In Affiliated Govt. Employees Distrib. Co. v. Commissioner, 37 T.C. 909 (1962), affd. 322 F.2d 872 (9th Cir. 1963), we addressed whether membership fees paid to the taxpayer, a nonstock membership corporation operating department stores for the exclusive use of its members and their guests, were contributions to capital. We held that the fees were payments for the privilege of shopping at the taxpayer's stores and were not contributions to capital because the members were not entitled to share in the profits of the enterprise and had no assurance of a share in the dissolution proceeds because the memberships were nonassignable and terminated at death. Id. at 918. In Oakland Hills Country Club v. Commissioner, 74 T.C. 35 (1980), we denied a country club's motion for summary judgment, holding that a "proprietary interest" is not sufficient to turn a membership fee into a capital contribution. However, the members could not resell their memberships or profit from appreciation in the value of the membership. We found the only benefit to the members was their right to use the club's facilities. In American Medical Association v. United States, 887 F.2d 760 (7th Cir. 1989), the Court of Appeals for the Seventh Circuit, to which an appeal in this case would lie, provided useful guidance in dealing with the member capital contribution issue. In holding that member dues placed in the AMA's "association equity" reserve account were current membership receipts that could be allocated to circulation income in the year received, the court rejected the taxpayer's alternative argument that membership fees so placed "should be likened to capital contributions." Id. at 773. The Court of Appeals explained: The problem with this argument is that the AMA members received nothing in return for their "investment" in the AMA other than the right to receive the benefits of membership in the single annual period for which dues were assessed. In exchange for a capital contribution the contributor receives a future or residual claim, for example, for return of capital as dividends or as the proceeds of liquidation. A capital contribution is in the nature of an investment whereby the investor purchases a continuing interest in an enterprise.14 In this case there is no evidence that AMA members received anything more for their annual membership fee than an annual membership; they received no claim of future benefit. 14 See, e.g., Commissioner v. Fink, 483 U.S. 89, 97*** (1987) (contributors must intend "to protect or increase the value of their investment in the corporation"); In the Matter of Larson, 862 F.2d 112, 117 (7th Cir. 1988) (capital contribution characterized by fact that investor expects to recoup her investment, hopefully with a profit, in the event the corporation is successful). [Id. at 773-774.] Explaining and applying Washington Athletic Club v. United States, supra, the Court of Appeals noted: Since members received no benefit through payment of the surcharge other than the rights attendant to an annual membership in the club, the members lacked an "investment motive" in making the payments, and therefore treatment of the monies received as a capital contribution was inappropriate. Id. The reasoning of Washington Athletic Club is persuasive, and directly applicable here. The AMA's members received no continuing benefit from their payments into the association equity account; the sum paid as an annual membership fee entitled the member only to the benefits of membership in the year of payment. Therefore the funds placed in the association equity account were current "income" of the AMA ***. [American Medical Association v. United States, supra at 774; fn. ref. omitted.] In reconciling the cases relied upon by petitioner and respondent, we discern three objective factors whose presence tends to support the existence of an investment motive: (1) The fee in question is earmarked for application to a capital acquisition or expenditure; (2) the payors are the equity owners of the corporation and there is an increase in the equity capital of the organization by virtue of the payment; and (3) the members have an opportunity to profit from their investment in the corporation. The first factor is whether the payment is specifically earmarked or applied to a capital acquisition or expenditure. Webster's Ninth New Collegiate Dictionary defines earmarking as "to designate or set aside (funds) for a specific use or owner". The repealed excise tax on club dues 15 and the regulations thereunder provide an appropriate framework for giving content to the concept of earmarking as it should be applied in this case.16 Section 4241 imposed an excise tax on club dues, 15 Secs. 4241 and 4243, and the regulations thereunder, were repealed by sec. 301 of the Excise Tax Reduction Act of 1965, Pub. L. 89-44, 79 Stat. 145. 16 The Commissioner has recognized that Federal income tax principles can be relevant to the and section 4243 provided an exemption from the excise tax for members' payments for the construction or reconstruction of capital improvements.17 The structure for imposing the club dues excise tax and allowing the capital expenditure exemption parallels the approach under section 118 for differentiating payments for services from capital contributions; amounts that corporate shareholders or association members pay for the use of corporation or association facilities and services are ordinary income to the recipient, whereas their payments in aid of capital improvements are capital contributions. The interpretive regulations under section 4243 stated that the exemption applied to amounts paid for the retirement of indebtedness (a mortgage loan, for example) incurred by reason of the construction or reconstruction of any capital addition, improvement, or facility.18 Sec. 49.4243-2(b)(iii), Excise Tax Regs. However, the regulations did not allow the exemption unless the funds were earmarked for capital purposes. Id. In Atlanta Athletic Club v. United States, 277 F. Supp. 669 (N.D. Ga. 1967), the court held that the board's resolution to divert 40 percent of future assessments to qualified purposes allowed the payments so used to qualify for the exemption. The court based its holding on the facts that the assessments were based upon known existing needs, although no specific project was stated, and the funds, although commingled with operating funds, were held for future construction require ments. In Gibbons v. United States, 277 F. Supp. 749 (S.D. Ill. 1967), the court held that there was insufficient earmarking for the exception to apply where the members were not told that a specific portion of fees would be set aside for capital improvements, and all income and receipts were commingled. The court stated that "the amount or proportion to be used consideration of Federal excise tax issues. G.C.M. 37989 (June 22, 1979); G.C.M. 36046 (Oct. 9, 1974); G.C.M. 35442 (Aug. 16, 1973). 17 Congress enacted sec. 4243 to provide club dues excise tax relief from the burdensome and heavy initial cost of construction or reconstruction of a club facility, whereas "charges which go to the upkeep and operation of social, athletic, or sporting clubs [were to] continue to be taxable." Conf. Rept. 2596, 85th Cong., 2d Sess. 4437-4438 (1958). 18 For payments made before Nov. 1, 1959, the regulation stated that "Assessments paid for the retirement of indebtedness (a mortgage loan, for example) incurred by reason of the construction or reconstruction of any such facility *** are considered to be assessments for construction or reconstruction." Sec. 49.4243-2(a), Excise Tax Regs. for capital improvements must be stated at the time of 'assessment' and earmarked for that purpose at the time of receipt." con In Maryland Country Club, Inc. v. United States, 75–2 USTC par. 16,190 (D. Md. 1975), revd. 539 F.2d 345 (4th Cir. 1976), the court, after examining the above-cited cases, 19 cluded that there were three basic conditions of earmarking: First, there must be a definite commitment to engage in some capital construction; second, at the time of the initial payment, both the club and the member must be operating under the assumption that the funds so collected will be used for capital purposes; and, three, the funds must be accounted for at the time of payment and held for that purpose and for no other purpose. Using this test, the court held that the earmarking requirement had not been met because the club used the amounts in the capital accounts for operating expenses. The court held that this use related back to and invalidated the initial purported earmarking. In light of this history, we conclude that petitioner's procedures for the collection, accounting, and use of the transfer fees provide sufficient assurance that the transfer fees are dedicated to the required purpose of reducing petitioner's mortgage debt, in accordance with the requirements of rule 243. As in Maryland Country Club v. United States, supra, petitioner's rule 243 illustrates petitioner's definite commitment to engage in a capital use with the funds; i.e., the retirement and redemption of the CBOT building indebtedness, which was incurred to finance capital construction projects. Both petitioner and its members are aware that the transfer fees are collected for a designated purpose. Prospec 19 In addition to the above-cited cases, the court also examined Cactus Heights Country Club v. United States, 280 F. Supp. 534 (D.S.D. 1967) (holding that a resolution, prior to collection of the funds, to apply 80 percent of the funds collected to capital improvements was sufficient to bring that 80 percent within the exception), and Pinehurst Country Club v. United States, 248 F. Supp. 690, 692–693 (D. Colo. 1965). The court said that Pinehurst was probably at the clearly qualified end of the scale of acceptable earmarking, stating that "Although earmarking was not in question in that case, the earmarking which did occur and which was plainly acceptable serves as a useful example in other cases." Maryland Country Club, Inc. v. United States, 75-2 USTC par. 16,190, at 88,952 (D. Md. 1975), revd. 539 F.2d 345 (4th Cir. 1976). In Pinehurst the new members, in addition to paying dues, had an option of paying an assessment for capital improvements and construction in cash or in installments. The amounts paid as capital contributions were accounted for separately and deposited in a separate escrow bank account, and thereafter were transferred directly from the escrow account to a construction account at which time members who had paid construction assessments were credited with the amounts not used. tive members are given a copy of, and tested on, petitioner's rules, including rule 243. Finally, the fees are accounted for separately from operating revenues. They are accounted for by book entries as "restricted capital". The funds are held in these accounts until petitioner makes a mortgage principal payment in an amount greater than the amounts in the book entries. Only then are the amounts in the book entries reclassified as "unrestricted capital". The bylaw restriction in rule 243 and the accounting ledger accounts sufficiently restrict the amounts of the transfer fees collected until an equal amount is paid toward the mortgage principal.20 We thus conclude that petitioner's rule 243 and its accounting procedures sufficiently earmark the transfer fees for use in reducing its mortgage debt, a designated capital expenditure. The second factor is whether the equity interest of the members increased because of the contribution to the membership organization. There is no dispute that petitioner's members are the equity owners of petitioner. They have voting rights and liquidation rights according to the interest held, and their interests are freely transferable to qualified purchasers or transferees. Because petitioner's largest liability is the mortgage on the CBOT building, any decrease in that liability directly increases petitioner's members' equity. The transfer fees accounted for over $300,000 of the mortgage principal payments made in each of the taxable years. The members' equity accounts increased each year by an amount no less than the transfer fees collected. Respondent argues that the members cannot have an investment motive because they enjoy no right to any return of the amount of transfer fees paid in connection with that membership. We are not persuaded. There is no requirement that the payments directly increase the individual payor's equity interest on a dollar-for-dollar basis. Nor is there any requirement that a member must have a right to recover from petitioner the amount of the transfer fee paid.21 20 The Commissioner in Maryland Country Club v. United States, supra, argued that earmarking, under sec. 4243, required that the taxpayer record the funds in a separate bookkeeping account, which was to be matched by available qualified funds in a bank account, and/or to designate funds as capital contributions by some formal mechanism such as a bylaw. In the case at hand, petitioner records the transfer fees in separate bookkeeping accounts, which are always matched by available qualified funds in its general bank account, and the transfer fees are designated as capital contributions by petitioner's rule 243. 21 Respondent seems to be arguing that, in order for the transfer fees to be capital contribuContinued |