Sierra Club v. Commissioner

T.C. Memo. 1999-86

UNITED STATES TAX COURT

SIERRA CLUB, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent*

Docket No. 8650-91. Filed March 23, 1999.

On remand from the Court of Appeals for the Ninth
Circuit. Sierra Club, Inc. v. Commissioner, 86 F.3d
1526 (9th Cir. 1996), affg. in part, revg. in part
and remanding 103 T.C. 307 (1994) and T.C. Memo.
1993-199. The Court of Appeals remanded for findings
of fact whether P’s income from the affinity card
program, which was the subject of our report at 103
T.C. 307, constituted “royalties” within the meaning
of sec. 512(b)(2). Held, the receipts constitute
“royalties” within the meaning of sec. 512(b)(2).

Robert L. Dietz, and B. Holly Schadler, for petitioner.

* This report supplements our report in Sierra Club, Inc, v.
Commissioner, 103 T.C. 307 (1994), revd. and remanded 86 F.3d
1526 (9th Cir. 1996).
 - 2 -

Stephen M. Miller, Diane I. Crosby, Judith Cavell Cohen,

William A. Goss, and Donald W. Williamson, Jr., for respondent.

SUPPLEMENTAL MEMORANDUM FINDINGS OF FACT AND OPINION

HALPERN, Judge: This case is before the Court on remand

from the Court of Appeals for the Ninth Circuit (the Ninth

Circuit). Sierra Club, Inc. v. Commissioner, 86 F.3d 1526 (9th

Cir. 1996) (Sierra Club (1996)), affg. in part, revg. in part and

remanding 103 T.C. 307 (1994) and T.C. Memo. 1993-199. The Ninth

Circuit reversed our order granting petitioner’s motion for

partial summary judgment. That order was issued pursuant to our

report in Sierra Club v. Commissioner, 103 T.C. 307 (1994)

(Sierra Club (1994)) revd. and remanded 86 F.3d 1526 (9th Cir.

1996). In Sierra Club (1994), we concluded that petitioner’s

receipts from the affinity credit card program there described

did not constitute “unrelated business taxable income” within the

meaning of section 512(a)(1) because they constituted “royalties”

within the meaning of section 512(b)(2). The Ninth Circuit

determined that we had improperly resolved disputed factual

issues in favor of petitioner, and it remanded for findings of

fact whether the receipts in question constitute “royalties”

within the meaning of section 512(b)(2).

Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the years in issue, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.
 - 3 -

We shall not here repeat the preliminaries concerning

respondent’s determinations and other matters set forth in our

prior reports.

FINDINGS OF FACT

Introduction

Some of the facts have been stipulated and are so found.

The stipulations of facts filed by the parties, with attached

exhibits, are incorporated herein by this reference.

Affinity Card Programs

An affinity credit card program is an arrangement by which

an organization agrees with a credit card issuer that the

organization’s name and logo may appear on a credit card and,

thus, be used to market the card to an affinity group associated

with the organization. The organization receives a small

percentage of total amounts charged on the card.

History of the Affinity Card Program

In 1980, petitioner was approached by Edward Shelton,

president of Shelton Financial Services (Services), who proposed

an affinity card program to petitioner, with a credit card to be

marketed to petitioner’s members and supporters (hereafter,

without distinction, the members). Negotiations between

petitioner and Services continued for almost 6 years. During

that period, Services changed its name to American Bankcard

Services (ABS). On January 10, 1986, ABS submitted to petitioner

a proposal by Chase Lincoln First Bank, N.A. (Chase Lincoln), for

an affinity card program. Among other things, Chase Lincoln’s
 - 4 -

proposal provides: “Chase Lincoln First would own all cards and

accounts in their entirety. We would provide all services in

connection with the card program except marketing.” In pertinent

part, ABS’s submission provides: “[In the proposal], there is a

reference to marketing being the responsibility of the Sierra

Club and * * * [an affiliate of ABS]. * * * Pursuant to our

agreement with the Sierra Club, American Bankcard will be

responsible for all marketing subject to your advice and

consent.”

The Sierra Club-American Bankcard Services, Inc., Agreement

On February 20, 1986, petitioner entered into an agreement

with ABS, the “Sierra Club Bankcard Agreement” (SC-ABS

agreement), which concerns itself with the provision of a credit

card (the credit card) and certain other financial services to

the members.

In pertinent part, the SC-ABS agreement provides as

follows:

SC and ABS desire to make available to the members of
SC one or more packages of financial services upon the
terms and conditions hereinafter set forth.

NOW, THEREFORE, it is agreed by the parties hereto as
follows:

ARTICLE 1. The Services

ABS proposes to offer members of SC the product
and service options set forth in Attachment “A” hereto
(* * * the "Services").

ARTICLE 2. SC Participation

2.1 SC agrees to cooperate with ABS on a
continuing basis in the solicitation and encouragement
 - 5 -

of SC members to utilize the Services provided by ABS,
all as more specifically described herein.

* * * * * * *

2.3 ABS has entered into a written agreement
whereby Chase Lincoln First Bank, N.A. of Rochester,
New York (“Chase Lincoln”) has agreed to act as a
financial institution to issue bankcards for SC. SC
has selected Chase Lincoln as the financial institution
to be the issuer of Sierra Club bankcards under this
Agreement. * * *

2.4 Chase Lincoln has represented to ABS that
the membership fee customarily charged cardholders by
Chase Lincoln will be waived for all SC members for the
first year of the term of this Agreement. ABS will
attempt to obtain from Chase Lincoln, or from any
successor financial institution selected by SC, a
waiver of such membership fee for each year of the
initial four year term of this agreement. In the event
ABS is unable to obtain a waiver of such membership
fee, ABS will pay to SC, and SC will refund to
participating members, the membership fee charged such
members during each year of the term of this Agreement.

ARTICLE 3. Program Control

* * * * * * *

3.2 ABS shall provide SC with monthly computer
reports which set forth the Total Cardholder Sales
Volume, as defined in Attachment "B" hereto, and the
royalty fees payable to SC.

3.3 ABS shall be entitled to offer to SC members
who select one of the options in Attachment “A" such
other services or products as are mutually agreed upon
from time to time between the parties hereto and for
which mutually agreed upon compensation is paid to SC.

3.4 ABS shall keep and maintain true, correct
and complete books of account and records from which SC
royalty fees can be determined. * * * SC shall have
the right at any time to examine, inspect, and audit
all such books and records, and all such other papers
and files of ABS relating to the performance of this
Agreement.
 - 6 -

3.5 ABS agrees that it will not use or permit to
be used the SC name or marks without prior written
consent in each and every instance.

ARTICLE 4. Sharing of Income and Expense

4.1 ABS agrees to remit or cause to be remitted
to SC on a monthly basis throughout the term of this
Agreement a royalty fee calculated in accordance with
Attachment “B”. * * *

4.2 ABS shall be responsible for the development
of all promotional and solicitation materials and
programs designed to encourage the acquisition and
usage of the Services by the members of SC subject to
the approval by SC of all such materials and programs.
The cost of such materials and programs shall be borne
by ABS, and SC shall not be liable for any costs
related thereto with the exception specified in Section
4.3 below. SC shall cooperate fully with ABS in
encouraging the acquisition and use of the Services.

4.3 SC may elect to pay for the production and
mailing costs associated with direct mail or other
solicitations to its members to encourage their
acquisition and use of the Services. In the event SC
so elects, the royalties payable by ABS shall be
adjusted as provided in paragraph 2 of attachment “B".

4.4 ABS, its agents, or participating financial
institutions shall be responsible for all expenses
associated with the Services except for any non-
Service related matters requested by SC such as special
mailings, special printouts or other similar actions
not part of bankcard routine operations. * * *

ARTICLE 5. Term of Agreement

* * * [four years plus renewal periods] * * *

ARTICLE 6. Hold Harmless

6.1 ABS agrees to indemnify and hold SC and each
and every participating SC member harmless from any and
all direct or contingent liabilities, claims, damages,
losses and expenses arising directly or indirectly from
the activity of ABS, its agents, or participating
financial institutions in participating in the program
except for such expenses as are specified in Sections
4.3 and 4.4, and interest and other normal bankcard
charges against cardholders for the Services.
 - 7 -

6.2 SC agrees to indemnify and hold ABS, its
agents, and participating financial institutions
harmless from any and all direct or contingent
liabilities, claims, damages, losses and expenses
arising from SC activities in participating in the
program to the extent that the same are the result of
SC gross negligence or wilful misconduct.

6.3 Nothing in this Agreement shall be construed
as constituting a partnership or agent/principal
relationship between the parties.

ARTICLE 7. Confidentiality

7.1 ABS agrees that in the event of the
termination of this Agreement, all data, documents and
information pertaining to SC members will be returned
forthwith to SC; provided however that ABS, its agents,
or participating financial institutions may retain
copies of any materials required to properly control
and handle any established customer relationships. ABS
agrees that it acquires no right under this Agreement
to inspect, copy or gain possession of any list of
members of SC or any part thereof.

7.2 ABS agrees that any and all information
provided by SC shall be the sole property of SC, and
shall not be used, transferred, reproduced or otherwise
dealt with by ABS, its agents or any participating
financial institution except under terms and conditions
approved by SC.

* * * * * * *

ARTICLE 8. Exclusivity

* * * * * * *

ARTICLE 9. Event of Default

In the event ABS fails to perform any of its
obligations under this Agreement, SC shall give notice
of such event ("Event of Default") to ABS. If ABS has
not cured the Event of Default within 10 days after
receipt of notice, SC may, in addition to its remedies
at law or in equity, terminate this Agreement. If this
Agreement terminates by expiration of the term set
forth in Article 5 or pursuant to the provisions of
Section 2.3 [sic], ABS and participating financial
institutions may retain such records as are necessary
in order for them to maintain any customer
 - 8 -

relationships established hereunder with any SC member.
In the event this Agreement is terminated pursuant to
this Article 9, notwithstanding any provision of this
Agreement to the contrary, ABS shall, and ABS shall
cause its agents and all participating financial
institutions to, immediately (1) cease using the Sierra
Club name and marks, (2) cease communicating with SC
members except to the extent necessary to terminate the
Services, and (3) return to SC all records relating to
the performance of this Agreement, and all copies
thereof, and make no effort to communicate with SC
members thereafter.

ARTICLE 10. Notices

* * * * * * *

ATTACHMENT “A”
DESCRIPTION OF AFFINITY GROUP BANKCARD PROGRAM

1. Qualified members of SC will be issued Sierra Club
Visa and/or Mastercard [sic] credit cards which contain
the standard bankcard design (either Visa or
MasterCard) along with the name of SC on one side and
the logo or other design of SC on the reverse side, as
approved by Visa, USA or MasterCard International.

2. Annual fees for the cards will be waived for the
first year, and fees for the second year may be
initiated only after an evaluation of the profitability
of the program by the participating financial
institution. In the event the participating financial
institution initiates an annual fee in the second year,
ABS will pay those fees on behalf of the cardholders.

* * * * * * *

5. If the cardholder uses a special 800 number
provided by ABS to make travel reservations and
purchases using his Sierra Club bankcard, an additional
royalty fee as set forth in Attachment "B" will be paid
to SC.

6. Other enhancements such as Visa or MasterCard
Travelers Checks and the ABS Universal Debit Bankcard
will be made available to cardholders from time to time
pursuant to mutually agreed upon royalty fees payable
to SC.
 - 9 -

ATTACHMENT “B”
ROYALTY FEE SCHEDULE

1. The royalty fee payable to SC shall be one half of
one percent (0.5%) of the Total Cardholder Sales Volume
if the fees received by ABS from the participating
financial institution are between 0.5% and 1.0% of the
Total Cardholder Sales Volume. Total Cardholder Sales
Volume is defined as the sum of all SC bankcard sales
drafts resulting from purchases at merchants by members
of SC using SC bankcards net of credit vouchers issued
for returned merchandise or other services, and net of
cash advances.

2. If SC elects to pursue the option specified in
Section 4.3 of this Agreement and if the fees received
by ABS from the participating financial institution are
between 0.6% and 1.0% of the Total Cardholder Sales
Volume, the royalty fee specified in Section 1. of this
Attachment "B" shall be increased to six tenths of one
percent (0.6%) of the Total Cardholder Sales Volume.

3. If the fees received by ABS from the participating
financial institution are more than 1.0% of the Total
Cardholder Sales Volume, the fee payable to SC, whether
otherwise 0.5% or 0.6%, shall be increased by an amount
equivalent to 50.0% of the fees payable to ABS in
excess of 1.0%.

4. If the fees received by ABS from the participating
financial institution are less than 1.0% of the Total
Cardholder Sales Volume, but more than 0.5% (or, in the
event SC elects the option referred to in Paragraph 2.
above, more than 0.6%), there will be no decrease in
the fees payable to SC under Paragraph 1. or 2. above.
However, if the fees received by ABS are less than 0.6%
or 0.5% (whichever is otherwise payable to SC), the
fees payable to SC will be the total fees received by
ABS from the participating financial institution.

5. When SC members use the 800 number travel service
described in Section 5. of Attachment "A", SC will be
paid a royalty of three percent (3.0%) of the price of
airline tickets purchased with the Sierra Club
bankcards and fifty percent (50.0%) of the hotel and
car rental commissions received by the participating
travel agency. These royalties are in addition to the
royalties specified in Section 1., 2., 3., or 4. of
this Attachment “B”.
 - 10 -

ABS-Concept I, Inc., Agreement

Concept I, Inc. (Concept), a Massachusetts corporation, is

the party that brought Chase Lincoln to the attention of ABS as a

bank willing to issue the credit card. On March 9, 1986, ABS

entered into an agreement with Concept (the ABS-Concept

agreement), which concerns itself with ABS’s rights and duties

under Article 4 of the SC-ABS agreement to solicit the members

with respect to the credit card. The ABS-Concept agreement

recites that ABS desires to assign those rights and duties to

Concept. Among other things, the ABS-Concept agreement provides

that (1) by doing so, ABS intends to satisfy its obligations with

respect to solicitation under the SC-ABS agreement and

(2) Concept and Chase Lincoln have entered into an agreement

pursuant to which Chase Lincoln has agreed to act as the

financial institution that will issue the credit card. Concept's

obligations under the ABS-Concept agreement are tied to its

rights and obligations under its agreement with Chase Lincoln.

Concept-Chase Lincoln Agreement

On March 28, 1986, Concept entered into an agreement with

Chase Lincoln. That agreement (the Concept-Chase Lincoln

agreement) makes reference to both the SC-ABS agreement and the

ABS-Concept agreement and recites that Chase Lincoln is willing

to serve as the issuing financial institution with respect to the

“Card Program” contemplated in the SC-ABS agreement (the credit

card program). Among other things: Concept agrees to solicit

(or cause to be solicited) the members for participation in the
 - 11 -

credit card program. Concept must submit to Chase Lincoln for

approval all promotional material containing the name of the

bank. Chase Lincoln agrees to issue to qualified members its

Premier Visa Card. Such cards, as well as any indebtedness or

other customer relationships resulting from use of the cards,

become and remain the property of the bank. Information supplied

by members to the bank in connection with the credit card program

becomes the property of the bank upon the issuance of a card to

the member, for use in the bank's sole discretion in the normal

course of conducting its business. The bank agrees, however,

that it will not disclose the fact that any participant in the

credit card program is a member. Chase Lincoln agrees to waive

the normal annual membership fee for the card for each member’s

first year of membership and to charge a reduced membership fee,

no more than $30, for each subsequent year of membership. The

bank agrees to pay to Concept a fee based on purchases made by

members with a card. That fee will also vary depending on Chase

Lincoln's cost of funds, which is determined with reference to

the published discount rate applicable to 91-day U.S. Treasury

bills. In no event, however, can the fee paid by Chase Lincoln

to Concept decrease below 0.25 percent of the total purchases

made by members with a card. Petitioner's interest in the

agreement is acknowledged.
 - 12 -

Amendment to ABS-Concept Agreement and Concept-Chase Lincoln
Agreement

On March 28, 1986, the ABS-Concept agreement and the

Concept-Chase Lincoln agreement were amended (the ABS-Concept

Concept-Chase Lincoln amendment) such that (1) should ABS fail to

perform under the SC-ABS agreement, (2) should Concept fail to

perform under the ABS-Concept agreement, or (3) should both ABS

and Concept fail to perform under such agreements, Chase Lincoln

has the right to assume the responsibilities and enforce the

rights under such agreements.

SC-Chase Lincoln Agreement

On March 26, 1986, petitioner and Chase Lincoln entered

into an untitled agreement (the SC-Chase Lincoln agreement) that

references the SC-ABS agreement. Among other things, the

SC-Chase Lincoln agreement provides that (1) should ABS fail to

perform under the SC-ABS agreement, Chase Lincoln has the right

to assume the responsibilities and enforce the rights of ABS

under that agreement and (2) during the term of the agreement

(until March 28, 1988, unless extended) petitioner will not

authorize any other bank to issue Visa credit cards to its

members.

ABS-Concept Modification

By letter dated July 7, 1986, the ABS-Concept agreement was

amended and modified (the ABS-Concept modification). Among other

things, the letter provides that (1) Concept's duties to solicit

members are reassigned back to ABS and (2) to compensate Concept
 - 13 -

for obtaining a bank issuer for the credit card program, Concept

may retain a portion of the payments it receives from Chase

Lincoln.

Member Lists

Petitioner develops and maintains mailing lists with

respect to the members composed of names, addresses, and related

information. Petitioner has exclusive ownership rights in its

mailing lists, including the right to all net income from such

lists.

On April 14, 1986, petitioner provided ABS a magnetic tape

containing an initial list of the members. Subsequently, on

seven occasions, petitioner provided ABS labels containing the

names and address of new members.

Marketing Plans and Solicitations

In March 1986, ABS circulated to petitioner a proposed

marketing plan, schedule, and sample solicitation materials

(together, the initial plan) for petitioner’s review and

approval. Petitioner objected to certain aspects of the initial

plan. A revised plan (the revised plan) was circulated within

petitioner’s organization in early April 1986. A cover letter

accompanying the revised plan states: “You will note that the

pitch has been toned down considerably and the letter to the

leadership doesn’t do anything except inform them of the Club’s

plans for a credit card.” Also, the cover letter states that

proposals for telemarketing, membership solicitation and drive

packages, membership renewal packages, automatic membership
 - 14 -

renewal, and automatic monthly billing of contributions had been

eliminated.

ABS initially solicited petitioner’s members with respect

to the credit card program in a communication dated June 15, 1986

(the June 15 communication). The June 15 communication contains

letters on Sierra Club stationery, with facsimile signatures by

officers of petitioner, informing members of “a new member

service” and of the benefits both to members and to petitioner

(“royalty fees”). An enclosed brochure invites communication

with ABS and states:

American Bankcard Services, Inc. is an independent
California corporation organized to provide bankcards
to the members of various national Affinity Groups as
a unique member service and fund raising opportunity.
American Bankcard has contracted with the Sierra Club
in order to make Sierra Club VISA cards available to
members of the Club.

Members are instructed to mail their applications to Chase

Lincoln. The June 15 communication was mailed to members using

petitioner’s nonprofit postage permit. ABS paid for the June 15

communication, including the costs of design, printing, business

reply envelopes, postage, and mailing labels.

After a member’s application was accepted, the member

received a letter congratulating the member “for joining with the

Sierra Club and Chase Lincoln First in this important new

program” and stating: “The added income to the club [sic] from

your use of the card will certainly benefit the Club in its

continuing efforts to improve our environment, to keep endangered

species alive and to save the wilderness.” That letter
 - 15 -

contained the letterheads of both petitioner and Chase Lincoln

and facsimile signatures of officers of both organizations. ABS

paid all of the costs of that letter.

Advertisements

Advertisements for the credit card program appeared in

three issues of petitioner’s magazine, Sierra, during each of

1986 and 1987. Those advertisements (the advertisements) were

designed by JMP Marketing and Design, a design agency retained by

ABS. The advertisements instructed petitioner’s members to

submit applications to Chase Lincoln and to direct questions to

ABS. ABS was billed for the advertisements at the same prices

and on the same terms as applicable to any unrelated advertiser.

ABS failed to pay amounts billed to it for the 1987

advertisements in the amount of $8,230. Petitioner attempted to

collect that amount but was unsuccessful.

ABS also placed advertisements for the credit card program

in publications of local chapters of petitioner. ABS paid for

those advertisements and received no discount from the rates

charged others.

Administration of the Program

Petitioner did not maintain individual files concerning

each member’s participation in the credit card program. The

credit card program was administered, and records kept, by ABS

and Chase Lincoln. Members’ complaints and inquiries with

respect to the credit card program were directed to ABS or Chase

Lincoln.
 - 16 -

Termination of the SC-ABS Agreement

By the Concept-Chase Lincoln agreement, Chase Lincoln

agreed to waive its annual fee for the first year of a member’s

participation in the credit card program. By the SC-ABS

agreement, ABS agreed to pay any annual fees charged by Chase

Lincoln during the remaining term of the SC-ABS agreement. For

some members, their second year of participation in the credit

card program began in August or September 1987. Chase Lincoln

charged a membership fee for that year (the second year fee) and

ABS was unable to obtain a waiver. ABS issued checks to members

reimbursing them for the second year fees, but a substantial

amount of those checks were dishonored by ABS’s bank. Petitioner

considered ABS in breach of the SC-ABS agreement and terminated

that agreement by a letter to ABS dated December 29, 1987 (the

December 29 letter). The December 29 letter requested ABS to

comply with Article 9 of the SC-ABS agreement, “specifically

including returning to the Club all lists of Sierra Club

members”.

Petitioner’s Receipts

Petitioner’s receipts from the credit card program were

$6,021 and $303,225, for its taxable years ending September 30,

1986 and 1987, respectively.

OPINION

I. Introduction

Respondent determined deficiencies in petitioner’s 1986 and

1987 Federal income taxes based, in part, on adjustments made
 - 17 -

with respect to petitioner’s participation in the credit card

program described in our findings of fact. Petitioner’s receipts

from the credit card program (the receipts) were $6,021 and

$303,225 for 1986 and 1987, respectively. Respondent adjusted

petitioner’s “unrelated business taxable income” by including the

receipts and determining that they did not constitute “royalties”

within the meaning of section 512(b)(2). Among other assignments

of error, petitioner assigns error to respondent’s determinations

of deficiencies based on petitioner’s participation in the credit

card program. Principally, petitioner argues that the receipts

were “royalties” within the meaning of section 512(b)(2).

Alternatively, petitioner argues: (1) Its activity with respect

to the credit card program did not constitute a trade or

business, (2) that activity was substantially related to its

exempt purposes, and (3) that activity was not regularly carried

on.

The parties have raised principally questions of fact with

respect to the receipts. The credit card program was the product

of numerous agreements between various parties (the agreements),

including petitioner, ABS, and Chase Lincoln. We shall look to

the agreements, along with the relevant facts and circumstances

surrounding the execution of the agreements, to determine the

nature and character of the receipts. Petitioner bears the

burden of proof. See Rule 142(a).
 - 18 -

II. Internal Revenue Code

Pursuant to sections 511 through 513, an organization

otherwise exempt from the income tax is required to pay tax, at

regular corporate rates, on its “unrelated business taxable

income” (UBTI). UBTI is defined by section 512(a)(1) as “the

gross income derived by any organization from any unrelated trade

or business * * * regularly carried on by it * * * [less certain

deductions and with certain modifications].” As relevant here,

section 512(b)(2) excludes from UBTI “all royalties * * * whether

measured by production or by gross or taxable income from the

property”.

III. Definition of Royalties

In Sierra Club (1996), 86 F.3d at 1532, the Ninth Circuit

held: “[U]nder § 512(b)(2) ‘royalties’ are payments for the

right to use intangible property.” Accord Disabled Am. Veterans

v. Commissioner, 94 T.C. 60, 70 (1990), revd. on other grounds

942 F.2d 309 (6th Cir. 1991). The Ninth Circuit further held

that a royalty is by definition “passive” and, thus, “cannot

include compensation for services rendered by the owner of the

property.” Sierra Club (1996), 86 F.3d at 1532.

IV. Arguments of the Parties

Both parties fasten on the definition of the term

“royalties” adopted by the Ninth Circuit. Petitioner argues that

its name, logo, and mailing list are all intangible assets,

which, by one of the agreements (the SC-ABS agreement), it

licensed to ABS in return for payments that, in form and
 - 19 -

substance, were “royalties”, as that term is used in section

512(b)(2). At trial and on brief, respondent variously claims

that petitioner was in the business of either (1) “marketing”,

(2) “sponsoring, promoting, and marketing”, or (3) “sponsoring,

endorsing, promoting, and marketing” a credit card (the credit

card). Respondent argues that none of the agreements licensed or

otherwise made available petitioner’s name, logo, or mailing list

to ABS or Chase Lincoln. Instead, respondent argues: The

agreements were for services only, and “[t]he income Sierra

received emanated from activities it engaged in and services it

performed”. Respondent argues that “in the first instance”, the

fee paid by Chase Lincoln pursuant to the Concept-Chase Lincoln

agreement was the income of petitioner, and petitioner then paid

ABS for services ABS provided to petitioner. Because we find

that the receipts constitute “royalties” within the meaning of

section 512(b)(2), we need not address petitioner’s alternative

arguments.

V. Discussion

A. Payment of Royalties

The principal agreement governing petitioner’s

participation in the credit card program is the SC-ABS agreement.

We have no doubt that petitioner and ABS, in entering into the

SC-ABS agreement, had in mind the use by ABS of petitioner's name

and marks in connection with ABS's marketing efforts under the

SC-ABS agreement. Our reasoning is essentially as follows.
 - 20 -

The description of services attached to the SC-ABS

agreement (ATTACHMENT “A”) recites that members who become

cardholders will receive a credit card with the name of

petitioner on one side and a "logo or other design of SC" on the

reverse side. Also, Article 9 of the SC-ABS agreement

(hereafter, Art. 9) provides that, if ABS defaults, it must

immediately cease using petitioner's name and marks. In light of

the provisions cited, we view ABS's agreement that it will obtain

prior written consent from petitioner for use of its name or

marks (Article 3.5) as a provision regulating ABS's use of those

items and preserving petitioner's property interests therein.

Similarly, we view petitioner's right to advise and consent with

regard to the marketing materials prepared by ABS (see

Article 4.3) as a right intended to safeguard petitioner's name,

marks, logo, and the other intangibles (such as facsimile

signatures of petitioner’s officers) used in marketing the credit

card program.

The SC-ABS agreement further implicitly provides that ABS

will be allowed access to the members. The parties have

stipulated that petitioner provided lists of the members directly

or indirectly to ABS in connection with the credit card program.

The preamble to the SC-ABS agreement recites that the parties

thereto “desire to make available to the members of SC” the

services to be offered by ABS. Article 3.3 entitles ABS to offer

additional services to the members and, if ABS defaults, Art. 9

requires ABS to cease communicating with the members. Thus,
 - 21 -

notwithstanding the lack of particular language setting forth

ABS's right of access to the members, we think it clear that such

access is a key component of ABS's rights under the SC-ABS

agreement, to be accomplished by the use (license) of

petitioner's mailing lists to ABS.

We conclude that the SC-ABS agreement made available for

ABS's use petitioner's name, marks, logo, and certain other

intangible property used in marketing (such as facsimile

signatures of petitioner’s officers), as well as provided ABS

access to the members by way of petitioner's mailing lists. The

financial consideration petitioner received under the SC-ABS

agreement (the receipts), therefore, was, at least in part,

consideration for the use of valuable intangible property, and as

such constituted royalties within the meaning of section

512(b)(2). See supra sec. III.

B. Petitioner Did Not Receive Payments for Services

1. Introduction

We now turn to the question of whether any part of the

receipts was received by petitioner in consideration of its

services. In the context of its argument that petitioner was in

the business of marketing the credit card program to the members,

respondent argues that petitioner was compensated for performing

the following services: (1) controlling the marketing plans, (2)

offering the affinity credit card as a member service, (3)

placing advertisements for the affinity credit card in its

magazines and local publications, (4) allowing solicitations to
 - 22 -

be made using its nonprofit mail permit, (5) actively endorsing

and sponsoring the acquisition of the affinity credit card

through brochures and letters from its officers, (6) guaranteeing

refunds of the annual fee if the Chase Lincoln imposed such a

charge, and (7) attempting to persuade the Chase Lincoln to relax

its credit tolerances so that additional affinity credit cards

could be issued and higher profits realized.

2. Control of Marketing Plans

a. SC-ABS Agreement

Respondent argues that petitioner controlled the marketing

plans for the credit card program, and, thus, petitioner was

compensated for providing services. Petitioner’s rights and

duties with respect to marketing are set forth in the SC-ABS

agreement. For the most part, the SC-ABS agreement assigns to

ABS responsibility for marketing the credit card program.

Article 4.2 assigns to ABS the initiative for developing

marketing plans: “ABS shall be responsible for the development

of all promotional and solicitation materials and programs

designed to encourage the acquisition and usage of the Services

by the members”. Article 4.2 imposes on ABS the cost of such

materials and programs, unless petitioner elects (which it did

not) to pay for production and mailing costs in consideration of

a larger payment. Article 3.3 places with ABS the initiative to

propose additional services to offer to the members.

Article 4.2 subjects promotional and solicitation materials

and programs developed by ABS to approval by petitioner.
 - 23 -

Petitioner, thus, had control over those materials and programs

by way of its power to negate. As discussed infra in section

V.B.2.c, we believe that such control was exercised by petitioner

to safeguard the valuable intangible property rights that it had

licensed to ABS. In theory, at least, petitioner’s power to

negate could allow petitioner to assume responsibility for

development of the marketing program. Practicably speaking,

however, such responsibility does not appear to have been

intended, since the SC-ABS agreement contains no provision to

compensate ABS for following petitioner’s directions except if

petitioner elects to bear solicitation costs, Article 4.3, or

requests certain nonroutine actions, Article 4.4.

Petitioner’s other significant rights under the SC-ABS

agreement do not give petitioner control directly or indirectly

over any marketing plan. Article 3.2 provides that petitioner is

entitled to monthly accountings from ABS from which it can

determine total cardholder sales volume and its share thereof.

Article 3.5 prohibits ABS from using petitioner's name or marks

without its consent. Article 6 generally holds petitioner

harmless from losses except as otherwise specified.

Article 6.3 provides that the agreement is not to be

construed as constituting an agent-principal relationship between

petitioner and ABS, which tends to eliminate one kind of control

over marketing that respondent has implied.

Article 2.1 sets forth petitioner’s principal duty with

respect to the SC-ABS agreement: “SC agrees to cooperate with
 - 24 -

ABS on a continuing basis in the solicitation and encouragement

of SC members to utilize the services provided by ABS.”1

ATTACHMENT “B”, read in conjunction with the Concept-Chase

Lincoln Agreement, provides that, in consideration of its

cooperation, petitioner is to receive a minimum of 0.25 percent

of total cardholder sales volume. ATTACHMENT “B” further

provides that petitioner is to receive royalties if members

purchase certain additional services.

Finally, under the SC-ABS agreement, as implemented,

petitioner did not receive a fee for any marketing activities or

share in any economies realized by ABS in its expenditures made

in carrying out its marketing responsibilities.

We conclude that petitioner did not control the marketing

plan for the credit card program and, thus, was not compensated

for providing marketing services.

b. Petitioner’s Intent

We have also considered the negotiations preceding the SC-

ABS agreement and its implementation. As stated, petitioner did

have some control over marketing efforts through its right to

approve all promotional and marketing materials and programs.

Nevertheless, the SC-ABS agreement, considered in light of the

parties’ negotiations and course of action preceding it,

convinces us that, in entering the SC-ABS agreement, petitioner

1
Article 4.3 gives petitioner the privilege, but not the
duty, to pay production and mailing costs of solicitations, for
increased compensation.
 - 25 -

intended not to be responsible for marketing efforts with regard

to the credit card program, except to exercise its approval

rights with respect to ABS’s efforts in that regard. Indeed,

Michael McCloskey, chairman of Sierra Club, testified that, at

the inception of the credit card program, he anticipated that the

only staff resources that petitioner would have to devote to the

program would be “a bit” of the time of Leonard Levitt, then

director of finance and administration, and that no additional

office space would be necessary. Mr. McCloskey was credible, and

his testimony supports our conclusion that, in entering into the

SC-ABS agreement, petitioner did not contemplate being in the

marketing business or performing marketing services for

compensation.

c. Safeguarding Intangible Property Rights

We do not view petitioner’s actual exercise of its rights

and duties under the SC-ABS agreement as amounting to the

performance of services. Petitioner acted to safeguard its

intangible property interests. Article 4.2 placed the

responsibility for developing marketing materials on ABS.

Petitioner exercised its right of approval and, as a result, the

“pitch” of ABS’s marketing proposals was “toned down”, and

proposals for telemarketing, membership solicitation and drive

packages, membership renewal packages, automatic membership

renewal, and automatic monthly billing of contributions were

eliminated from the marketing plan. ABS’s presentation of its

initial marketing plan (the initial plan) and petitioner’s
 - 26 -

responses to the initial plan were accomplished in a relatively

short period. We do not view petitioner’s exercise of its

discretion as a disguised attempt to exercise creative or

production control over ABS’s efforts. Moreover, we do not find

the existence, or exercise, of petitioner’s rights to be

inconsistent with a royalty arrangement. In Wm. J. Lemp Brewing

Co. v. Commissioner, 18 T.C. 586 (1952), we dealt with an

agreement that allowed a party to manufacture and sell beer under

an old family name used by the taxpayer. The agreement reserved

to the taxpayer a right of approval over methods of brewing,

advertising, and the marketing of beer that would carry its name.

We stated:

The significance of such provision, when read in
the light of the entire agreement, is that petitioner,
having licensed the use of its formulae and trade name,
desired to retain the right to supervise the methods of
brewing, advertising, and marketing of beer sold under
the “Lemp” name for the protection and preservation of
what petitioner considered a valuable property right.
Since the license granted was for an indefinite period,
and could be canceled by * * * [the licensee] at will,
such a protective provision was a most desirable one.
* * *

Id. at 596. We found that payments made pursuant to the

agreement to manufacture and sell beer under the family name

were royalties. Id. at 597; see also Disabled Am. Veterans v.

Commissioner, 94 T.C. at 78.

Here, when viewed in light of the SC-ABS agreement and the

negotiations that preceded it, we conclude that petitioner’s

exercise of its right of approval with respect to ABS’s

marketing proposals evidences only petitioner’s concern with
 - 27 -

protecting the worth of its property interest in its good name

and marks. It was not an indirect method of putting petitioner

in the business of marketing, nor was it a marketing service

provided by petitioner to ABS pursuant to the SC-ABS agreement.

d. Conclusion

For the reasons stated, we conclude that petitioner did

not control the affinity credit card program's marketing plans

except to the extent that it reserved the right to approve any

use of its name, marks, and logo. Such reserved right is

commonplace in licensing agreements, and the mere retention of

quality control rights by a licensor in a licensing agreement

situation does not cause payments to the licensor under the

agreements to lose their characterization as royalties. Sierra

Club (1996), 86 F.3d at 1533 n.15 (quoting Rev. Rul. 81-178,

1981-2 C.B. 135); see id. at 1535-1536 (petitioner did not

perform services with respect to the rental of mailing lists

even though it retained the right to approve the contents of

mailings of list users).

3. Member Services

Respondent argues that petitioner offered the credit card

as a member service. While it is true that petitioner endorsed

the credit card program, Chase Lincoln was the financial

institution that extended credit to the members, and it was

ABS’s marketing efforts that brought the possibility of the

credit card and certain other services to the attention of the

members. Although the term “member service” appears in certain
 - 28 -

solicitations for the credit card program, petitioner expressly

did not treat the credit card to be a member service in the

sense of a service being offered and overseen by petitioner.

Rose Marie Maune (Ms. Maune) was employed by petitioner from

1976 until 1992. She was petitioner's membership director

until about the years in issue, when she became director of

operations, where she fulfilled a similar role. Ms. Maune

testified that the membership services department did not

handle any inquiries regarding the affinity credit card

program. She testified that they would not answer members'

questions because they were not in control of the program.

Moreover, petitioner did not provide any significant

administrative services with respect to the credit or other

services provided by Chase Lincoln and ABS.

If, by characterizing the credit card program as “a member

service”, respondent means that petitioner provided something

of value to the members, that something was the opportunity for

the members to benefit petitioner by using a credit card that

was to be provided by Chase Lincoln or to use a travel service

that was affiliated with ABS. That is the essence of an

affinity card program, and the intended result of the license

of the organization’s name, logo, mailing list, and other

intangibles. The income received in consideration for such

licenses alone is royalties within the meaning of section

512(b)(2).
 - 29 -

4. Advertising

ABS advertised the credit card program in both

petitioner’s national magazine, Sierra, and in the publications

of local chapters. ABS was charged the usual rates for such

advertisements, although it failed to pay amounts billed to it

for advertisements in Sierra for 1987 in the amount of $8,230.

Petitioner attempted to collect that amount but was

unsuccessful.

The SC-ABS agreement does not require petitioner to accept

advertisements from ABS although it does require petitioner “to

cooperate with ABS on a continuing basis in the solicitation

and encouragement of SC members to utilize the Services

provided by ABS”. It is conceivable that petitioner and ABS

contemplated such cooperation as extending to the acceptance of

advertising by petitioner. Even if that were so, however, the

evidence is that ABS was charged the usual rates for

advertising. Although ABS failed to pay for its 1987

advertisements, nothing indicates that, when petitioner

accepted ABS’s advertising, petitioner had any lower

expectation that ABS would pay than it had for any other

advertisers. In other words, there is no evidence that

petitioner extended ABS any credit preference. That being the

case, we find no basis for concluding that any portion of the

receipts was in consideration of advertising services. Neither

do we conclude that petitioner anticipated ABS’s failure to pay

its 1987 bill and, in negotiating the SC-ABS agreement,
 - 30 -

bargained for, and received, any consideration on account of

that anticipation.

Generally, income realized by an exempt organization from

the sale of advertising in a periodical is taxable UBTI. See

sec. 1.512(a)-1(f)(2), Income Tax Regs. The SC-ABS agreement

was not a contract for advertising, and, notwithstanding that

petitioner entered into contracts for advertising at the same

time it was obligated under the SC-ABS agreement, nothing in

sections 511 through 513 or the opinion of the Ninth Circuit in

Sierra Club (1996) indicates to us that the contemporaneous

existence of obligations under the two contracts necessarily

means that some or all of the receipts, received pursuant to

the SC-ABS agreement, cannot properly be characterized as

“royalties” under section 512(b)(2).

None of the receipts were received on account of

petitioner's providing advertising to ABS.

5. Nonprofit Mail Permit

In soliciting the members with respect to the credit card

program, ABS, on at least one occasion, used petitioner’s

nonprofit mail permit. ABS paid the postage.

During the years 1986 through 1992, petitioner held a

nonprofit mail permit (the mail permit) and regularly used the

mail permit to send communications to its members, supporters,

and other interested persons at the nonprofit rate. Under

U.S. Postal Regulations, cooperative mailings may be made at

the special bulk rates available to nonprofit organizations
 - 31 -

only when each of the cooperating organizations is individually

authorized to mail at the special bulk rates.

Edward Shelton, president of ABS, testified that it was a

business mistake for ABS to use the mail permit because of mail

delivery restrictions applicable to such permitted mail. He

also testified that ABS paid the postage and that use of the

permit was not considered when the SC-ABS agreement was entered

into and petitioner became obligated “to cooperate”.

Mr. Shelton was credible in all of that testimony.

We have found that petitioner was not in the business of

marketing the credit card program or in the business of

providing marketing services to ABS. The mailings in question

were ABS’, and, thus, since ABS was not entitled to the special

bulk rates in question, ABS’ use of the mail permit was

unlawful. Because it involved an unlawful action, we hesitate

to classify it as cooperation under the SC-ABS agreement. We

become firm in that conclusion based on Mr. Shelton’s credible

testimony that, at the time that agreement was entered into, it

was not considered. Therefore, we conclude, and find, that use

of the mail permit was not a service provided to ABS pursuant

to the SC-ABS agreement.

None of the receipts were received on account of ABS’s use

of the mail permit.

6. Active Endorsement and Sponsorship

Respondent argues that the obligation “to cooperate”

imposed on petitioner by Article 2.1 is an obligation to
 - 32 -

perform services, particularly including the service of

endorsing and promoting the credit card program.

As has been well established, in many respects, the SC-ABS

agreement is ambiguous. Nevertheless, considering both the SC-

ABS agreement and the circumstances preceding and following its

execution, we conclude that petitioner's obligation to

cooperate was not an agreement to endorse or promote the credit

card program beyond the endorsement that necessarily results

from petitioner’s license of its logo, name, and the other

intangibles here in question.

The use of petitioner's name, marks, logo, and its

continued endorsement was precisely the valuable consideration

petitioner provided pursuant to the SC-ABS agreement, and it

was precisely for what ABS was paying. Petitioner may have

approved solicitations and communications to the members with

respect to the credit card program, but it was ABS that

designed and paid for those communications, which actions were,

primarily, for its own benefit, pursuant to its duties under

the SC-ABS agreement. Respondent has stated in a revenue

ruling that income from the endorsement of products, use of

signatures and trademarks, and review of licensed products is a

royalty within the meaning of section 512(b)(2). Rev. Rul. 81-

178, 1981-2 C.B. 135 (distinguishing circumstance where

personal services, in the form of appearances and interviews,

are required). Accord Mississippi State Univ. Alumni, Inc. v.

Commissioner, T.C. Memo. 1997-397.
 - 33 -

Petitioner’s endorsement and promotion of the credit card

program were not in consideration of the receipt of anything

other than “royalties” within the meaning of section 512(b)(2).

7. Refunded Annual Fee

Respondent argues that petitioner guaranteed the members a

refund of Chase Lincoln’s second year membership fee (the

second year fee), if, indeed, Chase Lincoln imposed a second

year fee. Respondent notes that petitioner actually reimbursed

some of the members for ABS's dishonored checks and argues that

petitioner therefore provided a service pursuant to the credit

card program.

No plausible reading of the agreements reveals any

obligation by petitioner to use its own funds to reimburse the

members for the second year fee. We have found that, pursuant

to the SC-ABS agreement, petitioner allowed ABS to use

petitioner’s name and marks in connection with ABS’s marketing

efforts under the SC-ABS agreement. Supra sec. V.A. Implicit

in its license of its name and marks, and allowing ABS to use

facsimile signatures of its officers, is petitioner’s

endorsement of whatever ABS is marketing. See Rev. Rul. 81-

178, 1981-2 C.B. at 136 (“payments for the use of a

professional athlete’s name, photograph, likeness, or facsimile

signature are ordinarily characterized as royalties.”).

Although a licensor may not expect the value of its name or

other intangibles to suffer on account of their license, we

assume that some portion of the royalty is in consideration of
 - 34 -

the licensee assuming that risk. The Commissioner’s position

in Rev. Rul. 81-178, id., with which we agree, Disabled Am.

Veterans v. Commissioner, 94 T.C. at 70 (1990), revd. on other

grounds, 942 F.2d 309 (6th Cir. 1991), is that payments for the

use of a name or signature, without any personal appearance or

interviews, are royalties within the meaning of section

512(b)(2). In part, petitioner received royalty income in

consideration of assuming the risk of damage to its intangible

assets. When that risk matured into a foreseeable loss,

petitioner spent its own money to avoid that loss. That is not

inconsistent with its receipt of royalty income.

8. Extension of Credit

Pursuant to the Concept-Chase Lincoln agreement, Chase

Lincoln was responsible for receiving and processing

applications for the affinity credit card at its sole expense.

Chase Lincoln retained a subcontractor to run the credit

scoring system. Chase Lincoln was responsible for issuing the

credit cards to all of the members that qualified, also at

Chase Lincoln's sole expense. Under the agreements, other than

Chase Lincoln's right to acquire responsibility for the duties

of ABS and Concept, the duties of the parties were discrete:

e.g., no party other than Chase Lincoln could accept an

application for credit (i.e., issue a credit card). Respondent

argues that petitioner attempted to persuade Chase Lincoln to

relax its credit tolerances so that additional credit cards

could be issued and higher profits realized. Respondent
 - 35 -

asserts that this was a service for which petitioner received

compensation under the credit card program. We believe that

that argument is more properly addressed to respondent's

conceded joint venture theory, and we fail to see how it

advances respondent's payment-for-services argument. We,

therefore, find that petitioner was not compensated for

services to the extent that it attempted to persuade Chase

Lincoln to relax its credit tolerances so that additional

credit cards could be issued and higher profits realized.

9. Conclusion

For the foregoing reasons, we conclude that none of the

receipts were in consideration for services provided by

petitioner as part of the credit card program. Rather, the

receipts were in consideration for the use of petitioner's

valuable intangible property, and, as such, constituted

"royalties" within the meaning of section 512(b)(2).

C. Subsequent Events

After the years here in question, ABS defaulted in its

obligations, petitioner terminated the SC-ABS agreement, and

entered into two agreements, the Termination Agreement and the

Bankcard Agreement (the two agreements), with Chase Lincoln.

The two agreements, among other things, establish a direct

relationship between petitioner and Chase Lincoln, provide for

the issuance of a new credit card not bearing petitioner’s

logo, and provide that petitioner would bear certain

advertising expenses. Whether amounts received in
 - 36 -

consideration of petitioner’s duties and obligations under the

two agreements would pass muster as “royalties” is not a

question now before us. We believe, however, that the

reordering of relationships under the two agreements

constitutes a sufficiently significant change that those

relationships are not determinative of results under the credit

card program.

VI. Conclusion

Amounts received by petitioner pursuant to the SC-ABS

agreement during the years in question (the receipts)

constituted “royalties”, within the meaning of section

512(b)(2) and were not compensation for services. Therefore,

we need not consider petitioner's alternative arguments that

the receipts do not constitute UBTI.

Decision will be entered

for petitioner.