## Facts

- Southwest Texas Electrical Cooperative, Inc. was a rural electric cooperative exempt under I.R.C. § 501(c)(12).
- The Cooperative obtained approval for a $5.148 million loan from the Rural Electrification Administration (REA) to expand and upgrade electric facilities, with draws permitted only to reimburse construction costs.
- From 1983 to 1985, the Cooperative drew about $2.574 million but did not draw the remaining $2.574 million because improved finances made additional debt undesirable.
- In 1989, REA notified the Cooperative that eligibility for the remaining loan amount would expire; the Cooperative drew the remaining $2.574 million at 5% interest to preserve access to the funds and avoid losing prior loan-application value.
- Immediately after receiving the funds, the Cooperative deposited them into its general fund and used essentially all of them to buy two U.S. Treasury Notes yielding more than 9%.
- The Cooperative earned interest of approximately $146,096 (1989) and $230,938 (1990) and incurred related expenses, including REA interest, of approximately $86,222 (1989) and $134,813 (1990).
- The Cooperative reported no taxable income for 1989 and 1990; the Commissioner treated the net Treasury-note interest as unrelated business taxable income (UBTI).

## Issues

1. Whether interest from Treasury Notes purchased with REA loan proceeds was “debt-financed income” from “debt-financed property” under I.R.C. § 514 and therefore includible in UBTI under I.R.C. §§ 511–514.
2. Whether the Cooperative’s asserted non-investment “primary purpose” for borrowing (preserving future low-cost financing) prevented application of the § 514 debt-financed income rules.
3. Whether taxing debt-financed income under UBIT requires proof of actual or potential unfair competition with taxable entities.

## Decision

- The Fifth Circuit affirmed the Tax Court’s judgment for the Commissioner.
- The Treasury Notes were “debt-financed property” because they were held to produce income and were acquired with “acquisition indebtedness” within the meaning of I.R.C. § 514.
- The Cooperative’s subjective borrowing purpose did not alter the objective debt-financed character of the investment.
- UBIT treatment of debt-financed income was not conditioned on evidence of actual or potential unfair competition.

## Legal Principles

- Under I.R.C. § 514, income from property held to produce income is included in UBTI to the extent the property is financed by “acquisition indebtedness.”
- Application of § 514 turns on objective facts—whether borrowed funds were used to acquire income-producing property—not on an exempt organization’s claimed motives for borrowing.
- The policy rationale of preventing unfair competition does not operate as an extra-textual requirement limiting UBIT liability where statutory conditions for debt-financed income are met.
- On appeal from the Tax Court, legal conclusions are reviewed de novo and factual findings for clear error.

## Conclusion

The Fifth Circuit held that when a tax-exempt cooperative borrows funds and promptly invests them in income-producing securities, the resulting interest is taxable as debt-financed income under I.R.C. § 514 and included in UBTI, regardless of the cooperative’s asserted borrowing purpose and without any separate showing of unfair competition.


Sw. Tex. Elec. Coop., Inc. v. Comm’r, 67 F.3d 87 (5th Cir. 1995)