Bartels Trust for Benefit of Cornell University Ex Rel. Bartels v. United States
U.S. Court of Appeals9/7/2010
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Full Opinion
United States Court of Appeals
for the Federal Circuit
__________________________
THE HENRY E. AND NANCY HORTON BARTELS
TRUST FOR THE BENEFIT OF CORNELL
UNIVERSITY, BY KENNETH G. BARTELS, JOHN B.
LOEHMANN, PHILIP H. BARTELS, INGE T.
REICHENBACH, AND JOHN F. MURPHY,
TRUSTEES,
Plaintiff-Appellant,
v.
UNITED STATES,
Defendant-Appellee.
__________________________
2009-5122
__________________________
Appeal from the from the United States Court of Fed-
eral Claims in 03-CV-2526, Judge Lawrence J. Block.
__________________________
Decided: September 7, 2010
__________________________
PHILIP H. BARTELS, Shipman & Goodwin LLP, of
Greenwich, Connecticut, argued for plaintiff-appellant.
JENNIFER M. RUBIN, Trial Attorney, Appellate Section,
Tax Division, United States Department of Justice, of
Washington, DC, argued for defendant-appellee. With
BARTELS TRUST v. US 2
her on the brief were JOHN A. DICICCO, Acting Assistant
Attorney General, and KENNETH L. GREENE, Attorney.
__________________________
Before PROST, MAYER, and SCHALL, Circuit Judges.
PROST, Circuit Judge.
This is a tax refund suit. It was filed by a taxpayer
that qualifies as a tax-exempt organization under I.R.C. §
501(c), The Henry E. and Nancy Horton Bartels Trust for
the Benefit of Cornell University (“Cornell Trust” or
“Trust”). As the name suggests, the Trust was formed to
financially support Cornell University. We must decide
whether this tax-exempt organization owed unrelated
business income tax (“UBIT”) on income resulting from
the sale of securities it purchased on margin. After
paying the UBIT, the Trust filed this refund claim in the
United States Court of Federal Claims. The Court of
Federal Claims denied the claim, concluding that the
proceeds from the margin-financed trades were taxable as
income from debt-financed property and thus income from
an unrelated trade or business, which is subject to the
UBIT. I.R.C. §§ 512(b)(4), 514.
The Trust now appeals. Before this court, the Trust
argues that the Court of Federal Claims misinterpreted
the relevant provisions of the Internal Revenue Code
(“Code” or “tax code”). Because we agree with the trial
court that securities purchased on margin are “debt-
financed property,” and thus “unrelated business taxable
income” within the meaning of I.R.C. § 512 and § 514, we
affirm.
3 BARTELS TRUST v. US
BACKGROUND
The relevant facts are simple and undisputed. The
taxpayer is a trust that was formed to support Cornell
University. Shortly after its formation, the Internal
Revenue Service (“IRS”) granted the Trust’s application
for tax-exempt status under I.R.C. § 501(c)(3).
This case arises from some of the Trust’s investment
activities during the 1999 and 2000 tax years. During
those years, the Trust invested in stocks purchased “on
margin.” In other words, the Trust used money borrowed
from its broker to complete the stock purchases. The
Trust subsequently sold the stocks.
When the Trust filed its “Exempt Organization Busi-
ness Income Tax Return” for the 1999 tax year, otherwise
known as its Form 990T, the Trust reported the income
from the sale of the margin-financed securities as capital
gains, without reporting any associated income tax liabil-
ity. After an IRS audit, the Trust paid $48,770 in taxes
on the margin sales for the 1999 tax year. For the 2000
tax year, the Trust reported income from the sale of the
margin-financed securities as capital gains and paid the
associated UBIT of $39,479.
The Trust subsequently filed amended Forms 990T
for the 1999 and 2000 tax years. These forms claimed a
total refund of $88,249 for UBIT payments made by the
Trust on the sale of the margin-financed securities. After
the IRS denied the refund claims, the Trust filed this suit
in the Court of Federal Claims.
Both parties moved for summary judgment. In a
clear, thorough, and insightful opinion, the Court of
Federal Claims granted the government’s motion. It
BARTELS TRUST v. US 4
ruled that the Trust’s income from securities purchased
on margin was by definition unrelated business taxable
income under I.R.C. § 514. The Trust timely appealed.
We have jurisdiction under 28 U.S.C. § 1295(a)(3).
ANALYSIS
We review grants of summary judgment by the Court
of Federal Claims without deference. CNG Transmission
Mgmt. VEBA v. United States, 588 F.3d 1376, 1378 (Fed.
Cir. 2009). Questions of law, such as the proper interpre-
tation of a statute, are reviewed de novo. Consolidation
Coal Co. v. United States, 528 F.3d 1344, 1347 (Fed. Cir.
2008). Here, the only issue in dispute is the proper inter-
pretation of “unrelated business taxable income.”
Organizations otherwise exempt from federal taxation
pursuant to § 501(c) remain subject to tax on their “unre-
lated business taxable income.” I.R.C. § 511(a). Unre-
lated business taxable income is generally defined as “the
gross income derived by any organization from any unre-
lated trade or business (as defined in section 513) regu-
larly carried on by it, less the deductions allowed by this
chapter which are directly connected with the carrying on
of such trade or business, both computed with the modifi-
cations provided in subsection (b).” Id. § 512(a)(1). Sec-
tion 513 defines “unrelated trade or business” to include
“any trade or business the conduct of which is not sub-
stantially related (aside from the need of such organiza-
tion for income or funds or the use it makes of the profits
derived) to the exercise or performance by such organiza-
tion of its charitable, educational, or other purpose or
function constituting the basis for its exemption under
section 501.” Id. § 513(a). The related Treasury Regula-
tion further explains that a trade or business is “related
5 BARTELS TRUST v. US
to exempt purposes, in the relevant sense, only where the
conduct of the business activities has a causal relation-
ship to the achievement of exempt purposes (other than
through the production of income).” 26 C.F.R. § 1.513-
1(d)(2).
This case turns on I.R.C. § 514 and § 512(b)(4), which
modify the computation of “unrelated business taxable
income” under § 512(a)(1) when income is from a particu-
lar source, namely “debt-financed property.” See I.R.C. §§
512(b)(4), 514(a). As relevant here, § 514 provides that
“[t]here shall be included with respect to each debt-
financed property . . . an item of gross income derived
from an unrelated trade or business.” Id. § 514(a)(1)
(emphasis added). Moreover, § 512(b)(4) requires that “in
the case of debt-financed property (as defined in section
514) there shall be included, as an item of gross income
derived from an unrelated trade or business, the amount
ascertained under section 514(a)(1), and there shall be
allowed, as a deduction, the amount ascertained under
section 514(a)(2).” Id. § 512(b)(4) (emphasis added).
“Debt-financed property” is defined as “any property
which is held to produce income and with respect to which
there is an acquisition indebtedness (as defined in subsec-
tion (c)) at any time during the taxable year.” Id. §
514(b)(1); see also 26 C.F.R. § 1.514(b)-1(a). 1 In other
words, § 512(b)(4) and § 514(a) together define an addi-
tional category of unrelated business taxable income,
debt-financed property, which is accordingly subject to the
1 Debt-financed property does not include “any
property substantially all the use of which is substantially
related (aside from the need of the organization for in-
come or funds) to the exercise or performance by such
organization of its charitable, educational, or other pur-
pose or function constituting the basis for its exemption
under section 501.” I.R.C. § 514(b)(1)(A)(i).
BARTELS TRUST v. US 6
UBIT. For items within this category, § 514 nullifies §
512(b)’s general exemption of dividends, interest, royal-
ties, and the like from the UBIT. See id. § 512(b)(4);
Henry E. & Nancy Horton Bartels Trust for the Benefit of
the University of New Haven v. United States (Bartels
Trust for New Haven), 209 F.3d 147, 150-51 (2d Cir.
2000); Kern Cnty. Elec. Pension Fund v. Comm’r, 96 T.C.
845, 850-51 (1991).
As used in § 514, “acquisition indebtedness” means
“the unpaid amount of . . . indebtedness incurred by the
organization in acquiring or improving [debt-financed
property].” I.R.C. § 514(c)(1)(A). Acquisition indebted-
ness does not include “indebtedness the incurrence of
which is inherent in the performance or exercise of the
purpose or function constituting the basis of the organiza-
tion’s exemption, such as the indebtedness incurred by a
credit union described in section 501(c)(14) in accepting
deposits from its members.” Id. § 514(c)(4).
On appeal, the crux of the dispute is whether the
Trust’s income from its securities purchased on margin is
subject to the UBIT. The Trust argues that the UBIT
does not apply because: (1) doing so is contrary to con-
gressional intent; and (2) investing in securities is not a
“trade or business” under the tax code.
For the following reasons, we reject these arguments.
The language of § 512(b)(4) and § 514 is plain and unam-
biguous. It is undisputed that to purchase securities on
margin, the Trust borrowed funds. “[I]ndebtedness [was
thus] incurred by the organization in acquiring” these
securities. Id. § 514(c)(1). Accordingly, under § 514(c),
these securities were subject to acquisition indebtedness
and constitute “debt-financed property” within the mean-
ing of § 514(b)(1). See Bartels Trust for New Haven, 209
7 BARTELS TRUST v. US
F.3d at 150-51; Mose & Garrison Siskin Mem. Found.,
Inc. v. United States, 790 F.2d 480, 483-84 (6th Cir. 1986);
Elliot Knitwear Profit Sharing Plan v. Comm’r, 614 F.2d
347, 350-51 (3d Cir. 1980). As the Court of Federal
Claims correctly recognized, § 514(a) and § 512(b)(4) treat
income the Trust derived from selling these securities as
“an item of gross income derived from an unrelated trade
or business,” and therefore unrelated business taxable
income under § 512.
1. The Statute and Congressional Intent
Notwithstanding the clear language of § 514 and its
straightforward application to these facts, the Trust
argues that the UBIT requires a showing of unfair compe-
tition because Congress’s “sole” purpose in enacting the
UBIT was to prevent tax-exempt organizations from
gaining an unfair competitive advantage over taxable
entities.
We are not persuaded. To determine Congress’s in-
tent, we begin with the text of the statute. Sharp v.
United States, 580 F.3d 1324, 1237 (Fed. Cir. 2009).
When a statute’s language is plain, our sole function is to
enforce the statute according to its terms. Id.; see also
Jimenez v. Quarterman, 129 S. Ct. 681, 685 (2009); Hart-
ford Underwriters Ins. Co. v. Union Planters Bank, N.A.,
530 U.S. 1, 6 (2000). Here, Congress intended to impose
the UBIT on all debt-financed property, regardless of
whether that particular type of property was a source of
unfair competition. This intent is evident on the statute’s
face: “There shall be included with respect to each debt-
financed property . . . an item of gross income derived
from an unrelated trade or business.” I.R.C. § 514(a)(1);
see also id. § 512(b)(4). Nothing in § 512 or § 514 prem-
ises application of the UBIT on showing unfair competi-
BARTELS TRUST v. US 8
tion. See Bartels Trust for New Haven, 209 F.3d at 151-
52.
In arguing that one of the purposes motivating en-
actment of the UBIT trumps the statutory text, the Trust
improperly elevates an interpretive tool to a command.
See Garcia v. United States, 469 U.S. 70, 74 (1984); Bull
v. United States, 479 F.3d 1365, 1376 (recognizing that
“[b]eyond the statute’s text, the traditional tools of statu-
tory construction include the statute’s structure, canons of
statutory construction, and legislative history” (altera-
tions omitted)). While our decisions recognize that legis-
lative history can shed light on congressional intent, we
have never held that legislative history trumps clear text.
See, e.g., Sharp, 580 F.3d at 1238; Glaxo Operations UK
Ltd. v. Quigg, 894 F.2d 392, 396 (Fed. Cir. 1990); see also
Coltec Indus., Inc. v. United States, 454 F.3d 1340, 1354
(Fed. Cir. 2006). Rather, we must presume that Congress
says in statute what it means and means in a statute
what it says. Conn. Nat’l Bank v. Germain, 503 U.S. 249,
254 (1992).
We think our inquiry thus begins and ends with what
§ 514 does (and does not) say. Id. However, even if we
were to examine the legislative history of the UBIT, there
is no “extraordinary showing” of a “clear intent contrary
to the [statute’s] plain meaning.” Glaxo Operations UK,
894 F.2d at 396.
We agree with the Second and Third Circuits that the
legislative history supports a literal reading of the stat-
ute. See Bartels Trust for New Haven, 209 F.3d at 153-54;
Elliot Knitwear, 614 F.2d at 350-51; Kern Cnty., 96 T.C. at
851. As originally enacted, § 514 extended the UBIT only
to income from borrowed funds used to finance the pur-
chase of real property. See I.R.C. § 514(b)(3)(A) (1968). In
9 BARTELS TRUST v. US
1969, Congress amended § 514. See Tax Reform Act of
1969, No. 91-172, 83 Stat. 487. The amendment broad-
ened § 514’s scope beyond business leases, making the
UBIT applicable to all income resulting from property
subject to acquisition indebtedness, i.e., “debt-financed
property.” Far from evincing an intent to limit the reach
of the UBIT, the legislative history of § 514 supports our
conclusion that “debt-financed property” should be given
its plain meaning.
The Trust cites numerous cases in support of its con-
tention that the sole purpose of the UBIT was eliminating
unfair competition. See, e.g., Portland Golf Club v.
Comm’r, 497 U.S. 154, 161-62 (1990); United States v.
Am. College of Physicians 475 U.S. 834, 837-38 (1986);
United States v. Am. Bar Endowment, 477 U.S. 105, 114
(1986). The Trust is correct that these decisions recognize
that the primary, if not sole, objective for adopting the
UBIT “was to eliminate a source of unfair competition by
placing the unrelated business activities of certain ex-
empt organizations upon the same tax basis as the nonex-
empt business endeavors with which they compete.” 26
C.F.R. § 1.513-1(b). These decisions, however, do not
resolve the question presented here: None hold that a
showing of unfair competition is required for imposing the
UBIT, particularly for debt-financed property. See
Bartels Trust for New Haven, 209 F.3d at 153; State Police
Ass’n v. Comm’r, 125 F.3d 1, 8 (1st Cir. 1997) (holding
that the UBIT does not necessarily require a showing of
actual competition); Fraternal Order of Police, Ill. State
Troopers, Lodge No. 41 v. Comm’r, 833 F.2d 717, 722-23
(7th Cir. 1987); Clarence LaBelle Post No. 217, Vets. of
Foreign Wars of the U.S. v. United States, 580 F.2d 270,
272 (8th Cir. 1978). Though unfair competition may have
been among Congress’s concerns in establishing the
UBIT, what matters is that the statutory provisions
BARTELS TRUST v. US 10
Congress enacted used broader terms, which do not limit
the UBIT to situations involving unfair competition. We
do not agree that upholding application of the UBIT to the
Trust’s income from its margin-financed securities defeats
or compromises the purpose of the relevant statutes. See
I.R.C. §§ 511-514. To the contrary, the plain language of
these sections makes clear that Congress intended other-
wise tax-exempt organizations to still pay taxes on certain
income, namely, what the tax code defines as “unrelated
business taxable income.” See id.
The Trust’s reliance on cases like Gregory v. Helver-
ing, 293 U.S. 465, 470 (1935), Jade Trading, LLC ex rel.
Ervin v. United States, 598 F.3d 1372 (Fed. Cir. 2010),
and Coltec Industries, Inc. v. United States is similarly
unavailing. 2 For example, Jade Trading and Coltec
Industries disallowed certain tax benefits under the
economic substance doctrine. The doctrine disregards for
tax purposes transactions that comply with the literal
terms of the tax code but lack economic reality in order to
prevent taxpayers from subverting the legislative purpose
of the Code. Coltec, 454 F.3d at 1352; see also Tank Truck
Rentals v. Comm’r, 356 U.S. 30, 35 (1958). This case
differs in every respect that matters. Here the taxpayer
seeks to avoid a tax (rather than obtain a tax benefit) by
arguing that the tax code should not be read literally
2 These cases accord with the general interpretive
rule that deductions and other tax benefits are construed
narrowly because they are a matter of legislative grace;
they are exceptions to the general rule that all income is
taxable. I.R.C. § 61; see Stobie Creek Invs. LLC v. United
States, 608 F.3d 1366, 1375 (Fed. Cir. 2010). This inter-
pretive rule does not apply here because we are concerned
with the applicability of a tax, not the availability of a tax
benefit.
11 BARTELS TRUST v. US
(rather than arguing for a literal reading) to effectuate
the Code’s purpose. We decline to extend the economic
substance doctrine. The doctrine is a judicial tool for
enforcing the Code, not a judicial tool for negating its
application. Coltec, 454 F.3d at 1352.
2. Unrelated Trade or Business
The Trust also argues that the UBIT does not apply
because its investment activities do not constitute a
“trade or business.”
The Trust is correct that only income from an “unre-
lated trade or business” is subject to the UBIT. I.R.C. §
512(a)(1). Section 513 generally defines “unrelated trade
or business” as (1) any trade or business (2) regularly
carried on by the organization (3) the conduct of which is
not substantially related (aside from the production of
funds) to the organization’s performance of its exempt
functions. Id. § 513(a); 26 C.F.R. § 1.513-1(a); Am. College
of Physicians, 475 U.S. at 838-39. According to the Trust,
the first requirement is not met because investing in
securities is not a “trade or business” since the invest-
ments do not meet the definition of “trade or business” in
I.R.C. § 162, which § 513 incorporates by reference. 26
C.F.R. § 1.513-1(b); see Am. Bar Endowment, 477 U.S. at
110; Disabled Am. Veterans v. United States, 650 F.2d
1178, 1186-87 (Ct. Cl. 1981); La. Credit Union League v.
United States, 693 F.2d 525, 530 (5th Cir. 1982).
We reject this argument and instead agree with the
Second Circuit that it does not matter whether the Trust’s
investments in securities on margin satisfy the definition
of “unrelated trade or business” in § 513 because separate
provisions—§ 512(b)(4) and § 514—explicitly classify
income from debt-financed property as income from an
BARTELS TRUST v. US 12
unrelated trade or business. I.R.C. §§ 512(a)(1), 512(b)(4),
514(a); see Bartels Trust for New Haven, 209 F.3d at 151.
CONCLUSION
The judgment of the Court of Federal Claims is af-
firmed. We join our sister circuits in holding that the
securities purchased on margin by otherwise tax-exempt
organizations are debt-financed property, the income from
which is subject to the UBIT. I.R.C. §§ 512, 514; Bartels
Trust for New Haven, 209 F.3d at 150-51; Elliot Knitwear,
614 F.2d at 350-51; Sw. Tx. Elec. Co-op., Inc. v. Comm’r,
67 F.3d 87, 89-90 (5th Cir. 1997); Mose & Garrison Siskin,
790 F.2d at 483-84.
AFFIRMED