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May 19, 1993


The opinion of the court was delivered by: THOMAS A. FLANNERY

 This matter comes before the Court on the United States' motion for summary judgment. This suit was filed following a decision of the Internal Revenue Service ("IRS") to revoke the tax-exempt status of Airlie Foundation, Inc. ("AFI"). AFI seeks a declaratory judgment under 26 U.S.C. § 7428 that it is still entitled to its tax-exempt status.


 AFI has been classified as a tax exempt organization since 1963. In 1979, Dr. Murdock Head, the founder and executive director of AFI, was convicted in the Eastern District of Virginia of conspiracy to commit tax fraud and to bribe public officials. The Fourth Circuit reversed the conviction based on an improper jury instruction. United States v. Head, 641 F.2d 174 (4th Cir. 1981). Dr. Head was retried and again convicted in 1981. The conviction was affirmed in United States v. Head, 697 F.2d 1200 (4th Cir. 1982), cert. denied, 462 U.S. 1132, 77 L. Ed. 2d 1367, 103 S. Ct. 3113 (1983). AFI and Raven's Hollow, Ltd., a related corporation also controlled by Dr. Head, were named as unindicted co-conspirators in the case. *fn1"

 Based on the testimony at the criminal trials, the IRS began to examine AFI's tax-exempt status for the years 1976 through 1980. The IRS notified AFI of its concern by a draft technical advice memorandum ("draft TAM"), dated December 15, 1980. The draft TAM identified eleven issues to be addressed, each constituting a potential ground for revocation. Subsequent to the issuance of the draft TAM, AFI sought and received several extensions of time in which to respond to the draft TAM. AFI filed its response, called a protest, in 1983. AFI challenged the IRS' use of grand Jury materials and testimony from Dr. Head's criminal trials in its evaluation of AFI's tax-exempt status. The Fourth Circuit ultimately upheld this practice. United States v. Under Seal, 783 F.2d 450 (4th Cir. 1986), cert. denied sub. nom, Raven's Hollow, Ltd. v. United States, 481 U.S. 1032, 95 L. Ed. 2d 535, 107 S. Ct. 1964 (1987).

 In 1988, the IRS completed its determination which had been held in abeyance while the IRS' use of the grand jury materials and testimony was being challenged. In November 1988, the IRS issued its final TAM, revoking AFI's exempt status effective January 1, 1976, based on its conclusion that AFI was serving the private interests of Dr. Head. The IRS also based the revocation on its conclusion that AFI was operating as a commercial enterprise.

 Following a hearing on the United states' motion for summary judgment, the court remanded the matter to the IRS. The Court directed the IRS to set forth the facts, with specific citations to the administrative record, on which the IRS had based its revocation decision, in order that the Court could review the IRS' conclusions. See Memorandum Order, August 21, 1992. The IRS filed a compliance document in October 1992.


 A. Network of organizations

 The IRS revoked AFI's exempt status based, in part, on the conclusion that AFI was serving the private interests of Dr. Head. *fn2" This conclusion rests on Dr. Head's control over a network of organizations, including AFI, that were involved in numerous transactions and exchanges of money, marketable assets and land.

 At the center of this network was AFI, which was incorporated in 1960 as a Virginia non-stock corporation. Dr. Murdock Head founded AFI. The Foundation applied for tax-exempt status under Section 501(c)(3) of the Internal Revenue Code on August 17, 1962. The Foundation's application was referred to the Internal Revenue Service National Office for consideration and exempt status was granted in 1963. Dr. Head served as the unpaid Executive Director of AFI until October 1979. He admitted at his criminal trial that he controlled AFI. Head II, vol. XVIII at 85-86. *fn3"

 AFI, however, did not pay the rent. As of August 21, 1970, AFI owed Airlie Farm $ 442,740.93 in unpaid rent, represented by an unsecured note to Dr. Head. AFI's A.R. 22 at 67 (AFI's Protest). Interest due to Airlie Farm was apparently forgiven. In June, 1974, AFI issued a similar note for $ 132,823 to cover additional rent. AFI's A.R. 22 at 67. Dr. Head later used the two notes to establish the Airlie Trust, another non-exempt organization which he controlled.

 Kimmaren Corporation, another part of the network, was formed as a stock corporation in the Commonwealth of Virginia on December 23, 1975. On December 22, 1976, Dr. and Mrs. Head transferred the Airlie Farm property to their three children. Five days later, on December 27, 1976, Airlie Farm was transferred to Kimmaren Corporation in exchange for stock. The transfer included the realty leased to AFI; Kimmaren then, operated Airlie Farm and became AFI's landlord. AFI's A.R. 22 at 61. Kimmaren traded under the name Airlie Farm.

 Dr. Head controlled Kimmaren and his three children served as directors of the company. Dr. Head served as president and managing executive of Kimmaren Corporation. In 1977, Dr. Head received $ 12,000 compensation from Kimmaren. His daughter Kimberly Head replaced him as president in 1978. Viola Westlake was an officer for both AFI and Kimmaren Corporation.

 Yet another part of the network was Raven's Hollow, Ltd. This company was first incorporated on July 25, 1963. Dr. Head testified that he and Mr. Henry Bernie created Raven's Hollow. Head II, vol. XVIII at 79. Dr. Head exerted early control over Raven's Hollow. For example, although Dr. Head's name is not listed as one of the initial board of directors, Mr. Bain, one of the initial board members, testified before the grand jury that the information in the Raven's Hollow Articles of Incorporation came from Dr. Head.

 Raven's Hollow was next incorporated as a Virginia non-stock, not-for-profit corporation on December 20, 1965 and was voluntarily dissolved in May of 1977. AFI's A.R. 22 at 69. A new Virginia for-profit corporation bearing the name Raven's Hollow was formed in May, 1977. AFI's A.R. 22 at 70 ("New Raven's Hollow"). The new charter authorized the sale of stock so that the new Raven's Hollow entity could raise capital. Amended Complaint at P 46.

 Although the day-to-day control over the company may have been handled by paid managers, Dr. Head admitted at his criminal trial that he controlled Raven's Hollow: he was the company's "majordomo." He was a director of Raven's Hollow in 1965. Charles Francis, former president of Raven's Hollow, also confirmed in his trial testimony that Dr. Head controlled the company. Head I. vol. XVI at 361.

 Dr. Head testified that "Raven's Hollow was created to service the Foundation . . . Raven's Hollow, I presume, could exist on its own, but was not created to do that." Head I, vol. XIX at 1316. Raven's Hollow performed film work and ground and building maintenance for AFI. Raven's Hollow was located on the grounds of Airlie Foundation and operated from buildings which it leased from Airlie. AFI's A.R. 22 at 71. John Berne, an official of both AFI and Raven's Hollow, testified before the grand jury that "Raven's Hollow would not have existed if it didn't have a relationship with Airlie Foundation . . . because there wasn't any other film business at that time." Gov't.A.R. no. 23 (b) at 45.

 In addition to Raven's Hollow's dependence on AFI for business, the two organizations shared several officers and directors. For example, Edwin Bain was the Secretary of AFI and also on the board of Raven's Hollow. John Berne was President of AFI and an official of Raven's Hollow. Most importantly, Dr. Head agreed that it was a fair statement that he, AFI, and Raven's Hollow were synonymous. Head II, vol. XVIII at 190.

 B. Grounds for revocation

 In the final TAM, the IRS set forth various acts involving Dr. Head and this network of organizations that allegedly benefited the private interests of Murdock Head or his family.

 1. Airlie III

 In August, 1971, Dr. Head and AFI purchased a 42 foot fishing trawler for $ 62,388. The fishing trawler was modified to include a color television, new wiring to accommodate a refrigerator and other appliances, and chairs for deep-sea fishing. AFI entered into a lease agreement with Raven's Hollow, Ltd. for the trawler, Airlie III, for $ 28,800 per annum, from 1973 until 1976. Raven's Hollow had difficulty making the rent but AFI did not terminate the lease or reclaim the yacht.

 Although the boat was leased to allow Raven's Hollow to perform film work, no log or other record showing use of the trawler was maintained and none was presented to the IRS. See Head I, vol. XIX at 1379 (Dr. Head testified that no log was kept for the boat). Dr. Head did use the fishing trawler for personal use, but apparently reimbursed Raven's Hollow for such use. See AFI's A.R. 29 (letter of May 30, 1985, from AFI's counsel to IRS with attachments of copies of checks used for reimbursement by Dr. Head to Raven's Hollow for use of the Airlie III). Frank Kavanaugh, Executive Director of AFI, averred that the Airlie III had been used for filming but that its use was terminated due to one of AFI's projects. He also averred that the Airlie III was used as a base of operations for Airlie personnel, to store filming equipment and for fundraising and promotional purposes.

 2. Condominium

 In 1975, Dr. Head purchased for $ 29,000 condominium unit Number 101, located at The Old Cove Inn, Naples, Florida. Dr. Head made $ 5,000 in improvements to the unit. By letter of January 1, 1976, to Mr. Ross, AFI Director, Dr. Head wrote that the condominium was to be "passed free and clear to the Foundation with the retention of right of occupancy for myself in my lifetime based, of course, upon appropriate notice to the Airlie Foundation." *fn4" On July 30, 1976, Dr. Head donated the condominium to AFI and took a charitable deduction in the amount of $ 34,000, equal to the unit's appraised fair market value, on his 1976 Federal income tax return. AFI's A.R. 22 at 86. However, AFI's records do not reflect the alleged transfer nor do AFI's records show the condominium unit as an asset. Additionally, no log or record showing the use of Unit 101 was ever presented to the IRS.

 3. AFI buys property from Dr. Head.

 In June 1979, Dr. Head sold 39.298 acres of real estate to AFI for $ 300,000. Apparently no appraisal of the property was prepared nor is there any evidence that the sale price was reasonable for the property. Additionally, the transfer is not reflected as an asset on the 1979 return of AFI.

 4. Airlie Trust

 On July 1, 1974, Murdock Head, as grantor, established an irrevocable trust known as the Airlie Trust. The trust is a separate taxable entity. Dr. Head established the trust with two promissory notes from AFI. The notes represented unpaid rent which AFI owed to Airlie Farm. The first promissory note in the amount of $ 442,740.93 as well as an additional AFI note in the amount of $ 132,822.27 payable to Dr. Head was transferred to the Airlie Trust and then paid for by AFI. AFI's A.R. 22 at 67. AFI is the beneficiary of the trust, but if it ceases to exist, George Washington University will be the beneficiary. AFI did receive some income from the trust.

 There are two trust documents and the parties disagree which document controls. The first trust document provided that upon his retirement, Dr. Head was to receive "at least 5%" of the trust corpus, on a per annum basis. Gov't. Trial Ex. A-44a at P 1(a), (first trust document). The trust agreement was redrafted on the advice of Price, Waterhouse, AFI's certified public accountant, who was concerned that the provision which would have permitted Dr. Head to receive income from the trust would have an effect upon AFI's exempt status. AFI's A.R. 22 at 88-89 n.34. This second trust, backdated to July 1, 1974, but recorded in 1977, did not contain the reversionary income interest provision to Dr. Head. However, this document provided for compensation to the Executive Director (Dr. Head) as approved by the Executive Director, as well as the power to replace the trustees if they are unable to act. Gov't. Trial Ex. A-44 at 1, 4 (second trust document). Under the terms of either trust, as long as AFI exists, the trust corpus Is to be used as a fund for the purposes set forth in the document. *fn5" Additionally,

Pursuant to the death of the Grantor or following action of the Board of Directors in concert with expressed desire of the Grantor, it may be elected to utilize the corpus of the trust to purchase a portion of the real estate currently leased by Airlie Foundation from Airlie Farm.

 Id. Under the terms of either trust, then, Dr. Head could benefit, although AFI contends that he has never received any funds or other inurement from the trust.

 Although he was not on the board of trustees, Dr. Head exerted control over Airlie Trust. He retained the power under either trust document to replace trustees upon their resignation. Each of the trustees also had some connection to Dr. Head or his three organizations. The trustees of the Airlie Trust were Richard Ross, Edward Bain, and later Jean Head Sisco. Richard Ross was an officer with AFI, Director and Vice-President, and Vice-President with Kimmaren Corporation. Edward Bain, an attorney, was also the registered agent for Kimmaren and attorney for Dr. Head. ...

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