APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE WESTERN DISTRICT OF PENNSYLVANIA (D.C. Civil No. 73-1051).
Seitz, Chief Judge, Rosenn and Garth, Circuit Judges.
This case, involving the Pittsburgh Press Club's action for an income tax refund, comes before us for the second time. Because crucial findings of fact made by the district court were based on inadmissible evidence, we must once again reverse.
The Pittsburgh Press Club (PPC or the Club), organized in 1885 under the laws of Pennsylvania, and reactivated in 1955, applied in 1956 for a federal income tax exemption as a social club. In 1959 the Internal Revenue Service (IRS) granted the exemption pursuant to IRC § 501(c)(7), which exempts from federal income taxation:
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.
In its application for tax exemption, the Club stated that its purpose was:
To provide a professional and social meeting place for those engaged in news and advertising work on newspapers, magazines, radio and television and in public relations activities for the furtherance of common interests.*fn1
In 1964 IRS examined PPC's books and records for fiscal year 1962, and determined that "outside" groups (i.e., nonmember groups) had been permitted to use the Club's facilities twelve times during that fiscal year. IRS did not then challenge PPC's exempt status, but warned the Club's officers that continued use by outside groups jeopardized PPC's exemption. PPC responded by a letter stating that nonmember use of its facilities would be discontinued.
In 1970 an IRS agent conducted an extensive audit of the Club for fiscal years 1967, 1968 and 1969. He determined that during the period of these three years more than 800 functions had been held by nonmember outside groups, although each such group had been member sponsored.*fn2 Based on these findings the agent further determined the amount of "outside" revenues for the three years in question, as well as the percentage those revenues were of the Club's gross receipts (defined to exclude receipts from initiation fees). These determinations were:
Fiscal Outside Percentage of
Year Revenue Gross Receipts
On February 1, 1972, IRS revoked the Club's exempt status as of fiscal year 1967, and assessed income taxes for fiscal years 1967 through 1971. The taxes so assessed were paid under protest. IRS's revocation of PPC's exempt status was based on two factors. First, observing that voting members paid lower dues than the other classes of members (associate or affiliate members), IRS concluded that the differential in dues constituted an inurement of net earnings to the benefit of the voting members, who were considered by IRS to be private shareholders. IRS charged that this practice violated IRC § 501(c)(7). See generally Rev. Rul. 70-48, 1970-1 Cum. Bul. 133. Second, IRS claimed that PPC's continued practice of permitting its facilities to be used for outside affairs, resulting in PPC's receiving substantial revenues from these outside sources, constituted engaging in business. Thus, it charged that the Club was not being operated exclusively for nonprofit purposes, and was therefore in violation of IRC § 501(c)(7). See generally Treas. Reg. § 1-501(c)(7)-1(b); Rev. Rul. 60-324, 1960-2 Cum. Bul. 173.
PPC brought suit in the district court for a refund of the taxes which it had paid. IRS counterclaimed for interest which had accrued prior to payment. The district court ruled in the Club's favor ...