ON APPEAL FROM THE UNITED STATES TAX COURT (Tax Court No. 2725-77)
Before Gibbons, Rosenn and Garth, Circuit Judges.
The taxpayer, Elliot Knitwear Profit Sharing Plan (the Plan), appeals from a judgment entered in favor of the Commissioner of Internal Revenue on its petition contesting a claimed deficiency in income tax in the amount of $20,719.00. The Plan alleges that this claimed deficiency resulted from the erroneous inclusion in its taxable income by the Commissioner of income realized by the purchase and sale of securities on margin. The Tax Court determined that such securities purchased on margin were debt-financed property within the meaning of section 514(b)(1) of the Internal Revenue Code (Code), and that the income therefrom was therefore subject to taxation as unrelated business income under section 511 of the Code.*fn1 We affirm.
The parties have stipulated to the relevant facts. On October 22, 1959, Elliot Knitwear Corporation, employer, adopted the Elliot Knitwear Profit Sharing Plan and Trust, taxpayer. During the fiscal year ending April 30, 1972, the taxable year in question, the Commissioner had determined that the Plan qualified under section 401(a) of the Code and was therefore exempt from federal income taxation under section 501(a).*fn2
Employees contributed to the Plan to a limited extent. The Plan was funded primarily by employer contributions that were paid out of net profits in such amounts as the employer determined in its sole discretion. The trust agreement authorized the trustee, inter alia, to borrow money, pledge securities as collateral, and purchase securities on margin.
During the fiscal year, the Plan purchased securities on margin for the purpose of increasing the funds that eventually would be available for distribution to employees. For such purchases, the Plan incurred indebtedness with respect to their acquisition. The Plan realized substantial income from these transactions and contends that this income is not taxable.
The question presented on this appeal is whether securities purchased on margin by a tax-exempt employee profit-sharing plan constitute debt-financed property, such that profits derived from the sale thereof are taxable as unrelated business income.
There is no dispute that the Plan is tax-exempt under sections 401(a) and 501(a). Section 511(b) imposes a tax on the unrelated business taxable income of tax-exempt trusts.*fn3
Unrelated business taxable income is defined to mean "the gross income derived by any organization from any unrelated trade or business . . . regularly carried on by it, less deductions . . . which are directly connected with the carrying on of such trade of business . . . ." 26 U.S.C. § 512(a)(1).
An unrelated trade or business in the context of a trust under section 401(a) means any trade or business regularly carried on by such a trust, the conduct of which is not substantially related to its tax-exempt purpose. 26 U.S.C. § 513(b)(2). Income earned on debt-financed property is treated as income derived from an unrelated trade or business, 26 U.S.C. § 514(a), and as such is taxable under section 511. See 26 U.S.C. § 511.
Taxpayer contends that securities purchased on margin are not within the statutory definition of debt-financed property. Section 514(b)(1) sets forth the ...