Opinion
Docket No. 4297.
Promulgated September 30, 1947.
The petitioner, a foundation organized under the founder's will for the purpose of aiding and promoting the science of ceramic engineering, held, exempt from income tax under section 101 (6) of the Internal Revenue Code, notwithstanding that it acquired, under the will, and operated a going business consisting of the manufacture and sale of pyrometric cones, and, out of its income, paid a life annuity to the founder's widow.
Joseph P. Eagleson, Esq., John H. Eagleson, Esq., and Clarence D. Laylin, Esq., for the petitioners.
Cecil H. Haas, Esq., for the respondent.
This proceeding involves a deficiency of $648.38 in income tax for 1940. The only question in issue is whether the petitioner is exempt from tax as a foundation organized for scientific or educational purposes.
FINDINGS OF FACT.
The return for the period here involved was filed with the collector of internal revenue for the eleventh district of Ohio, at Columbus.
The parties have filed a written stipulation of facts, which we adopt by reference as our findings of fact herein. For the purpose of our consideration of the question presented the facts are summarized as follows:
The petitioner, Edward Orton, Jr. Ceramic Foundation, hereinafter referred to as the foundation, was established under the will of Edward Orton, Jr., deceased, which was admitted to probate February 28, 1932. The purposes of the foundation were described in the will as follows:
The first and principal purpose is to provide a stable and dependable organization for continuing the manufacture and sale of Standard Pyrometric Cones of the highest quality and most exact accuracy that is commercially feasible, at a reasonable price. The second and subsidiary purpose of this trust is to provide a Research Organization for the prosecution of studies and researches for overcoming technical and manufacturing difficulties, and for thus advancing the ceramic arts and industries in the United States.
The will further provided in subitem 3 as follows:
Historical statement concerning the manufacture of The Standard Pyrometric Cones. Prior to 1896, there was no convenient or generally accepted mode of regulating the firing process or heat treatment of Claywares in the Ceramic Industries of the United States, and virtually no mode of comparing kiln-firing practice, as between different factories, and different industries. I entered the manufacture and sale of pyrometric cones, with the purpose of performing a definite and needed service to the Ceramic Industries; (1) by enabling them to better control the firing of their products, which is the weakest point of the manufacturing process; (2) by facilitating the freer exchange of exact information concerning the firing process between ceramic manufacturers, and (3) thus inducing a better and more cooperative relationship among them, and thus making greater scientific and industrial progress probable. In this enterprise, while manufacturing profit is essential to permit its continuance, it has, from the first, been my purpose to make financial profit incidental to the principal idea of furnishing to ceramic manufacturers, a mode of controlling or regulating the firing process of their wares with the highest attainable degree of dependability at the lowest reasonable cost. Having been successful in obtaining the confidence of manufacturers of ceramic products in Standard Pyrometric Cones, it is my desire to assure myself that the manufacturing establishment which I have built up shall continue to fulfill this same useful purpose, upon the same high plane, and with the same ideals of public service, after my death.
The testator divided his estate into two parcels, designated as "Parcel No. 1" and "Parcel No. 2." Parcel No. 1 comprised a going business consisting of the manufacture of pyrometric cones. Parcel No. 2 contained all of the remaining assets of the estate.
Pyrometric cones are used in the manufacture of ceramics for testing the firing process and maturing of various clay products. They are described as small, slender trihedral pyramids made of a mixture of minerals very similar to the minerals of which the ceramic bodies are composed. The cone bodies and the ceramic bodies are sufficiently alike that they react approximately the same, thermochemically.
Edward Orton, Jr., hereinafter referred to as the testator, was an outstanding authority on ceramics. His particular interest lay in scientific research and education in the field of ceramics and ceramic engineering. He received a degree as an engineer of mines from Ohio State University and later became a member of the faculty. He procured the establishment, by legislative enactment, and became the head of the Department of Ceramics at Ohio State University. He first began the manufacture of pyrometric cones in the university laboratory, with the permission of the trustees.
The only pyrometric cones available in this country at the time the testator began their manufacture were imported from Germany. The testator succeeded in developing a complete series of superior cones which, through his efforts, were standardized by the United States Bureau of Standards. The testator later established a laboratory on a privately owned site near the university campus and conducted the business of manufacturing the cones as a private enterprise. Just prior to his death the testator acquired a new site and erected a new laboratory, known as the Orton Memorial Laboratory, in which the business of manufacturing cones is now being conducted. This business, together with all of the real and personal property, including equipment and supplies used in connection therewith, comprised that portion of the testator's estate described as Parcel No. 1 which he bequeathed to the foundation.
Under the testator's will the foundation was to be administered by a board of seven trustees composed of the president of Ohio State University, a representative of the United States Bureau of Standards, Washington, D.C., the head of the Engineering Experiment Station of Ohio State University, the head of the Department of Ceramic Engineering of Ohio State University, the secretary and one other representative of the American Ceramic Society, and an attorney to be selected by the probate court of Franklin County, Ohio. The trustees were to take title to the property and operate the business. They were to receive a nominal compensation of $1 per year, plus their actual expenses, which were to be paid out of the trust funds. They were authorized to select a superintendent or a general manager and a research director and to fix their compensation. They were also authorized to:
* * * Alter the scope of the business, and to embark in allied or cognate lines of manufacture when and insofar as said Board shall find such steps necessary or advisable owing to changes of industrial conditions or scientific discoveries which would make the present product obsolete or unable to compete with other methods of control of kiln firing, or which would destroy the first or principal purpose for which this trust is created.
Upon application of not less than five of the trustees, and with the approval of the probate court, they could close up the cone-manufacturing business and dispose of the assets. In that event the assets were all to go to Ohio State University.
All of the testator's debts and obligations, except the current operating debts of the cone business, were to be paid out of parcel No. 2, and the residue thereof (parcel No. 2) was to go to the testator's wife outright.
* * * with the request that she formally accept the same in lieu of and as full satisfaction of all dower rights and right to distributive share which she would have under the law, in order that the other provisions made herein may be carried out and particularly in order that the part of my property constituting Parcel One, as defined in this instrument, may pass into the Trust created to administer it, with absolute and undoubted title, and without disarrangement of the assets thereof.
The will further provided in item III as follows:
In view of the fact that in the creation of said trust I have severely depleted my estate, and taken out from it its chief income producing element, and in view of the fact that the residue of my estate comprised in Parcel No. 2 at present consists chiefly of, and at the time of my death may probably consist, of real estate and other assets of low income producing value in its present form, it is my will that for the period of five years subsequent to my death, my executors, for such time as they control the property, and subsequently the Board of Trustees controlling Parcel No. 1, shall pay to my wife, Mina Althea Orton, and in the event of her death to our issue, if any, the following sums from the current earnings of said Cone business, the same being in lieu of the one year's support to which she is entitled under the law, and a reasonable provision for her support and maintenance during this period, which I believe to be reasonably necessary to enable her to place the property comprising Parcel No. 2, upon a proper income basis, namely:
First year, twelve thousand dollars.
Second year, ten thousand dollars.
Third year, eight thousand dollars.
Fourth and fifth years respectively six thousand dollars.
The total being forty-two thousand dollars.
The same to be paid in monthly installments.
The above provision takes the place, in part, of the salary and profits which I would withdraw from said Cone business, during said period, if I were living.
The testator was survived by his widow, who was his sole heir. She elected to take under the will, although under the statutes of descent and distribution of the State of Ohio she was entitled to take a one-half undivided interest in all of the testator's property. As a condition of her election to take under the will, she and the trustees of the foundation entered into a contract, which was approved by the probate court, whereby the trustees agreed to pay out of the income to be derived from the cone-manufacturing business certain claims against the estate which under the will were payable out of the assets of the residuary estate contained in parcel No. 2. The trustee also agreed to pay the widow a life annuity of $350 per month, to commence upon completion of the payments to her aggregating $42,000 as provided for in the will. These payments to the widow were made a charge against all of the assets of the foundation. The reason for this arrangement was that the assets comprising parcel No. 2 did not have sufficient ready realizable value and were not productive of sufficient income to meet the charges against the estate. The agreement considerably enlarged the obligations of the foundation over those provided for in the will. To meet these obligations the foundation borrowed $28,000 on a mortgage note, secured by the assets of the foundation and Mrs. Orton borrowed an additional $17,000 on her own note, which she lent to the foundation.
The executors transferred all of the assets of the cone business to the trustees of the foundation on or about December 6, 1933, and the business has been operated by them continuously since that time.
In addition to the cones described above, the foundation manufactured and sold the standard mixtures in powdered form to customers who made up their own testing devices. Most of the foundation's sales were to manufacturers of ceramic products. Some sales were made to scientific and research laboratories and ceramic art studios throughout the country.
The profits or losses of the foundation for each of the years 1934 to 1943, inclusive, from the cone business and from miscellaneous sources, and the total net profits, after the deduction of certain miscellaneous expenses not reflected in the miscellaneous income, were as follows:
Year Profit or (loss) Miscellaneous from cone income Net profit manufacturing or (loss) business 1934 ...................... $12,130.38 $103.32 $12,233.70 1935 ...................... 18,429.68 487.47 18,917.15 1936 ...................... 15,334.63 373.20 14,257.83 1937 ...................... 23,353.51 442.15 23,195.66 1938 ...................... 9,358.60 349.24 9,107.84 1939 ...................... 14,110.49 1,045.38 14,555.87 1940 ...................... 13,187.45 167.00 12,034.45 1941 ...................... 20,169.75 462.11 20,081.86 1942 ...................... 13,239.57 281.40 13,520.97 1943 ...................... (2,363.90) 931.16 (2,340.74) During the years 1934 to 1943, inclusive, the foundation made the following disbursements of income:Claims against testator's estate ................. $21,679.65 Assumed capital indebtedness ..................... 15,724.58 To Mrs. Orton under testator's will .............. 42,000.00 Research fellowships and endowment ............... 37,027.51 Additions to plant equipment ..................... 16,954.27 Interest and other charges on assumed claims and debts .................... 2,178.58 ---------- Total ..................................... 135,564.59
The above expenditures accounted for all of the net profits shown by the trustees' books and accounts for those years, computed as follows:
Gross receipts from sale of cones ............. $637,596.06 Miscellaneous income (fees, etc.) ............. 4,642.43 Manufacturing expenses ........................ 302,447.24 Selling and general expenses .................. 198,168.66 Miscellaneous deductions and losses ........... 6,028.00 ----------- Net profits ............................... 135,594.59
This figure is $30 in excess of the stipulated net profits as shown above.
The above item of "general expenses" includes $14,700 paid to Mrs. Orton under the contract between her and the trustees (as distinguished from the payments made to her under the will) and interest on assumed indebtednesses in the amount of $6,624.34. The payments to be made to Mrs. Orton under the will, aggregating $42,000, were completed at July 15, 1940, and the foundation then began paying her the annuity of $350 per month provided in the contract between her and the trustees. Those payments have continued up to the present time.
At December 31, 1934, the trustees set up the estimated amount of the annuity payments, amounting to $47,766.20, in the balance sheets as a liability and carried it in that manner until the close of 1939, when it was transferred to "Net Worth Account (Adjusted)." Since January 1, 1940, the monthly annuity payments to Mrs. Orton have been charged to expenses and to the profit and loss statements under the item "Endowment Interest."
At the present time the petitioner has at least two competitors, the H. D. Henderson Co., located at East Liverpool, Ohio, and the Accurate Pyrometric Cone Co., located at Pataskala, Ohio.
The foundation maintains a research staff at an annual expense of approximately $16,800. It continues tests and gives advice relating to the burning and curing of ceramic products without charge at the request of any person or corporation engaged in the business. Some fees, inconsequential in amount, are charged for such services conducted for other persons.
The foundation maintains fellowships in several of the leading technical schools of the United States. There were five of such fellowships in 1940, maintained at an expense of approximately $735 each.
Ceramic engineering is recognized as an applied science for instructional purposes in fifteen institutions of higher education in the United States and Canada, including Ohio State University, New York State College of Ceramics, Rutgers University, University of Illinois, Iowa State College, Georgia Institute of Technology, University of Washington, North Carolina State College, Missouri School of Mines, Pennsylvania State College, Massachusetts Institute of Technology, Graduate School, University of West Virginia, University of Alabama, University of Toronto, and University of Saskatchewan. Most of these schools and colleges grant degrees, such as Bachelor of Engineering in Ceramics, or Ceramic Engineer, for successful completion of undergraduate or graduate courses.
The ceramic art is recognized as one of the fine arts, for instructional purposes, in several institutions of higher education in the United States, including Ohio State University and New York State College of Ceramics.
Research in ceramic engineering, or ceramic art, or both, is fostered and carried on in or under the supervision of several institutions of higher education in the United States, including Ohio State University, New York State College of Ceramics, Rutgers University, University of Illinois, Iowa State College, Georgia Institute of Technology, University of Washington, North Carolina State College, Missouri School of Mines, and Pennsylvania State College.
The trustees filed a fiduciary return for 1940 showing undistributed net income of $8,527.27, after payments aggregating $4,850 to Mrs. Orton and $3,677.27 for five fellowships. The return showed a total tax due of $337.84, which was paid. Thereafter the foundation claimed exemption from tax under the provisions of section 101 (6) of the Internal Revenue Code.
In his deficiency notice the Commissioner denied the foundation's claim to tax exemption and disallowed as an expense deduction the payments of $4,850 made to Mrs. Orton. These, with other minor adjustments, resulted in the tax deficiency herein asserted of $648.38.
The foundation in the taxable year 1940 was a foundation organized and operated exclusively for scientific or educational purposes within the meaning of section 101 (6) of the Internal Revenue Code.
OPINION.
The petitioner's contention here is that it is exempt from tax under the provisions of section 101 (6) of the Internal Revenue Code. That section provides exemption from income tax for:
Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, and no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation.
That the petitioner was a "foundation" as that term is used in the statute is not questioned. The respondent argues, however, that petitioner was neither organized nor operated exclusively for the purposes enumerated in the statute and that a large portion of its profits inured to the benefit of an individual, Mrs. Orton.
The predominate purpose for which the petitioner was organized is clearly shown by the provisions of the founder's will under which it was created and in the other evidence before us. That purpose, in its broadest sense, was to promote the science or art of ceramics. More particularly, it was to promote and conduct scientific research in the field of burning and curing various types of clay used in the manufacture of ceramics. Whether such a purpose is within the scope of the above quoted statute is the first question to be decided.
The foundation was not a charity in the narrow sense of having a purpose of ministering to the wants of the poor; but the term "charitable" as used in the statute has a broader meaning than that. In United States v. Proprietors of Social Law Library, 102 Fed. 2d 481, it was said that:
The term "charitable" is a generic term and includes literary, religious, scientific and educational institutions. As the court said in Missouri Historical Society v. Academy of Science, 94 Mo. 459, 8 S.W. 346 * * *:
"Any gift not inconsistent with existing laws, which is promotive of science, or tends to the education, enlightenment, benefit, or amelioration of the condition of mankind, or the diffusion of useful knowledge, or is for public convenience, is a charity * * *."
It is stipulated herein that ceramic engineering is recognized as an "applied science" for instructional purposes in a number of leading universities and colleges in this country and Canada. In the absence of any factual showing to the contrary, we think that this establishes the scientific purpose of the foundation and satisfies the requirements of the statute, if the foundation was organized and operated solely, or predominately, to promote this science.
The manufacture and sale of the standard cones was not the ultimate purpose of the foundation. That was merely a means of accomplishing its real purpose. The income from this business was to be used for financing the research work. In applying the exemption clause of the statute, the test is not the origin of the income, but its destination. Trinidad v. Sagrada Orden de Predicadores, 263 U.S. 578; Roche's Beach, Inc. v. Commissioner, 96 F.2d 776. In the last cited case the court said of the statutory provisions under consideration that:
* * * This does not mean that to come within the exemption a corporation may not conduct business activities for profit. The destination of the income is more significant than its source. * * *
See also Koon Kreek Klub v. Thomas, 108 F.2d 616.
The respondent argues that the foundation was organized and operated principally for the benefit of the manufacturers of ceramics and not for the public at large. It is true that the manufacturers were the chief beneficiaries, but the products and the services of the foundation were available to anyone interested in ceramics. It was the science as a whole that the foundation sought to benefit.
Roger L. Putnam, 6 T.C. 702, is relied upon by the respondent "because of the striking similarity of its facts to those here." That case involved the deductibility under section 23 (o) (2), Internal Revenue Code, of a gift for the benefit of Lowell Observatory, a scientific organization which had been established by the donor's uncle. The donor's uncle in his will left the residue of his estate in trust, one-half the income, after deducting 10 per cent to be added to capital, to be paid annually to his wife for life and the balance to go to the observatory. The wife was also to have the use of the family residence, which was held by the trust, rent free. We held that the observatory was not an independent "fund or foundation" separate from the trust estate and that the trust estate as a whole was not operated exclusively for scientific purposes. We said that the benefits to the testator's widow were too material to be ignored.
In the instant case the foundation was a separate and distinct entity. Under the testator's will his wife was entitled to receive, over a period of five years, monthly payments out of the income of the foundation aggregating $42,000. The last payments, amounting to $2,845.93, were made to her during the taxable year 1940. After these payments ceased the wife began receiving the life annuity payments of $350 per month under the collateral agreement which she and the trustees of the foundation had entered into. The payments of income to the wife, both under the will and under the agreement, were not the real purpose for which the foundation was established. They were a charge upon its entire assets and had to be paid in order to free the assets and income for use in the scientific aims of the foundation. In this respect the facts are indistinguishable from those in Emerit E. Baker, Inc., 40 B. T. A. 555, where we held that a corporation, otherwise entitled to exemption from income tax under section 101 (6) of the Revenue Acts of 1934 and 1936, was not deprived of the exemption because of payment of an annuity to his widow. In that case the testator left his residuary estate to a charitable corporation which he had organized during his lifetime, subject to annuity payments of $12,000 a year for life to his widow. His widow, in lieu of her dower rights under the laws of the State of Illinois, agreed with the corporation to accept a life annuity of $19,200. Our holding that the life annuity to the widow did not defeat the exempt status of the corporation was based largely upon the decision of the United States Supreme Court in Lederer v. Stockton, 260 U.S. 3. In that case the Supreme Court held exempt from tax the income from a residuary estate which was devised to a hospital, subject to payment of certain annuities. The obligation to pay the annuities was held not to defeat the exemption. In the instant case the income-producing property all belongs to the foundation, and if the foundation should cease to exist it will all go to Ohio State College after the death of the life annuitant.
The respondent's contentions here are not without support, however. In Scholarship Endowment Foundation v. Nicholas (C. C. A., 10th Cir.), 106 F.2d 552, exemption was denied a scholarship endowment foundation where at first all of the income and later, by agreement, certain life annuities were payable to the founder and his wife. The funds consisted of stocks and bonds. Only a small portion of the income was used for endowment purposes in the taxable years involved. The court based its denial of exemption on the participation of those individual annuitants in the profits of the foundation.
The basis for distinguishing these cases must be found in the general purpose and history of the trusts or foundations under consideration. Where, as in the instant case, the evidence shows a clear and predominant purpose to aid the charity and where the noncharitable benefits are incidental to that purpose, we think that the exemption should be allowed. As stated in Helvering v. Bliss, 293 U.S. 144:
* * * The exemption of income devoted to charity and the reduction of the rate of tax on capital gains were liberalizations of the law in the taxpayer's favor, were begotten from motives of public policy, and are not to be narrowly construed. * * *
We think that the petitioner here is a tax-exempt foundation within the meaning of the statute.
Reviewed by the Court.
Decision will be entered under Rule 50.
I am of the opinion that the petitioner is not an exempt organization within the meaning of section 101 (6) of the code. First, by the terms of the decedent's will — the very instrument which provided for the establishment of the petitioner — the principal purpose was declared to be the continued operation of a going business, and the research, scientific, and educational purposes were declared to be subsidiary. Second, the petitioner was not organized and operated exclusively for charitable, scientific, or educational purposes. Rather, it operated a competitive, commercial business, from which all its income was derived. These commercial activities can by no means be said to be merely incidental and the profits derived therefrom were not a negligible factor, as was the situation in Trinidad v. Sagrada Orden de Predicadores, 263 U.S. 578. Third, a large part of the petitioner's income was not used for charitable, scientific, or educational purposes, but went to the decedent's widow, a private individual; and what she received was much too substantial to be ignored.
For the reasons stated I respectfully dissent.
VAN FOSSAN, MURDOCK, DISNEY, and OPPER, JJ., agree with this dissent.