The War against the IRS (1984 – 1992)
After 6 years of litigation the tax case between CSC and the IRS finally came to a decision before the U. S. Tax Court ("CSC vs. Commissioner of the IRS," No. 3352-78). On September 24th, 1984 the court issued following judgement:
"Petitioner, a Church incorporated in the State of California, was granted tax-exempt status in 1957 under Sec. 501(c) (3), I.R.C. 1954.
"In 1967, respondent sent petitioner a letter revoking its exemption following an audit of petitioner's records which was in part sparked by litigation involving the tax-exempt status of an affiliated Church of Scientology. Subsequent to issuing the letter of revocation, respondent conducted several audits of petitioner's records for various tax years and also reviewed the tax status of several affiliated churches.
"Petitioner was also investigated by several intelligence groups which respondent specially formed during 1969 through 1975 to investigate taxpayers allegedly selected by essentially political criteria. During the period that petitioner's taxes were under administrative review, petitioner conspired to prevent the IRS from determining and collecting taxes due from petitioner and affiliated churches.
"Petitioner sold religious services, books, and artifacts according to a fixed-fee schedule through its branch churches and franchises. Petitioner's profits from these sales were not less than $ 1,494,617.53 in 1970, $ 881,131.18 in 1971, and $ 1,707,287.17 in 1972. Petitioner maintained large cash reserves in a sham corporation and in a bogus trust controlled by key church officials including petitioner's founder.
"Held, petitioner was not the victim of selective enforcement of the tax laws since the notice of deficiency was based on valid regulatory considerations. Held, further, various other asserted constitutional rights of petitioner not violated. Held, further, petitioner was not operated exclusively for an exempt purpose under sec. 501(c) (3), I.R.C. 1954, since petitioner had a substantial commercial purpose, since its net earnings benefited key Scientology officials, and since it had the illegal purpose of conspiring to impede the IRS from collecting taxes due from petitioner and affiliated churches and thus its activities, dictated at the highest level, violated well-defined public policy."
In a first response to the decision the President of the "Church of Scientology International" (CSI), Heber Jentzsch, denounced the Internal Revenue Service as the "American Gestapo." He announced that the decision would be appealed and that Scientology would continue to "expose the crimes of the IRS." [Exh. No. 131] Shortly after Jentzsch's declaration, CSI's "Office of Special Affairs" published a series of advertisements in big newspapers "seeking information about IRS-abuses" or "exposing their crimes" [Exh. No. 132]. OSA-writers also would issue several very negative articles about the IRS in OSA's own magazine "Freedom" over the next 9 years.
On July 9th, 1985 one of the follow-up suits of the FBI-raids was dismissed after L. Ron Hubbard had failed to show up for a deposition ("FCDC vs. FBI et al.," No. CV 78-0107). The Scientology organization of Washington, DC had sued several government agencies, alleging it had been the victim of "an extensive campaign of government harassment." In that suit the U.S. district court in Washington, DC pronounced Hubbard as the managing agent of the Church of Scientology. At this point, Hubbard had been in hiding for several years and the Scientology organization claimed he had neither anything to do with the management of organizations nor the burglaries in Washington. Scientology appealed the decision, but the U.S. Appeals Court upheld the earlier judgement on September 26th, 1986. The court specifically stated with regards to the role of L. Ron Hubbard ("FCDC vs. FBI et al.," No. CV 85-5885):
"From evidence adduced below, Hubbard appears to have maintained control in administrative matters through high positions in such entities as the Sea Organization, ‘an elite fraternity of Scientologists.' Church of Scientology of California v. Comm'r, 83 T.C. 381, 389 (1984). Indeed, uncontested declarations before the District Court leave little doubt about either the ecclesiastical or administrative dimensions of Hubbard's authority during the period from 1966 to 1982. ...
"The Tax Court decision to which we just alluded, in denying the California Church of Scientology tax-exempt status for the years 1970, 1971 and 1972, set forth detailed findings about Hubbard's relation to that organization along with the numerous other Scientology organizations. Church of Scientology v. Comm'r, supra. The Tax Court harbored no doubt that Hubbard ‘kept control over' the policies, actions, and even the finances of the California Church. ...
"Beyond the overall dominance that he exercised over the Scientology organizations during this earlier period, Hubbard was closely linked to, if not in charge of, the activities for which appellees initially sought his deposition. The primary evidence about these activities emerges from the criminal prosecution in which seven members of the church, including Hubbard's wife, were found guilty of conspiracy to obstruct justice. In that trial, one defendant was found guilty of conspiring illegally to obtain government documents, and another was found guilty of theft of government property. See United States v. Hubbard, 208 U.S. App. D.C. 399, 650 F.2d 293, 301 (D.C. Cir. 1980). In a Stipulation of Evidence submitted in that case, the defendants recounted a full-fledged campaign mounted by the Church of Scientology and its affiliated organizations against the United States Government, particularly the Internal Revenue Service. ... The Stipulation indicated that Hubbard ‘was, by virtue of his role as the founder and leader of Scientology, overall supervisor of the Guardian's Office,' a Scientology entity, which carried out these illicit activities. ... Indeed, the grand jury named Hubbard as an unindicted co-conspirator in that case.
"The criminal case does not stand alone. The Tax Court decision to which we previously referred denied the Church tax exempt status in part because of this conspiracy by the Scientology organizations, ‘beginning in 1969 and continuing at least until July 7, 1977.'
"Finding that the Church of Scientology of California ‘filed false tax returns, burglarized IRS offices, stole IRS documents, and harassed, delayed, and obstructed IRS agents who tried to audit the Church's records,' id., the Tax Court held that the California Church had violated public policy and thereby lost entitlement to any exemption which it might otherwise have enjoyed. ...
"Abundant evidence supports the proposition that Hubbard continued in his de facto position as head of the Church. Based on the evidence in the record, the District Court rightly concluded that Hubbard was in a position to provide information about the conspiracy on behalf of the Scientology organizations for this purpose."
When the new management structure of Scientology with the "Religious Technology Center" (RTC) as trademark holder and "Church of Scientology International" as the new "mother church" was set up, it was proclaimed by Scientology that the activities were in fact bona fide religious. RTC, CSI and other new Scientology-corporations consequently applied for tax-exemption with the IRS. The IRS nevertheless initiated an investigation through its "Criminal Investigations Division" in Los Angeles (CID) into the operations of the organizations. Scientology countered the IRS-efforts by organizing an anti-IRS front group, called "Coalition of IRS-whistle blowers" and staging class action suits against the agency, initiated by "IRS-victims" [Exh. No. 133].
Around the same time period, during Spring of 1985, Scientology made public that it had run a covert operation against an ex-Scientologist, Gerald Armstrong, who had been an informant of the CID in Los Angeles. The previous year, in 1984, Armstrong had been approached by three Scientology double agents, David Kluge, Daniel Sherman and Michael Rinder, who had pretended to be part of a group of dissatisfied Scientology-members (the "Loyalists") who wanted to take over the Scientology-management and looked for his assistance.
Four "clandestine" meetings between Armstrong, Kluge and Rinder were arranged during November 1984 at Griffith Park in Los Angeles, where the potential take-over and a possible suit by the "Loyalists" against the Scientology management were discussed. Unbeknownst to Armstrong every meeting was videotaped by private investigator Eugene Ingram and was used five months later as a provocation operation against the IRS CID agents Al Lipkin, Alfonse Ristuccia and the three U.S Attorneys Richard Greenberg, Thomas Doughty and Bracket Denniston [Exh. No. 134].
On July 28th, 1987 the U. S. Court of Appeals issued its ruling in the Scientology tax case between CSC and the IRS ("CSC vs. Commissioner of the IRS," No. 85-7324). It upheld the decision of the lower court in 1984 and stated:
"Internal Revenue Code @ 501 exempts certain organizations from taxation.
"Section 501(c) (3) exempts: corporations and any community chest, fund, or foundation, organized and operated exclusively for religious ... purposes, ... no part of the net earnings of which inures to the benefit of any private shareholder or individual.
"To qualify for exemption, a church must show that it is (1) organized, and operated, exclusively for religious or charitable purposes. Hall v. Commissioner, 729 F.2d 632, 634 (9th Cir. 1984).
"The Church strenuously argues that the trial court failed to recognize it as a bona fide religion. This argument goes to whether the Church meets the organizational test. Neither the Commissioner, nor the Tax Court, nor this court questions that the Church of Scientology of California was organized for a bona fide religious purpose. The only question before the court, is whether the Church met the second requirement for tax-exempt status, the operational test.
"Four elements compose the operational test. First, the organization must engage primarily in activities which accomplish one or more of the exempt purposes specified in @ 501(c) (3). ... Second, the organization's net earnings may not inure to the benefit of private shareholders or individuals. ... Third, the organization must not expend a substantial part of its resources attempting to influence legislation or political campaigns. ...
"Courts have imposed a fourth element. Organizations seeking exemption from taxes must serve a valid public purpose and confer a public benefit. Bob Jones University v. United States, 461 U.S. 574, 585-92, 76 L. Ed. 2d 157, 103 S. Ct. 2017 (1983). If an organization fails to comply with anyone of these four elements, it will fail the operational test and lose its eligibility for tax-exempt status. Harding Hospital, Inc. v. United States, 505 F.2d 1068, 1072 (6th Cir. 1974).
"We conclude that the Church failed to establish that ‘no part of the net earnings ... inures to the benefit of any private shareholder or individual ... ' 26 U.S.C. @ 501(c) (3). Because we may affirm the Tax Court on this ground, we do not reach the questions of whether the Church operated for a substantial commercial purpose or whether it violated public policy. ...
"We affirm the Tax Court decision upholding the Commissioner's revocation of the Church of Scientology of California's tax exempt status on the ground that a portion of its income inured to the benefit of L. Ron Hubbard and others. We reject the Church's argument that the notice of deficiency was constitutionally and administratively defective. Finally, we uphold the Commissioner's imposition of a penalty on the Church for failure to file the proper returns."
In another tax case, where a public Scientology member sued the IRS, when the agency did not allow "donations to the Church" as tax-deductible contributions, the U. S. Appeals Court for the 9th Circuit upheld the decision of the IRS [Exh. No. 135].
Around that time another Appeals Court, this time in St. Louis, ruled that such donations were in fact tax-deductible, while another court in Boston decided similar as the one in California. Two years later, on June 5th, 1989, the U. S. Supreme Court ultimately decided in the California tax case that "donations" towards the Church of Scientology were not tax-deductible ("Hernandez vs. Commissioner of the IRS," No. 87-963):
"Payments to the Church's branch churches for auditing and training services are not deductible charitable contributions under § 170.
"a) Petitioners' payments are not ‘Contribution(s) or gift(s)' within the meaning of § 170. The legislative history of the ‘contribution or gift' limitation reveals that Congress intended to differentiate between unrequited payments to qualified recipients, which are deductible, and payment made to such recipients with some expectation of a quid pro quo in terms of goods or service, which are not deductible. To ascertain, whether a given payment was made with such an expectation, the external features of the transaction must be examined. Here external features strongly suggest a quid pro quo exchange of petitioners' money for auditing and training sessions, since the Church established fixed prices for such sessions in each branch church; calibrated particular prices to sessions of particular lengths and sophistication levels; returned a refund if services were unperformed; distributed ‘account cards' for monitoring pre-paid but as-yet-unclaimed services; and categorically barred the provision of free services."
Still in 1987, Scientology finally lost its FOIA-suit against the IRS, which was originally filed on December 18th, 1980 at the U.S. District Court in Washington ("CSC vs. IRS et al.," No. CV 80-03239). Scientology requested in that suit:
"1. All documents or records ‘relating to or containing the names of Scientology, Church of Scientology, any specific Scientology church or entity identified by containing the words Scientology, Hubbard and/or Dianetics in their names, L. Ron Hubbard or Mary Sue Hubbard,' which could be located in a number of systems of records or files specifically identified in the FOIA request, ‘including but not limited to those located at the National Office, Regional Offices, Service Centers, District offices or Local IRS offices.'
"2. All documents generated, received or which otherwise came into the possession of the IRS subsequent to the preparation of an index in a tax case involving the Church of Scientology of California pending in the United States Tax Court, ... ."
The U. S. Supreme Court ultimately denied Scientology the right to get that information and stated that the IRS "has no duty under the Freedom of Information Act" to disclose internal records. [Exh. No. 136]
In another setback for the Scientologists on July 8th, 1988 the IRS denied three corporations, CST, RTC and CSI, tax-exempt status [Exh. No. 137]. In a lengthy letter the IRS summarized the major events in the history of Scientology's tax-exempt applications and concluded the finding by stating:
"1. You have failed to establish that you are operated exclusively for exempt purposes as required by section 501 (c) (3) of the Code. You have not demonstrated that your activities and purposes conform to exempt purposes and activities as required by section 501 (c) (3) of the Code.
"2. You are operated for a substantial non-exempt commercial purpose.
"3. You are operated for the benefit of private interests and your net earnings to the benefit of private individuals.
"4. You have failed to establish that you are not operated for the benefit of private interests and that your net earnings do not inure for the benefit of private individuals."
In response, CST filed suit against this decision at the U. S. Claims Court on October 6th, 1988 ("CST vs. United States," No. 88-581).
In 1989/'90 the FBI conducted an investigation into the activities of Scientology, due to allegations of blackmail brought up by ex-members [Exh. No. 138] but closed the case after several months of investigating.
After its application for tax-exemption was denied, CSI submitted a new request on March 15th, 1990 with the IRS' National Office in Washington. In its later application from 1993 it stated that in the course of the determination an IRS working group was formed in 1991 "to consider the exempt status of CSI and all churches of Scientology and all related organizations" [Exh. No. 139, Excerpt].
During that year, CSI launched another media campaign against the IRS, this time in alliance with a sweeping attack against "Time" magazine and the pharmacy giant Eli Lilly in retaliation for a negative article that had appeared in a May issue of Time [Exh. No. 140].
According to a public speech from October 1993 by David Miscavige, the head of RTC, the Scientologists filed another suit (for seeking $ 128 million) against the IRS during that period in the early 1990s, alleging misconduct in handling Scientology's tax-exempt applications.
Additionally, four senior executives of Scientology, including Miscavige, filed FOIA-suits against the IRS and the FBI at the U. S. District Court in Los Angeles:
- Mark Rathbun vs. IRS, No. CV 91-00844, filed on February 14th, 1991; - David Miscavige vs. IRS, No. CV 91-03721, filed on July 10th, 1991; - Norman Starkey vs. IRS, No. CV 91-04158, filed on August 2nd, 1991 and - Lyman Spurlock vs. FBI, No. CV 91-05602, filed on October 15th, 1991.
Last but not least, on August 12th, the Church of Scientology International filed a complaint for discrimination against the IRS ("CSI vs. IRS & William Connett," No. CV 91-0070 (JHG)). A later U. S. District Court opinion stated:
"Plaintiff, ... , initiated this action against the Internal Revenue Service (‘IRS') and William Connett (‘Connett'), the IRS representative in Paris and the IRS District Director for the Los Angeles, California office from 1973 to 1986, alleging, inter alia, that defendants interfered with the ability of Plaintiff's members to obtain valid entry visas under the immigration laws of the United States by furnishing to United States consular officials in Europe false and misleading information regarding CSI, the Scientology religion, and the legal requirements for the entry of such members into the United States."
The conflict arose when two Belgian Scientologists applied for visas at the U. S. embassy in Brussels in order to do Scientology training in Los Angeles. The consular official Jones denied the request, after having been informed by IRS representative in Paris, William Connet, that Scientology was not found tax-exempt by U.S. courts. The Legal Officer of the local Office of Special Affairs, Martin Weightman, however relied on a telex sent by the State Department, informing all embassies that it would recognize the Scientology organization in the U. S. as a "bona fide religion." The two Scientologists finally received "temporary visas" and apparently could later enter the United States.
In the above-mentioned speech, Miscavige revealed a particular detail of Scientology's dealings with the IRS that happened in 1991 and that later caused some speculation about its importance for the subsequent course of events:
"In October of 1991, while this war was raging at its apex, Marty Rathbun and I were in Washington D.C. to attend one of these court hearings I mentioned. It was to be the next day. We had just finished a lunch meeting and our next appointment wasn't for a couple of hours. In other words – we had some spare time on our hands. That's not something we're accustomed to! So we thought at least we could create some mischief. We told the lawyers we'd see them in an hour or so and that we would be down at the IRS building. Of course they had a good chuckle as we left the room. Off we proceeded to 1111 Constitution Avenue – which if you didn't know is the address of the National Headquarters of the IRS. We presented ourselves at security at the front door, signed the visitors log and informed them we were there to see Fred. They asked, ‘Fred who?' We answered, ‘Fred Goldberg of course, the commissioner of the IRS.' ‘Is he expecting you?' they asked. ‘No', was our response. ‘But if you phone him on the intercom and tell him we are from the Church of Scientology, I am sure he would love to see us.' Have you ever wondered whether we were really impinging, when we have spoken of the IRS at previous events? Well – if so – shame on you.
"We did meet with the commissioner, and, as the saying goes – the rest is history."
The next year saw, for the time being, the last legal defeat for the Scientologists against the IRS. On June 29th, 1992 the U. S. Claims court confirmed the decision of the IRS that CST was not operated for tax-exempt purposes.
With regards to CST's alleged "religious activity" of archiving Hubbard's writings, the court stated:
"1. Activity Cannot be Confused with Purpose
"CST has assiduously developed a record which demonstrates that most, if not all, of its prior activities are directed at preserving scripture. CST does not sell or market archived material, or make any profit on its activities. But even if CST could show that 95 per cent of its employees did nothing but archive Scientology documents, and only the remaining five percent were in charge of CST's property interests and finances that alone would not be enough to secure tax-exempt status. Congress did not intend for mere quantity of dedicated resources to be the deciding factor in whether an organization is operated for exclusively exempt purposes. Section 501(c) (3) contemplates that the IRS (and the court, if necessary) will inquire into the reality of an organization. ‘The bare fact that approximately half of each group is composed of not-for-profit organizations does not compel the conclusion that there is absent a substantial nonexempt purpose.' Copyright Clearance Ctr. v. Commissioner, 79 T.C. 793, 809 (1982); See also Better Business Bureau, 326 U.S. at 283.
"CST confuses activity with purpose. The law does not. As the Tax Court has held, ‘The operational test focuses on the purpose and not on the nature of the activity.' Goldsboro Art League v. Commissioner, 75 T.C. 337, 343 (1980). The Commissioner, and the court, are permitted to consider not just an organization's activities, but also to inquire into its purposes. The fact that an organization's activities have religious overtones and do not produce profits is no assurance those activities will be tax-exempt. ‘The critical inquiry is whether petitioner's primary purpose for engaging in its sole activity is an exempt purpose, or whether its primary purpose is the non-exempt one of operating a commercial business producing net profits for petitioner.' B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352, 359 (1978); accord Christian Manner Int'l, Inc. v. Commissioner, 71 T.C. 661, 668 (1979).
"In evaluating the real purpose of a transaction, the Supreme Court has cautioned against uncritical reliance on form as against function. Gregory v Helvering, 293 U.S. 465, 470 (1935), involved a scheme to avoid taxation of corporate distributions by invoking a code provision applicable to reorganizations: The whole undertaking, though conducted according to the terms of subdivision (B), was in fact an elaborate and devious form of conveyance masquerading as a corporate reorganization, and nothing else. The rule, which excludes from consideration the motive of tax avoidance is not pertinent to the situation, because the transaction upon its face lies outside the plain intent of the statute. To hold otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose.
"In like fashion here, CST must demonstrate that it was organized for an independent and bona fide purpose. Given the prior history of Scientology and the peculiar circumstances of CST's birth, it is appropriate to look beyond the flurry of archiving activity and inquire into whether the very existence of CST was brought about primarily to serve the non-exempt ends of other Scientology organizations. Although CST is entitled to minimize its own taxes, it would be a misuse of I.R.C. @ 501(c) (3) if its primary raison d'etre was to shield the income of other organizations from tax."