. Maine, 75 F.3d 716, 722 (1st Cir. 1996). Thus, the very
implausibility of the Association's proposed construction suggests
that the phrase "return[s] made" must have some other meaning.
This conclusion is fortified by the wonted operation of
the relevant provisions of the Internal Revenue Code.
Specifically, a return relative to the unrelated business taxable
income of a normally tax-exempt organization (a so-called "990-T"
return) is deemed made, for purposes of starting the running of the
limitation period, when the information return (a so-called "990"
return) is in fact made. See California Thoroughbred Breeders
Ass'n v. Commissioner, 47 T.C. 335, 338 (1966) (construing IRC S
6501(g)(2)). Without this rule deeming the Association's 990
return to be a 990-T return, the statute of limitations that the
6
Association seeks to invoke would, presumably, not yet have begun
to run. The Association thus seeks to link the two forms for the
purposes of starting the limitations period, but would have us
decouple the forms in reviewing its agreement to extend that
period. Perhaps more important, reading the Form against the
backdrop of the California Thoroughbred Breeders rule suggests
another (broader) meaning for the phrase "return(s) made" _ a
meaning which extends to returns deemed made _ and thus highlights
the ambiguity of the Form.
That ends the matter. The presence of an ambiguity
permits a reviewing court to examine extrinsic evidence in an
effort to clarify the intent of the parties. See Smart v. Gillette
Co. Long-Term Disability Plan, 70 F.3d 173, 179 (1st Cir. 1995);
RCI Northeast, 822 F.2d at 202. Here, the extrinsic evidence is
telling: the Association's reading of the Form contradicts what
even the Association admits was the parties' mutual intention _ to
extend the limitation period as to any unrelated business income
tax that might be due for the affected periods.
We need not linger. We resolve contractual ambiguity in
The court below suggested that, if it were unable to construe
the language in the Form to give effect to the parties' discerned
intention, it could reach the same result by reforming the
instrument. See Tax Ct. Op. at 589 n.4. In general, reformation
is available when a writing is clear on its face (i.e.,
unambiguous) but nonetheless misstates the parties' intent. See,
e.g., United States v. Lumbermens Mut. Cas. Co. , 917 F.2d 654, 658
(1st Cir. 1990); Rocanville Corp. v. Natural Gas Pipeline Co. , 823
F.2d 92, 94 (5th Cir. 1987); see also Restatement (Second) of
Contracts S 155 (1979). The doctrine can be applied in tax cases.
See, e.g., Woods v. Commissioner, 92 T.C. 776, 782-83 (1989).
However, because we uphold the Tax Court's implicit finding that
7
favor of effectiveness, accept the discerned intent of the parties,
endorse the Tax Court's interpretation of the phrase "return[s]
made," and hold that the Form extended the limitation period as to
the assessment of unrelated business income tax. The notice of
deficiency was, therefore, timely as to all the contested tax
years.
III. THE MERITS
The gravamen of the Commissioner's case is the charge
that the activity undertaken in connection with publication of The
Constabulary generated unrelated business taxable income. The
allegation that an activity engaged in by a tax-exempt organization
gives rise to unrelated business taxable income requires proof of
three components. The Commissioner must demonstrate (1) that the
activity comprises a trade or business, (2) which is regularly
carried on, and (3) which is not substantially related to the
organization's tax-exempt purpose. See United States v. American
Bar Endowment, 477 U.S. 105, 110 (1986); see also IRC S 513(a).
A.
At the gateway to this issue, the parties dispute the
standard of review. The Association asserts that the Tax Court's
findings _ that publication of The Constabulary involved a business
regularly carried on _ are subject to de novo review. The
the Form is ambiguous, we need not reach the reformation issue.
The Association does not mount a challenge on the third prong
of the tripartite test, instead conceding that if the activity
amounts to a regularly conducted trade or business, it is, as the
Tax Court found, not substantially related to the Association's
8
Commissioner maintains that these findings are entitled to greater
deference.
Congress has directed the courts of appeals to use the
same standards in reviewing Tax Court decisions that traditionally
are used in appellate review of district court decisions in civil
actions tried without a jury. See IRC S 7482(a). Consequently, we
evaluate the Tax Court's findings of fact under the clearly
erroneous standard. See Commissioner v. Duberstein, 363 U.S. 278,
291 (1960); Manzoli v. Commissioner, 904 F.2d 101, 103 (1st Cir.
1990); see also Fed. R. Civ. P. 52(a). This mode of review
requires us to accept the Tax Court's credibility determinations
and its findings about historical facts unless, after careful
evaluation of the evidence, we are left with an abiding conviction
that those determinations and findings are simply wrong. See
Reliance Steel Prods. Co. v. National Fire Ins. Co. , 880 F.2d 575,
576 (1st Cir. 1989). Notwithstanding the clearly erroneous rule,
however, the Tax Court's ultimate conclusions (e.g., whether the
facts, as found, are legally sufficient to demonstrate that the
Association engaged in a trade or business) are conclusions of law,
and are therefore subject to de novo review.
On the merits, the Association advances two challenges:
it asserts that the activities in question did not constitute a
trade or business, and that in all events those activities were not
conducted with the requisite regularity. We address these
challenges sequentially.
tax-exempt purpose. See Tax Ct. Op. at 591.
9
B.
The operating paradigm permitted the Association to
exercise significant control over the sales effort, the handling of
the funds generated, and the publication of The Constabulary.
Under this paradigm, the Association contracted with an outside
firm (originally Brent-Wyatt East, and later R.H. McKnight Co.) to
publish the yearbook and recruit telemarketers. These
telemarketers were considered joint employees of the Association
and the outside firm. Groups of eight to twelve callers worked out
of field offices selected by the outside firm with the
Association's approval and solicited local and national businesses
within geographic areas demarcated by the Association. In so
doing, they utilized a canned solicitation format approved by the
Association, introducing themselves as calling on behalf of the
Association. Troopers monitored all solicitations to make certain
that the sales staff did not trespass into forbidden terrain. The
Association also retained the right to inspect, without prior
notice, the field offices from which solicitations took place.
Prospective customers were offered the opportunity to
purchase display advertisements and listings. Displays ranged in
size from one-sixth of a page to a full page, and, at the
purchaser's option, could contain text, logos, slogans, borders,
We describe the relationship as it existed through mid-1990,
under contractual arrangements with Brent-Wyatt East. Although the
contract signed with McKnight on June 20, 1990, contained some
variations, the Tax Court supportably found that these changes were
largely cosmetic and did not alter the essential character of the
relationship. See Tax Ct. Op. at 585.
10
and blocking. The fee charged for a display advertisement or a
directory listing varied in direct proportion to the size of the
display or listing and to the number of editions in which it
appeared. The Constabulary was arranged so that displays were
interspersed with editorial matter, and the publication contained
a so-called "Index to Advertisers." Listings were arranged by type
of product or service in a separate business directory section.
Payments for ads sold were made to the Association and
the Association deposited the receipts in its account. It made
weekly accountings _ retaining a stipulated percentage "off the
top" for itself, paying set percentages of the gross receipts to
the telemarketers and to the outside firm, defraying the costs
associated with solicitation and publication _ and kept any excess.
The Association published The Constabulary annually.
Association members acted as the editorial staff, writing and
editing articles for the publication and approving the contents of
the finished product. The Association distributed the yearbook
free of charge at various state troopers' barracks, the
Association's annual picnic (the "Police Chase"), and other
occasions. Copies were sometimes sent to advertisers.
Based on this scenario, the Commissioner's theory is that
the Association _ which from time to time called The Constabulary
an "ad book" and which, in its contract with Brent-Wyatt East,
referred to the latter's assignment as "marketing advertising" _
The Association produced five regional editions with common
editorial material.
11
engaged in the business of selling advertising. The Association
counters that it did not engage in that business; in its view, the
displays and listings were not advertising at all, but merely a
means of identifying sponsors. The Tax Court rejected this
contention, see Tax Ct. Op. at 590, and so do we.
Even a cursory glance at the yearbook, the pricing
structure, and the terminology used by the Association belies the
belated claim that the ads and listings were not "advertising" as
that term is commonly understood. Nor is the Association's
attempted recharacterization made any more palatable by its
reliance on Proposed Treas. Reg. S 1.513-4, 58 Fed. Reg. 5690, 5690
(1993). The proposed regulation describes the permissible contents
of acknowledgements of sponsorship payments; it allows value-
neutral descriptions of a sponsor's products or services, and logos
or slogans "that are an established part of a sponsor's identity."
See id. S 1.513-4(c). We need not decide, however, whether the
materials in The Constabulary meet these exacting criteria; the
proposed regulation, by its terms, does not apply to periodicals
produced by tax-exempt organizations. See id. S 1.513-4(a).
Putting the proposed regulation to one side, the
Commissioner's appraisal of The Constabulary's contents comports
with common sense: the displays look like ads, the directory
listings function as guides to products and services, and the
Association itself, at least during the first four years of the
undertaking, consistently referred to the displays and listings as
ads rather than as acknowledgements. That appraisal also is
12
supported by well-reasoned precedent.
Fraternal Order of Police, Etc. v. Commissioner, 87 T.C.
747 (1986), aff'd, 833 F.2d 717 (7th Cir. 1987) (FOP), which also
involved the solicitation and sale of insertions in a publication
sponsored by a tax-exempt policemen's organization, bears a strong
resemblance to the case at bar. The Tax Court found that the
activity in question amounted to an unrelated business. 87 T.C. at
757. The Seventh Circuit affirmed this finding. 833 F.2d at 721-
22. The similarities are striking. There, as here, the
publication included display ads (using logos, slogans, and
blocking), a directory section, and a message asking readers to
patronize the businesses listed therein. See id. at 719-20.
There, as here, the size of an insertion was directly proportionate
to the price charged. See id. at 721. There, as here, the
sponsoring organization, prior to the time the Commissioner came
calling, characterized the disputed activity as advertising. See
id.
Given these similarities, FOP is powerful authority for
the Commissioner's position that the activity here in question
comprises a separate, unrelated business. We consider FOP
correctly decided, and we find unconvincing the Association's
attempts to distinguish it. Consequently, we hold that the Tax
In striving to reach escape velocity from FOP's precedential
orbit, the Association relies heavily on its presentation of expert
testimony at trial. But this testimony was discounted by the Tax
Court because the expert was dismally uninformed. See Tax Ct. Op.
at 589-90. That determination was well within the trier's purview.
See Seagate Tech., Inc. v. Commissioner, 102 T.C. 149, 186 (1994).
13
Court did not commit clear error in finding that the Association's
solicitation, sale, and publication of displays and listings in The
Constabulary constituted the business of advertising.
The Association's fallback position is its claim that the
Commissioner erred in treating the outside firms (Brent-Wyatt East
and McKnight, respectively) as agents of the Association (and,
thus, in attributing these firms' activities to the Association).
To bolster this claim, the Association stresses that the contract
documents required these firms to operate as independent
contractors. It follows, the Association says, that even if the
cited activities constituted the business of advertising, the
business belonged to the outside firms.
We are not persuaded. In the first place, an independent
contractor can be an agent if, and to the extent that, the
contractor acts for the benefit of another and under its control in
a particular transaction. See Restatement (Second) of Agency SS 2,
14N (1957). In the second place, the label which contracting
parties place on their relationship is not decisive of their status
vis-a-vis third parties. See Board of Trade v. Hammond Elevator
Co., 198 U.S. 424, 437 (1905). Either way, answering the question
that the Association raises requires that we examine the substance
of the contracting parties' relationship.
In this analysis, no single factor is dispositive. See
Labor Relations Div. of Constr. Indus. v. International Bhd. of
Teamsters, 29 F.3d 742, 748 (1st Cir. 1994). Rather, the nature of
the relationship between the Association and the outside firms
14
depends on a myriad of factors, including control over the manner
and means of performing the work, the skill required, the method of
payment, the duration of the relationship, and similar factors.
See, e.g., Saenger Org., Inc. v. Nationwide Ins. Licensing Assocs.,
Inc., ___ F.3d ___, ___ (1st Cir. 1997) [No. 96-2197, slip op. at
12]; Speen v. Crown Clothing Corp. , 102 F.3d 625, 629-30 (1st Cir.
1996). The relevant factors here, taken as a whole, solidly
support the Tax Court's determination that the outside firms acted
as the Association's agents.
First and foremost, the manner in which the Association
conducted its affairs undercuts its claim that it lacked the
requisite degree of suasion over the outside firms' activities.
The Association retained very tight control over the method and
manner of solicitation, the ingredients of the sales pitch, the
identity of the solicitors, the financial aspects of the
arrangement, the use of its name, the advertising formats, and the
contents of the yearbook. We refer the reader who hungers for a
blow-by-blow account to the details set out in the opinion below.
See Tax Ct. Op. at 584-85. Without belaboring the point, it is
enough to say that the record reveals an ample factual predicate
for the finding that an agency relationship existed between the
Association and the outside firms.
C.
The Association's final contention is that, even if its
activities comprise a business attributable to it, that business
was not carried on regularly. To buttress this contention, the
15
Association makes two separate, but related, arguments.
Its first asseveration rests on the decisions in National
Collegiate Athletic Ass'n v. Commissioner, 914 F.2d 1417 (10th Cir.
1990) (NCAA), and Suffolk County Patrolmen's Benevolent Ass'n v.
Commissioner, 77 T.C. 1314 (1981). These decisions are inapposite.
In each instance, the advertising activity was tied to the program
for a specific event. See NCAA, 914 F.2d at 1420 (collegiate
basketball tournament); Suffolk County , 77 T.C. at 1316 (vaudeville
show). Thus, resolution of those cases depended on Treas. Reg. S
1.513-1(c)(2)(ii), which specifically provides that "publication of
advertising in programs for sports events or music or drama
performances will not ordinarily be deemed to be the regular
carrying on of business." That regulation is of no assistance here
because the Tax Court found specially that the Association's
publication of The Constabulary was not linked to the occurrence of
a specific event, see Tax Ct. Op. at 593, and the Association has
not challenged that finding in this venue.
We hasten to add, moreover, that the mode of analysis
used in NCAA and Suffolk County cannot be employed here. Because
those cases each involved a particular event, they looked to the
time frame of the event in determining the regularity with which
the business was carried on. See NCAA, 914 F.2d at 1422-23;
Suffolk County , 77 T.C. at 1322-24. In a case like this one, where
It is interesting to note that Proposed Treas. Reg. S 1.513-4
draws a clear distinction between periodicals and material
published in connection with a specific sponsored event. We find
the distinction significant.
16
the publication of an ad book is not pegged to a particular event,
a court must assay the activities which collectively comprise the
business, and look to the overall time frame in which they
occurred. For present purposes, that means the time frame in which
the Association solicited, sold, and published advertising. See
Treas. Reg. S 1.513-1(b) (noting that the activities of soliciting,
selling, and publishing advertising collectively constitute a
business). Those activities persisted for approximately 46 weeks
a year. See Tax Ct. Op. at 593. This is more than sufficient
regularity by any standard.
The Association next argues that it did not regularly
engage in a business because it did not carry on the advertising
activity with the same entrepreneurial zeal that might typify a
commercial operator. But this is an ill-conceived comparison.
Although the purpose behind the unrelated business income tax is to
create a more level playing field between taxed and tax-exempt
enterprises, competitive similarities are not the only factors to
be taken into account. See FOP, 833 F.2d at 722-23. The
applicable regulation stipulates that the activity in question must
be judged "in light of the purpose" of the tax, but it does not
require that either actual competition or competitive equality be
To be sure, the Association argues that the time frame is much
shorter because, although solicitation and sales transpired 46
weeks a year, publication occurred within a very narrow temporal
window. This argument is disingenuous. Treas. Reg. S 1.513-1(b)
refers to the activities of soliciting, selling, and publishing
advertising as a singular business. That business must be
regularly carried on, but there is no requirement that each task
within the scope of the business must be carried on regularly.
17
shown. Treas. Reg. S 1.513-1(c)(1).
In this instance, the Association carried on its
activities in a systematic and well-organized fashion, with a
clearly defined profit motive. Given the limitations of clear-
error review, we cannot disturb the lower court's finding that the
Association's activities were sufficiently regular to bring them
within the ambit of the regulation. See Tax Ct. Op. at 593.
IV. CONCLUSION
We need go no further. While the Association makes
several other arguments, none requires discussion; each of them is
either adequately treated in the Tax Court's opinion, or obviously
incorrect, or both. It suffices to say that the Commissioner's
determination of the tax due and owing rests on a sturdy factual
and legal foundation.
Affirmed.
18