services are also available to and used by industry, and, in this respect, their availability is especially helpful to those industrial units which are not sufficiently large to have complete research facilities of their own. These institutes are recognized as important national scientific resources. Typically, such an institute is a nonprofit corporation with laboratories and related facilities in which scientific programs and projects are carried out. It provides an environment that is both appropriate for the conduct of scientific research and attractive to scientists.

If research contracts go to the organization having especially qualified individuals, then it is quite obvious that the nonprofit institutions do not have an advantage in securing research grants because of their tax status or any other status. The real advantage lies with the commercial organizations in this competition for research contracts, since the more flexible salary scales of these businesses should enable them to attract essential personnel.

Private industry, then, should be able to entice the best minds. Is this so in practice? Are the scientists in industry the leaders in their fields?

The surprising answer is "No," according to a study done by Francis Bello. He started out to identify a representative group of young scientists, those under 40, by asking for nominations of individuals thought to be the most promising both in industry and universities. Since it is the business of the foundations and the Government agencies charged with awarding research contracts to know the top men in the various research fields, these foundations and agencies were asked for nominations. Names of 225 promising young scientists emerged. The invesigator anticipated that the men would be about equally divided between industry and universities.

Imagine his surprise to find only 4 of his 225 were in industry. Since he feared that his sample was too biased, Bello went to the directors of leading corporations and to top academic scientists, asking for nominations of any scientists in industry they felt to be top rank. Even after all this extra searching, only 35 names were listed for industry.

Yet, this high percentage of promising young scientists in educational institutions is not because the majority of scientists are in the universities. The National Science Foundation finds that private industry employs more than half of our scientists and engineers. Of 250,000 persons employed at the professional level in the natural sciences, more than 60 percent are employed by private industry, almost 20 percent by higher educational institutions, and nearly 20 percent by Federal, State, and local governments. Of the estimated 700,000 engineers employed at the present time, about 75 percent work for private industry, about 20 percent for governmental agencies of various types, and probably 5 percent or less are employed by colleges, universities, and affiliated research institutions. Clearly then, the small group in the universities and research institutes comprise some of our best talent. Why are these men here rather than in industry where their monetary return would be greater?

The research environment may be the reason. Research, being forever at the fringes of knowledge, finds virtue in activity that seems to an outside observer to be completely purposeless. Problems still hidden in the fog of human ignorance cannot be defined until clearly seen. Discovery has an accidental quality. The contact of a trained, alert mind with an unexplained phenomenon initiates that basic research that may lead to profitable applied research and development. ***6

** * Although support of the individual of genius, who often times is a lone worker, has resulted in the accomplishment of great things in the past, Dr. Bush feels that much more has been and will be accomplished by "those who have brilliant creative skills combined with human attributes that make them always welcome in a community of their peers. *** The independent research institutions furnish an ideal climate in which such individuals can function to best advantage. ***7

5 "Strengthening American Science," a report of President Eisenhower's Science Advisory Committee, Dec. 27, 1958.

Dr. Clark A. Dunn, director of engineering research, Oklahoma State University writing in Industrial Research, summer, 1959.

7 Dr. Vannevar Bush writing in the Technology Review, of February 1954.

Substantial capital has been invested in these laboratories and related facilities. This capital has come from private grants and contributions that the provisions of section 170 of the Revenue Code have encouraged. However, in the rapidly changing economy of the 20th century the number and amount of such gifts has substantially decreased, with the result that it has become necessary for such organizations to earn their own way. The increased demand for the services of these organizations is creating a pressing need for additional capital expenditures and working capital which cannot be satisfied by available contributions.

Change and accelerated obsolescence are marks of scientific research. A scientific research organization cannot stand still; it must always be moving toward new frontiers. Its work constantly requires new instruments and facilities as well as continual modernization of older equipment. Adequate capital is essential. The fact that exempt scientific organizations, because they are nonprofit corporations, cannot have access to conventional sources of equity capital, requires the plowing back of earnings as an essential condition of survival in their present form.

EXEMPTION OF SCIENTIFIC ORGANIZATIONS FROM FEDERAL INCOME TAX AND ITS EFFECT

Before discussing the business income of exempt organizations, particularly the business income of exempt, scientific research organizations, it may be helpful to discuss the exemption itself. This exemption was first granted by section II (g) (a) of the act of 1913. The inclusion of "scientific" organizations in the exempting statute seems to have been justified and accomplished by reference to the practice of the State of Massachusetts-a State having perhaps the longest experience in supporting scientific activity. Congresswoman Rogers of Massachusetts requested the inclusion, saying:

In this connection I should like to refer to the language of the Massachusetts statute in this regard which exempts from taxation literary, educational, benevolent, charitable, scientific, or religious corporations. Three of the six exemptions along this line, which the Massachusetts law includes, are already in the act as reported; namely, educational, charitable, or religious corporations. I have not included in my amendment the word literary, although I think there is much to be said for that inclusion also, but I do think that there can be no sound objection to the inclusion of the words benevolent and scientific. * * * As to the inclusion of the word scientific, I have no especial need, I think, to dwell upon the propriety of that amendment. The great institutions in this country engaged in scientific research-with no purpose of gain or emolument in the institution as a whole or to the members who are concerned thereincertainly ought to be treated on the same basis as religious, charitable, or educational corporations.

In 1913, the institutions engaged in scientific research, to which Mrs. Rogers referred, consisted of academies of sciences in the several States, scholarly societies, museums, botanical gardens, and similar units. Many of these were supported wholly or in part, directly or indirectly, by State or local governments. Many also had private support. Among them was the Franklin Institute in Philadelphia. The Mellon Institute in Pittsburgh was being established at the time. At all times since 1913 the general concern with the development of scientific knowledge and its application has stimulated the growth

of scientific research organizations in the United States. However, it is very doubtful that Congressman Rogers could have foreseen the beneficial effect of the exemption of scientific organizations that has become so apparent since 1940. Federal research and development expenditures charted in figure 1 unmistakably record the rapid rise in Federal concern with scientific research since 1940. In the "years since the end of World War II science and technology have pushed to the forefront of national life with an urgency that no Congress or President serving in the first four decades of this century could have imagined. This year, 1958-59, the U.S. Government will spend over $5 billion on research, engineering, and development, substantially more than was spent in the entire four decades 1900 to 1939 and more than the total Federal budget of a generation ago." There is reason to expect continuing expansion of Government activity in this

area.

Growth. It is not surprising that the growth of nonprofit, taxexempt scientific organizations has been rapid during the past 15 years. The demand for research and development has grown more rapidly than the capacity of existing institutions to satisfy the demand. Research must be done by people; effective research can be done only by competent people. The noncaptive, independent, objective climate of the scientific research organizations that have qualified for exemption under the Internal Revenue Code has proved to be very attractive to the scientist. The result is that these scientific research organizations have been highly successful in gathering together staffs of talented scientists. This combination of experts and facilities, which has been made possible in large part by the exempting provision of our revenue code, has come into being because of the need for the services of such combinations. The usefulness of these organizations is suggested by their growth, which is shown in figure 2.

Approximately two-thirds of all of the research which is conducted by these organizations is paid for by the Federal Government. The other one-third of the work that is done by most of these organizations consists of a small self-sponsored portion and projects or programs that are paid for by State and local governments or their agencies, by private foundations, and by industry. A part, significant but not easily segregable, of the industrially sponsored research is actually supported by the Federal Government, but goes to the scientific research organization as a subcontract from the industrial prime contractor.

There are on the staffs of these institutes researchers in practically every recognized scientific discipline. Areas of study extend across the entire frontier of science.

BUSINESS INCOME OF EXEMPT SCIENTIFIC ORGANIZATIONS

The question of the tax treatment of business income of exempt nonprofit scientific research organizations is basically a question of national science policy. The exemption is based upon recognition by every Congress since 1913 of the public importance of scientific activ

8 "Strengthening American Science," a report of President Eisenhower's Science Advisory Committee, Dec. 27, 1958.

ity. The purpose of this exemption is the encouragement and promotion of that activity.

The language of the exempting provision itself expressly recognizes as a prerequisite to the effective operation of the exemption the existence of net earnings; unless there are net earnings, the exemption has little meaning.

What, then, are we talking about when we speak of "business income" of exempt nonprofit scientific research organizations? In the absence from the Internal Revenue Code of any comprehensive definition of "trade or business," it seems reasonable to regard the term "business" as including any regularly conducted exchange of services or goods for money or other consideration. This could classify as "business" activities practically all of the activities of exempt scientific research organizations because, in return for research performed for National, State, or municipal governments or for private foundations, or for industry, the exempt scientific research organization receives payment. It would seem to follow that all of the income which is thus received is business income.

The receipt by exempt organizations of payment or fees for services has long been an established and accepted practice. Examples are the fees received by hospitals and schools; even the offerings received by churches, to the extent that they are directed to current expenses and plant investment and maintenance, can be considered payments by members of the congregation for the material part of the benefits received by them from the church. Similarly, scientific research organizations receive payment for research projects conducted by them. The fact is that all of these organizations must realize this income in order to survive.

Considered in the light of the provisions of section 501 (c) (3) of the Internal Revenue Code, as that section originally appeared in 1913 and as it has continued to appear in every revision of the code since then, it is reasonable to conclude that the net earnings of an exempt nonprofit scientific organization which had their source in the exempt scientific activity are precisely the net earnings which each of the Congresses enacting this provision intended to exempt from income tax. The benefit which these Congresses intended to confer for the purpose of encouraging scientific activity was the ability of the nonprofit scientific organizations to use these net earnings, undiluted by taxes, for the expansion of scientific effort. Each of the enacting Congresses seems to have regarded the elimination of the possibility of personal profit from such exempt activity as a safeguard against abuse of the exempt privilege.

EFFECT OF AMENDMENT OF 1950

In 1950 the Congress added to the Internal Revenue Code sections 421, 422, and 423 (now secs. 512 and 513). These sections imposed Federal income tax upon such portion of the net income of exempt organizations as derived from any trade or business—

the conduct of which is not substantially related (aside from the need of such organization for income or funds or the use it makes of the profits derived) to the exercise or performance by such organization of its *** purpose or function constituting the basis for its exemption * * *.

In these added sections there is no language which taxes any income derived by a nonprofit exempt scientific research organization from scientific research. However, section 422 included, and section 512 currently includes, three affirmative specifications (sec 422 (a) (7), (8) (A) and (B)) of exemption of research income. These specifications actually do not apply to exempt independent scientific organizations, but they have been employed as the bases for inferences which have created confusion in the entire area of exemption of scientific organizations. Clarification of section 512 would be helpful and would complement action defining "scientific" as used in section 501 (c) (3).

NEED FOR CLARIFICATION

We have already seen that prior to the enactment of the 1950 amendment the exemption from Federal income tax of all net earnings of exempt nonprofit scientific research organizations which derived from their scientific activities was unquestioned and unquestionable. As a result, during the period from 1913 to 1950 this exemption operated