* * * *

10. [This stipulation1987 U.S. Tax Ct. LEXIS 130">*146 incorporates by reference to an attached exhibit the chart produced above outlining the revenues and expense for each activity].

89 T.C. 563">*571 We believe that the classification of petitioner's UBTI-producing activities into six separate categories (the five mentioned in stipulation No. 8 and interest income) is misleading and contrary to facts disclosed by the record as a whole. Therefore, we are not bound by this aspect of the stipulation. See Jasionowski v. Commissioner, 66 T.C. 312">66 T.C. 312, 66 T.C. 312">318 (1976). See also Mead's Bakery, Inc. v. Commissioner, 364 F.2d 101">364 F.2d 101, 364 F.2d 101">106 (5th Cir. 1966).

As stated in the findings of fact, petitioner was involved in only three nonmember activities. These are: (1) Nonmember golf tournaments which encompassed golf, golf cart rentals, guest fees, and a portion of the food and beverage revenues; (2) nonmember food and beverage sales not associated with golf tournaments; and (3) production of interest income.

Support for our conclusion in this regard can be found in the record. Respondent in his brief suggested that the guest fees were collected in connection with the nonmember golf tournaments. ¹⁵1987 U.S. Tax Ct. LEXIS 130">*147 It was petitioner's policy to require mandatory golf cart rentals and a mandatory luncheon or banquet with each nonmember golf tournament. With respect to the food and beverage sales not associated with golf tournaments, the record indicates that these derive from one source, the occasional use of petitioner's banquet facilities by nonmembers. ¹⁶ Applying commonsense standards, petitioner realized income from three nonexempt activities, all of which were entered into with the purpose of the production of profit: (1) Golf tournaments with associated banquets, fees, and golf cart rentals; (2) nonmember banquets; and (3) production of interest.

1987 U.S. Tax Ct. LEXIS 130">*148 Our classifications of petitioner's UBTI-producing activities are the only reasonable conclusions which can be formed from the record as a whole. We are faced with the problem, however, that the food and beverage revenues (and 89 T.C. 563">*572 expenses) were stipulated as though each constituted a separate activity. The stipulated figures represent the total food and beverage sales to nonmembers without allocation to the appropriate generating activity -- that is whether they were generated by golf tournament banquets or nontournament banquets. In view of our ultimate conclusion, however, that both of these activities were entered into with a profit motivation, it becomes unnecessary for us to have such a breakdown.

In arriving at our conclusion that petitioner entered into the nonmember golf tournament activity and the banquet activity with an objective for profit, we accept respondent's position that we must analyze each activity separately for profit motivation. Further, we look to the question of objective for profit not from the vantage point of taxable profit, as respondent urges, but rather from the standpoint of an incremental increase in available funds to petitioner. Thus, 1987 U.S. Tax Ct. LEXIS 130">*149 we keep in mind the fact that petitioner would incur the various fixed costs such as depreciation and overhead whether or not petitioner held golf tournaments or banquets. Thus, each dollar earned over and above the direct costs of each activity served to profit petitioner. When so viewed, the facts indicate petitioner received revenues (gross proceeds less direct costs) in 1979 as follows:

An analysis of petitioner's nonexempt activities in earlier years also yields similar results.

Respondent contends, however, that we must look to taxable1987 U.S. Tax Ct. LEXIS 130">*150 income in order to determine whether there is profit 89 T.C. 563">*573 motivation. He argues that since petitioner is allowed to deduct an allocable portion of the fixed or indirect costs in arriving at unrelated business taxable income, petitioner should also be required to take these costs into consideration in regard to determining profit motivation. Petitioner is, in effect, says respondent, having it both ways. While there is a certain pleasing symmetry to respondent's argument, we do not believe it to be determinative of the question before us. ¹⁸ The record as a whole makes it apparent that petitioner was seeking profit from these activities, and we so hold.

Having arrived at this determination, we now consider whether the losses incurred for tax purposes should be deductible from the other nonexempt income received by 1987 U.S. Tax Ct. LEXIS 130">*151 petitioner.

Computation of petitioner's UBTI is governed by the special rule of section 512(a)(3) and not the general rule of section 512(a)(1).

What we must ultimately decide is the extent to which (if at all), under section 512(a)(3), excess expenses from one of petitioner's UBTI-producing activities ¹⁹ can be used to offset net profit from other such activities. To resolve this, we must decide whether computation of UBTI under section 512(a)(3)(A) is to be made on an activity-by-activity basis or in the aggregate. Section 512(a)(3) provides that UBTI means gross income (excluding exempt function income), "less the deductions allowed by this chapter which are directly connected with the production of the gross income (excluding exempt function income)." Since the statute is not clear on this point, our question must be whether Congress intended an aggregate approach. We look to the history of section 512. See United States v. Public Utilities Commission of California, 345 U.S. 295">345 U.S. 295, 345 U.S. 295">315 (1953).

1987 U.S. Tax Ct. LEXIS 130">*152 For taxable years prior to those beginning January 1, 1970, section 501(c)(7) organizations, such as petitioner, 89 T.C. 563">*574 were not subject to tax on UBTI. Unless the organization's exemption was revoked, all income (whether or not related to the organization's exemption function) escaped taxation. See Ye Mystic Krewe of Gasparilla v. Commissioner, 80 T.C. 755">80 T.C. 755, 80 T.C. 755">762 (1983) (citations omitted).

Congress, however, changed this situation in regard to income from nonexempt activities by the enactment of the Tax Reform Act of 1969, Pub. L. 91-172, 83 Stat. 487, which subjected social clubs to a tax on UBTI for years beginning after December 31, 1969. The relevant provision (codified in sec. 512(a)(3)(A)) resulted from a proposal by the Treasury Department which read, in part, as follows:

Thus, under the proposal, all income, other than that from members in exchange for exempt function facilities, would be included in gross income, whether or not the activities generating the income were sufficient to meet the requirements of a "trade or business regularly carried on" generally applicable under the unrelated business income tax. Income from an investment1987 U.S. Tax Ct. LEXIS 130">*153 would be subject to the tax whether or not the activities engaged in by the social club in generating that income were sufficient to meet the "trade or business" test of the nonrelated business income tax. * * *

* * * *

The computation of income subject to the tax would be similar in most respects to the computation presently applicable under the unrelated business income tax in general. However, consistent with the elimination of the "trade or business regularly carried on" tests, deductions would be allowable if directly connected with an activity generating income subject to tax, rather than only if directly connected with an unrelated trade or business regularly carried on. * * *

[Technical Explanation of Treasury Tax Reform Proposals, Hearings on the Subject of Tax Reform before the Comm. on Ways and Means, 91st Cong., 1st Sess., part 14, at 5050, 5139-5141 (1969); fn. ref. omitted; emphasis included.]

The purpose behind the change extending the tax on UBTI to social clubs was stated in the Senate Finance Committee report as follows:

Since the tax exemption for social clubs and other groups is designed to allow individuals to join together to provide recreational or 1987 U.S. Tax Ct. LEXIS 130">*154 social facilities or other benefits on a mutual basis, without tax consequences, the tax exemption operates properly only when the sources of income of the organization are limited to receipts from the membership. Under such circumstances, the individual is in substantially the same position as if he had spent his income on pleasure or recreation (or other benefits) 89 T.C. 563">*575 without the intervening separate organization. However, where the organization receives income from sources outside the membership, such as income from investments (or in the case of employee benefit associations, from the employer), upon which no tax is paid, the membership receives a benefit not contemplated by the exemption in that untaxed dollars can be used by the organization to provide pleasure or recreation (or other benefits) to its membership. For example, if a social club were to receive $ 10,000 of untaxed income from investment in securities, it could use that $ 10,000 to reduce the cost or increase the services it provides to its members. In such a case, the exemption is no longer simply allowing individuals to join together for recreation or pleasure without tax consequences. Rather, it is 1987 U.S. Tax Ct. LEXIS 130">*155 bestowing a substantial additional advantage to the members of the club by allowing tax-free dollars to be used for their personal recreational or pleasure purposes. The extension of the exemption to such investment income is, therefore, a distortion of its purpose. [S. Rept. 91-552 (1969), 1969-3 C.B. 423, 469-470.]

The House Ways and Means Committee report points out that one of the main reasons for the changes was to tax passive income, such as interest. That report stated:

The bill also imposes a tax on investment income of organizations which are exempt on the grounds of mutuality or common membership. Social clubs, for example, are operated for the benefit of members and any profit derived from rendering the services to members is used by the club for the benefit of the members. Therefore, where a social club has income from interest, dividends, rents, royalties, etc., this income reduces the members' costs below the actual cost of providing the personal facilities made available by the organization. Because of this, the bill would tax the social clubs and these other membership organizations on all income other than that derived from rendering1987 U.S. Tax Ct. LEXIS 130">*156 services to the members. This income would be treated and taxed as business income. [H. Rept. 91-413 (Part 1) (1969), 1969-3 C.B. 200, 231.]

We considered a somewhat similar problem in Ye Mystic Krewe of Gasparilla v. Commissioner, 80 T.C. 755">80 T.C. 755 (1983). Ye Mystic Krewe was an exempt social club in Tampa, Florida, which sponsored a number of social events such as banquets, balls, tea dances, a parade, and a closing party. Its principal activity was a mock invasion of the city of Tampa, utilizing a replica of a West Indian bark, the Jose Gaspar. After the club's "pirates" debarked and captured the city, there was an annual parade of about 2 1/2 hours in which some members of the Krewe participated. The city of Tampa awarded concession rights to the Krewe along the parade route. The Krewe also received proceeds from an 89 T.C. 563">*576 official logbook of the proceedings. In addition to these income sources, the Krewe realized revenue from interest on savings accounts and Treasury bills. The bulk of its revenues, however, came from assessments on its members. We held that the concession income and interest income both constituted1987 U.S. Tax Ct. LEXIS 130">*157 unrelated business taxable income. We then went on to determine that the Krewe was not entitled to offset the expenses of staging the invasion and parade against the concession income received by it, holding that the expenses of staging the invasion and parade were not "directly connected with the production" of the concession income within the meaning of section 512(a)(3)(A). In Krewe, the taxpayer received only the net income from the concessions and logbook sales so that in effect, the expenses were already deducted from the gross proceeds since respondent agreed that the net amount constituted the unrelated business income. Further, we note that in Krewe, the taxpayer was attempting to offset some of the costs of its exempt activities against the unrelated income.

We then considered somewhat the same issue in The Brook, Inc. v. Commissioner, T.C. Memo. 1985-462, and supplemental opinion T.C. Memo. 1985-614, in which we held that a social club could not offset its net losses from nonmember food and beverage sales against the passive income it realized from investments. In The Brook, the taxpayer conceded 1987 U.S. Tax Ct. LEXIS 130">*158 that the prices charged for food and beverage services (the same to nonmembers as to members) were not intended to produce a profit and in fact they did not. We held in our supplemental opinion that "To the extent that the excess expenses resulting from nonmember food and beverage service, a nonexempt activity, were applied to reduce the taxable income from petitioner's investments -- another and unrelated nonexempt activity -- such investment income was shielded from taxation and was available to subsidize the operations of petitioner for the benefit of its membership." We held this to be contrary to the legislative history of section 512(a)(3). Upon appeal, the Second Circuit affirmed our decision but upon the different ground that deductions were allowable only if the deductions would be allowed under chapter 1 of the Internal Revenue Code. The Circuit Court held that the social club 89 T.C. 563">*577 did not satisfy the trade or business requirements of section 162 in order to take such deductions, since it admittedly did not intend to profit from the nonexempt food and beverage activities. 799 F.2d 833">799 F.2d 833 (2d Cir. 1986). ²⁰ In arriving at its conclusion, 1987 U.S. Tax Ct. LEXIS 130">*159 the court disagreed with our reasoning that there must be a direct connection between the expenses incurred and the specific income to be offset.

The Sixth Circuit, in Cleveland Athletic Club v. United States, 779 F.2d 1160">779 F.2d 1160 (1985), has taken yet a third approach. In Cleveland Athletic Club the club derived unrelated business income from investments as well as from sales of food and beverages to nonmembers. During the year in question the gross nonmember sales1987 U.S. Tax Ct. LEXIS 130">*160 receipts exceeded the direct expenses or cost of sales attributed thereto. However, after the indirect costs were allocated to the sales, loss resulted similar to the losses in the case at bar. Respondent argued that the club did not have a profit motive with respect to the nonexempt sales and that the net losses attributable to such sales could not be offset against the net investment income. The District Court below held, in cross-motions for summary judgment, that the club's primary motive with respect to the nonmember food and beverage activity was not to earn a profit but rather to lessen the financial burden on its members. The Sixth Circuit, in reversing the court below, interpreted section 512(a)(3) to mean that deductions are allowable if they meet the standard as ordinary and necessary to the production of income with a basic purpose of economic gain. The court went on to state (779 F.2d 1160">779 F.2d at 1165) "We do not believe that the non-member business activity must generate a tax profit." (Emphasis supplied.)

Unlike the situation we considered in The Brook, Inc. v. Commissioner, supra, the petitioner herein has clearly1987 U.S. Tax Ct. LEXIS 130">*161 shown profit-seeking motivation in its various nonexempt activities. Thus, the rationale in The Brook, either in our 89 T.C. 563">*578 opinion or in the affirmance by the Second Circuit, does not appear determinative of the case at bar.

Respondent in his deficiency notice, at trial, and on brief has devoted much of his argument to whether petitioner had a profit motivation, based upon Rev. Rul. 81-69, 1981-1 C.B. 352. That ruling concerned itself with a situation in which a club, such as that at bar, "sells food and beverage to nonmembers at prices insufficient to recover the costs of such sales." The ruling held that because the sales were not "profit motivated" the social club could not offset losses from such sales against its net investment income. The ruling does not elaborate upon the question we have considered here: whether there is a profit motivation where the nonexempt activities would have produced taxable income were it not for the allocation to them of fixed and indirect costs, items which would have been borne by the membership had the nonexempt activities not occurred.

Respondent relies in Rev. Rul. 81-69,1987 U.S. Tax Ct. LEXIS 130">*162 as well as in his argument herein, upon the decision in Iowa State University of Science & Technology v. United States, 205 Ct. Cl. 339">205 Ct. Cl. 339, 500 F.2d 508">500 F.2d 508 (1974). The taxpayer in that case (a sec. 501(c)(3) educational organization exempt from income tax, but subject to tax on UBTI) operated a commercial television station subject to unrelated business tax and two nonprofit radio stations not subject to tax. The specific issue before the Court of Claims was whether expenses from the nonprofit radio stations, which operated at net losses, could be used to offset net income from the commercial television station. Because the radio stations were operated without a profit motive and since section 162 allows for the deductibility only of expenses ordinary and necessary to trade or business (i.e., an activity entered into for profit), the court held the expenses from the radio stations could not be used to offset the net income of the commercial television station in computing the taxpayer's UBTI. 500 F.2d 508">Iowa State University of Science & Technology, supra at 520-521. There are, of course, important distinctions between the Iowa State University1987 U.S. Tax Ct. LEXIS 130">*163 of Science & Technology v. Commissioner case and the present situation. First, that case involved computation of UBTI under section 512(a)(1) which uses the "trade or business" language and not the special 89 T.C. 563">*579 rule of section 512(a)(3) at issue here. Section 512(a)(3), when applicable, contains no reference to unrelated trade or business, and allows deductions allowed by chapter 1 "which are directly connected with the production of the gross income." Secondly, in Iowa State University of Science & Technology the taxpayer was attempting to offset the costs of its exempt activity (the radio stations) against its nonexempt activity (the commercial television station). Petitioner here is simply attempting to offset losses from one nonexempt activity entered into for profit against gains from another. ²¹ This is different from the situation we considered in 80 T.C. 755">Ye Mystic Krewe of Gasparilla v. Commissioner, supra, where the attempt was to offset the costs of the "invasion" of Tampa, one of the exempt activities, against the proceeds from the sale of the logbook and other concessions. We stated in Krewe, 80 T.C. 755">80 T.C. 764:

1987 U.S. Tax Ct. LEXIS 130">*164 Congress clearly considered that nonmember income should not be used to subsidize the activities carried on for members, and there is absolutely no reason to believe that Congress meant for such a rule to apply only to income derived from a trade or business regularly carried on. In fact, the Treasury Explanation expressly rejects such a possibility, and the discussion in the committee reports of investment income also shows that the rules of section 512(a)(3) were not to be limited to income from a trade or business regularly carried on. If the Krewe's position were adopted, investment income or income from a business not regularly carried on could be used to subsidize the activities of members, and such a result is manifestly inconsistent with the objective of section 512(a)(3) and its legislative history.

Congress did not, on the other hand, intend to disallow the deduction of losses from one profit-motivated transaction against the revenue from another. In arriving at our conclusion in favor of petitioner herein, we have relied upon the language of section 512(a)(3) and its legislative history. We have not relied upon Proposed Treasury Regulation section 1.512(a)-(3)(b)(3). 1987 U.S. Tax Ct. LEXIS 130">*165 ²² Proposed regulations are not entitled 89 T.C. 563">*580 to judicial deference. See Scott v. Commissioner, 84 T.C. 683">84 T.C. 683, 84 T.C. 683">690 (1985). We note, however, that the result we reach here is consistent with the proposed regulation.

1987 U.S. Tax Ct. LEXIS 130">*166 Similarly, we are not bound by the decisions of either the Second Circuit in The Brook, Inc. v. Commissioner, supra, or the Sixth Circuit in 779 F.2d 1160">Cleveland Athletic Club, Inc. v. United States, supra, both of which decisions are distinguishable. Should the instant case be appealed, the appeal would be to the Ninth Circuit. See Golsen v. Commissioner, 54 T.C. 742">54 T.C. 742 (1970), affd. without discussion of this point 445 F.2d 985">445 F.2d 985 (10th Cir. 1971), cert. denied 404 U.S. 940">404 U.S. 940 (1971).

Decision will be entered for the petitioner.