*283 Decision will be entered for the petitioner.
Held, petitioner, during the fiscal years involved, was an organization exempt from income tax under section 101 (9), Internal Revenue Code.
*807 The respondent determined deficiencies in income tax of petitioner as follows:
| Fiscal year ended | Amount |
| Apr. 30, 1950 | $ 13,492.93 |
| Apr. 30, 1951 | 8,061.06 |
The question presented is whether or not petitioner qualifies during the years involved for exemption from income tax as a corporation "* * * organized and operated exclusively for pleasure, recreation, and other non-profitable purposes, no part of the net earnings of which inures to the benefit of any private shareholder * * *."
FINDINGS OF FACT.
Petitioner is the Aviation Country Club, Inc., a corporation organized on April 15, 1944, under the laws of the State of Colorado. The income tax returns here involved were filed with the collector of internal revenue for the district of Colorado.
Prior to February 1949, there were a number of clubs or groups in the vicinity of Denver, Colorado, *284 interested in aviation. Most of these clubs met regularly. None had a club house or meeting place of its own.
The Broadmoor Country Club (hereinafter called Broadmoor), a private taxable corporation incorporated in 1925, operated a ballroom, restaurant, and cocktail lounge at Edgewater, Colorado, on the outskirts of the city of Denver. The business enterprise was owned by Nellie Ott and her son, Eddie Ott (hereinafter sometimes respectively *808 referred to as Nellie and Eddie), with each owning an equal interest. The premises consisted of a large tract of land on which was located a building, constructed in 1925 by the Otts at a cost of $ 50,000 to $ 75,000, containing a main dining room and a dance floor, a south dining room, a kitchen, and a cocktail lounge known as the Hurricane Hut. The main dining room accommodated approximately 400 persons. There were also outdoor dining facilities known as the Garden Walk at which approximately 400 persons could be served and an outdoor dance floor. The corporation opened the night club for business on October 1, 1925, and thereafter operated it until about May 1, 1949, or shortly before. Of the original cost of construction, all*285 except $ 10,000 thereof, was borrowed. During the ensuing years, all except about $ 10,000 of such borrowing had been repaid out of the profits of the operation of Broadmoor. In addition such profits had furnished the principal livelihood of Eddie, George Ott (hereinafter called George), a brother of Eddie, and Nellie (hereinafter collectively referred to as the Otts). For several years prior to May 1, 1949, George had been actively managing Broadmoor and during the fiscal years immediately preceding such date, the profits derived and the losses sustained thereby were as follows:
| 1945 | ($ 376.00) |
| 1946 | 7,839.67 |
| 1947 | (1,016.71) |
| 1948 (10 months ended Apr. 30, 1949) | (5,525.46) |
No income was derived in the foregoing years from the operation of slot machines.
Eddie is widely known in Denver as being a good restaurant operator. He has been identified with a number of restaurant, ballroom, and cocktail lounge operations. He and members of his family have been engaged in the food business in the Denver area for approximately 40 years. In the latter part of 1948, Eddie took over the management of Mt. Vernon Country Club.
Among the members thereof was W. J. Bain, then Commissioner*286 for Aviation for the State of Colorado. Bain mentioned to Eddie that there were a number of groups interested in aviation and suggested that Broadmoor, the facilities of which were well suited for adaptation to the operation of a private membership club, might possibly be converted into an aviation club house. Eddie was receptive to the idea and both he and Bain discussed the matter further with George. Following these conversations a letter was sent out by George and Bain to the various aviation groups inviting their representatives to meet at Broadmoor to consider the possibility of the formation of an aviation country club and the leasing of the Broadmoor premises for this purpose.
*809 The substance of the conversation at the meeting was that the Otts would be willing to lease the Broadmoor Country Club premises to an aviation club if there could be recruited from the various aviation groups a sufficient number of members so that an aviation club could be operated as a private club on the Broadmoor premises. The persons attending the meeting as representatives of the various aviation clubs were to return to the clubs which they represented and ascertain the reaction of*287 the membership. Such reaction was favorable, and representatives of the various aviation clubs held from 6 to 8 additional meetings among themselves, which meetings were attended by from 12 to 20 such representatives. George and Eddie were called in at various stages of these meetings when it was desired to reach informal agreements. As a result of such meetings, petitioner's articles of incorporation and bylaws were drafted, and representatives of petitioner and the Otts began negotiations leading to the drafting of the lease and the management contract here in question.
Although Broadmoor had been incorporated in 1925 as a nonprofit corporation in order to obviate anticipated difficulty in obtaining a dance license, it was in fact at all times operated and filed its tax returns as a profit making organization. Its articles expired in 1945 and the period in which they might be renewed passed without the knowledge of the Otts or their legal advisers. It was necessary, therefore, that the corporation be liquidated and the lease with petitioner entered into by the individual owners of the property, Nellie and Eddie. Broadmoor, the corporation, was dissolved and liquidated. Its*288 assets were distributed one-half each to Nellie and Eddie, each of whom gave George a one-sixth undivided interest in the assets so distributed, with the result that Nellie, Eddie, and George each owned a one-third undivided interest therein. Each of the three then contributed his interest to a newly formed partnership bearing the same name. Simultaneously on April 28, 1949, a lease agreement covering the Broadmoor premises was entered into between the partnership as lessor and petitioner as lessee. A management contract was entered into between George, who had been managing Broadmoor since about 1938, and petitioner.
The fair market value on April 28, 1949, of Broadmoor's assets was reported by Nellie and Eddie for gift tax purposes as being $ 38,552 computed as follows:
| Tract 7, Grandview Acres, | |
| 5 acres more or less -- land value | $ 5,000 |
| Improvements -- Dance hall | 27,500 |
| Furniture & fixtures | 4,454 |
| Kitchen equipment -- china, dishes & silver | 1,598 |
| Total | $ 38,552 |
*810 The book values as of April 27, 1949, of the Broadmoor properties were reported on a partnership tax return filed thereby for the fiscal year ended April 27, 1950, as follows:
| Land | $ 5,000.00 |
| Depreciable assets | 34,834.29 |
*289 The actual appraised value of such properties including fixtures, equipment, land and buildings, etc., was $ 200,400 as of April 1949.
The lease entered into between petitioner and Broadmoor, the partnership, covered the land, improvements, furniture, fixtures, and equipment, excepting a second floor apartment, which was occupied during the years in question by Nellie and Eddie. The term of the lease was 10 years with option for renewal of another 10 years on the same conditions. Of the annual net profits, 40 per cent was payable as rent; 30 per cent was to be used for improvements and major repairs as directed by the lessor; and the remaining 30 per cent was to go to petitioner, with a guarantee that this 30 per cent would amount to $ 10,000, provided a membership of 1,500 were maintained during the year. The lease provided for minimum dues of $ 10 per year with a minimum of 1,500 members. If this membership were not reached within 6 months, the lease was cancelable by either party. A management contract whereby George would serve as manager was tied in with the lease. All revenues as defined in the lease received by the lessee were to be deposited in a designated bank and*290 expended by check signed by the manager, or in case of his illness or inability to attend to his duties, then by the president and treasurer of the lessee. During the fiscal years involved, George signed checks for petitioner.
The lease provided for payment of property taxes and maintenance expenses by the lessee. It contained the usual provisions regarding subletting and assignment. The lessee was required to maintain a nonprofit and a tax-exempt status. The lease provided that no activities contrary to law were to be carried on and that the facilities of the club were to be restricted to members and their guests. The lessee agreed to obtain liquor licenses. Failure to do so would render the lease null and void. Petitioner had no funds to start out with. The lessor agreed to advance up to $ 750 in organization expenses and the cost of obtaining licenses. Either party might terminate the lease on its anniversary without cause by giving 120 days' notice. The lessor could terminate the lease in the event of breach of the covenants thereof by the lessee at any time. The lease contained the usual provisions regarding vacation of the premises during the term, insurance, acceptance*291 of the premises, and waiver. With respect to the improvement fund the lease provided as follows:
Lessee agrees to improve the leased premises on the following terms: Thirty per cent of the annual net profits, * * * shall be segregated quarterly by lessee in a separate improvement fund which shall be expended by lessee exclusively *811 for such permanent improvements and major repairs * * * as directed by lessors only. Lessee shall have no authority save and except to segregate such funds in its name and pay out the same when so instructed by lessors. Any balance remaining in said fund not obligated or designated for definite improvements shall be divided equally between lessors and lessee on or before date of cancellation or termination of this lease. Lessee shall have the right to make advances from time to time to the improvement fund and shall receive credit for such advances on each subsequent installment of the improvement fund until such credit is exhausted. Lessors, however, will not be obligated to repay such advances in the event of expiration or termination of this lease. All improvements so made shall belong to and be the property of lessors upon cancellation*292 or termination of this lease.
The management contract recited that petitioner was a new corporation organized to promote and operate a clubhouse for its members; that George, manager and one of the lessors, had devoted his life to the operation of amusement enterprises and clubs and was personally interested in the success of the petitioner's venture. It provided for his employment as manager for the term of the lease or any renewal thereof at a salary of $ 6,000 per year. His prescribed duties consisted of the assumption of full, complete, and absolute responsibility for the management and operation of the premises, including catering and food and drink services, maintenance and repairs, management and employment of all personnel, and supervision and control of all activities conducted on the premises. The decisions of the manager in carrying out his duties were final and binding upon petitioner provided that such decisions were not in violation of petitioner's articles of incorporation or bylaws as they then existed. The manager agreed to carry out his prescribed duties and to devote his entire time and attention to the management of the petitioner's clubhouse, to employ a bookkeeper*293 to keep the books and accounting records which should be open to inspection by the lessee, and to use his best efforts to maintain the club on a level comparable with other similar clubs. The manager agreed to see to it that only members and their guests were admitted to the club and that no illegal activities were carried on on the premises. It was agreed that all funds received from operation of the club, including dues paid by members, be regularly deposited in a Denver bank, and that all disbursements therefrom be made by checks issued and signed by the manager "* * * or in the event of his illness or inability to attend to his duties, then and in which event only, by the President and Treasurer of the Company * * *." The manager assumed the risk of credit losses with respect to credit authorized by him as distinguished from the directors or officers. In the case of the death of George the surviving lessors were entitled to designate his successor. It was agreed that the management contract constituted a part of the consideration for the leasing of Broadmoor; that it was made simultaneously *812 with the lease and could not be extinguished without also extinguishing the*294 lease agreement.
Petitioner's articles of incorporation recited that the incorporators were desirous of associating themselves for civic, educational, scientific, and social purposes, and not for pecuniary profit. The objects of the corporation were stated to be to promote a club and clubhouse facility for the exclusive pleasure, recreation, and social benefit of the members of the club and for such other nonprofit purposes as might best promote the interests of the members, and to maintain a clubhouse or similar facility to be operated for the exclusive use of the members of the club and their guests. The articles prohibit operation for the pecuniary benefit of any member or the use of the club for any lobbying or legislative purposes. The articles place the affairs of the corporation under the control and direction of a board of directors consisting of 12 persons and give them extensive powers. The board is empowered to determine the qualifications for membership, to sell, lease, convey, encumber, or dispose of any property of the corporation, and to make, alter, amend, or repeal bylaws.
Petitioner's bylaws provide for annual membership meetings and for special meetings on call*295 of the board of directors. Proxy voting is prohibited. Directors were to be elected by the members and for staggered terms. Provision is made for regular monthly directors' meetings and for special meetings. The board of directors is given broad control and supervision over all expenditures, the approval or disapproval of candidates for membership, and is given the power to act as a court before which all questions affecting the interest of the club may be brought. It is empowered to exact penalties against members, including expulsion or suspension for the violation of the bylaws or rules, the power to hire or discharge employees, fix salaries and delegate this authority to a club manager upon such terms as the board may see fit. The bylaws also provide for the usual offices with the usual powers. All persons over the age of 21 years, who are directly connected with the aviation industry, or who have demonstrated an interest in aviation generally, are eligible for membership. The bylaws, as originally written, provide for dues of $ 10 per year. Election to membership requires an affirmative vote of the board of directors. Each candidate for membership must be proposed by*296 one member, and the proposal submitted to a membership committee appointed by the president. After approval by the committee, the name of the candidate is to be posted on the bulletin board of the club for at least 10 days. As a matter of practice, to become a member during the taxable years, required that an applicant be endorsed by two members, pay his $ 10 annual dues, and be passed upon by the membership committee. Not all members of petitioner were interested in aviation.
*813 Representatives of petitioner felt that the foregoing management contract and lease were advantageous to petitioner. Percentage leases and those under which the lessee assumes the cost of property taxes and maintenance are not unusual in the Denver area.
The Otts were interested in making a profit in the operation of Broadmoor. Eddie, while manager of the Mt. Vernon Club where slot machines were in operation, conceived the idea of reorganizing Broadmoor into a private club operation so that it would be enabled to install slot machines. There were virtually no private clubs in the Denver area where slot machines were not operated during 1949 and part of 1950. Although illegal, such operation *297 was with full knowledge and acquiescence of the law enforcement officials. Slot machines were removed from private clubs in early 1951 as a result of legislation and national publicity emanating from the congressional crime investigations. When slot machines went out 5 or 6 clubs which depended upon slot machine revenue went out of business. Petitioner continued to show a profit in 1951 and subsequent years. All clubs felt the pinch of the loss of slot machine revenue and endeavored, like petitioner, to control operations more closely. Slot machines often provided a club its margin of profit.
The Otts were considering a private club operation but thought it would be better to get some bona fide group like the aeronautical group and let them come into the picture instead of going out and getting members themselves. The primary purpose in leasing the property to the petitioner was to make money for the Otts. The installation of slot machines was one of the factors which induced them to lease.
There was no discussion at the original meeting between George, Eddie, and the representatives of the aviation clubs with respect to whether or not slot machines should or would be operated*298 at the Aviation Country Club nor were there any discussions during subsequent preliminary meetings. The aviation groups were not especially interested in slot machines. Two or three weeks before petitioner opened, slot machines were discussed for the first time as to whether their operation would be permitted. In the negotiations during the last few weeks before the incorporation of petitioner, slot machines were discussed along with all the other sources of possible revenue including meals, liquor, and dues, in connection with attempting to fix percentages under the lease. Thereafter Eddie made arrangements with certain persons to place the latters' slot machines in the club. There were from 4 to 8 slot machines placed in operation, ranging in denominations from nickels to dimes, quarters, one-half dollars, and dollar machines. Their owners and George made the collections from the machines. Of the revenue taken from the slot machines during the taxable years, 75 per cent was retained by petitioner.
*814 Among the activities which were carried on at the club during the years in question were family night buffet parties, dinner dance parties, Sunday morning breakfasts, *299 fashion shows, book reviews, and bridge parties. Petitioner sponsored an issue of a magazine called Rocky Mountain Aviation. It contributed to the Boy Scouts, the Girl Scouts, the Young America League, the polio fund, and many others. It also donated money to the Civil Air Patrol for the living expenses of two Civil Air Patrol cadets as exchange students to Europe under the Marshall Plan.
During the years involved, petitioner's directors met at least once a month and often more frequently. The average attendance was between 85 and 90 per cent and the average length of each directors' meeting was between 3 1/2 to 4 hours. Petitioner's president was at its premises on club business at least weekly, and daily conducted correspondence, telephone calls, and negotiations with contractors and business people. For this he received an allowance of $ 150 per month, which would about compensate him for his actual out-of-pocket expenses.
Eddie has never been a member or a director of petitioner. He has attended one directors' meeting on invitation and has taken no part whatever in the day-to-day operations of petitioner. George is not and never has been a member or director of petitioner; *300 he attends meetings on invitation only. The Otts played no part whatever in the selection of members or the passing upon the candidacy of members. The number of members has been limited at all times, although the Otts were not in favor of the limitations as imposed by the board of directors, and the view of the board of directors has always prevailed. Recommendations of the Otts were always carefully and cautiously examined by the directors.
Petitioner's books are kept by a bookkeeper employed by petitioner through George. These books are audited quarterly by a certified public accountant chosen and employed by the board of directors without consultation with the Otts. The Otts have their own accountant, who has no connection with the accountant employed by the petitioner through the board of directors. Separate records are kept for the Aviation Country Club and Broadmoor. The board of directors employed a certified public accountant in order to obtain more current information on the operations of the petitioner. It wished to secure at least monthly instead of quarterly operating statements.
Although petitioner's lease places the control of the improvement fund in the hands*301 of lessor, most of the improvements made have in fact represented the directors' ideas rather than the Otts' ideas. The pitch and putt golf course, the bowling green, the putting green, and the children's playground reflected the directors' ideas.
*815 A cocktail lounge was in the process of construction when the lease was entered into and was completed about 2 weeks after the lease was signed. Thereafter petitioner added a rug for the main dining room, drapes and chairs, kitchen equipment, enlarged the kitchen, installed a pitch and putt golf course, a bowling green, a putting green, and a children's playground. Most of these expenditures were made during the taxable years in question. During the taxable year ended April 30, 1950, there was expended on improvements $ 42,029.71. This amount exceeded 30 per cent of the net income by $ 26,803.35. During the year ended April 30, 1951, there was expended $ 7,191.93 on improvements whereas 30 per cent of the profits amounted to $ 15,406.55. There were thus at the end of the taxable year ended April 30, 1951, cumulative overexpenditures of $ 18,588.73. These overexpenditures were credited in later years. During the taxable*302 year ended April 30, 1950, $ 13,830 was spent on the Terrace Lounge, $ 981 on rest rooms, $ 13,628 on new kitchen equipment, $ 94 on a side entrance, $ 2,302 for additional land on which the golf course was constructed, $ 225 on water taps for the proposed swimming pool, $ 7,373 for the golf course, $ 584 for a new office, and $ 3,007 on the dining room and additions to the Hurricane Hut, a cocktail lounge. During the taxable year ended April 30, 1951, $ 5,191 was spent on the golf course and $ 2,000 on a new storage room in the rear of the kitchen.
Guests of members may use the facilities of the club only when accompanied by a member. An attendant at the door checks membership cards and no food or drink is served without the member's number appearing on the check. A large sign appears at the entrance to the club reading, "Private, Members Only." Petitioner's articles, bylaws, and the terms of the lease and management agreement all stipulate that only members and their guests may be permitted to use the facilities of the club. A member may charge an expenditure for food or drink for his guests and himself or may pay cash. A member may bring nonmembers to a party or to a luncheon. *303 Food and liquor bills may be paid in cash by nonmember guests and such guests may also spend their money at the club by playing slot machines. Between 75 and 80 per cent of revenue was estimated to represent member patronage with the remainder guest patronage.
The gross receipts, gross income, membership fees, slot machine revenue, and net income received by petitioner during the taxable years involved here, are in round figures, as follows:
| Fiscal year ended Apr. 30 | ||
| 1950 | 1951 | |
| Gross receipts | $ 304,000 | $ 336,000 |
| Gross incomes | 258,000 | 261,000 |
| Membership fees | 35,000 | 43,000 |
| Slot machine revenue | 68,000 | 43,000 |
| Net income | 40,000 | 29,000 |
*816 The rent paid, the sums allocated to the improvement fund, insurance, repairs and maintenance, and property taxes paid by petitioner during the years involved, follow:
| Fiscal year ended Apr. 30 | ||
| 1950 | 1951 | |
| Rent | $ 20,301.81 | $ 20,542.06 |
| Allocation to improvement fund | 15,226.36 | 15,406.55 |
| Insurance | 3,278.12 | 1,921.14 |
| Repairs and maintenance | 7,305.56 | 5,091.67 |
| Property taxes | 991.68 | 1,346.33 |
Respondent disallowed petitioner's claim for exemption from income taxation for the fiscal years ended April 30, *304 1950, and April 30, 1951.
The petitioner, during the fiscal years here in question, was a club organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes, no part of the net earnings of which inured to the benefit of any private shareholder.
OPINION.
The sole question presented is whether petitioner qualified during the taxable years involved as a corporation exempt from income tax pursuant to section 101 (9), Internal Revenue Code. 1
In order so to qualify petitioner must have been, during the period, a club "* * * organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes, no part of the net earnings of which * * * [inured] * * * to the benefit of any private shareholder * * * ." Whether petitioner can be said*305 to come within such qualification is purely a question of fact, those pertinent to which have been set forth above in extenso. Further elaboration thereon is unnecessary. We have considered such facts and carefully assayed all the evidence of record on which they are grounded. We have concluded and found as a fact that petitioner was such an organization during the years before us. Accordingly, we here so hold. Cf. Aviation Club of Utah, 7 T.C. 377">7 T.C. 377, affd. 162 F.2d 984">162 F.2d 984, in which, during the war, the club was opened to nonmember Army officers and practically taken over by them. The club was diverted from its previous exempt status, resulting in large indirect profits to the members of the club in the shape of enlarged facilities, and otherwise. The net income for 1943 was 25 times the normal net income for the year 1941. The holding of the Court was that the club was exempt from taxation in 1941 but taxable in 1942 and 1943. In the instant case, there is a notable parallelism between the situation obtaining in the Utah case *817 in 1941 and the taxable years here involved for petitioner. Respondent's determination*306 to the contrary is error and it is reversed.
Decision will be entered for the petitioner.
Footnotes
1. SEC. 101. EXEMPTIONS FROM TAX ON CORPORATIONS.
(9) Clubs organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes, no part of the net earnings of which inures to the benefit of any private shareholder;↩