MacRae Land Trust v. Commissioner

Hugh MacRae Land Trust, R. M. Sheppard, Julian W. Morton, and R. O. Crockett, Trustees, Petitioners, v. Commissioner of Internal Revenue, Respondent MacRae Land Trust v. Commissioner Docket No. 108797 United States Tax Court 1 T.C. 899; 1943 U.S. Tax Ct. LEXIS 187; April 13, 1943, Promulgated *187 Decision will be entered for the petitioners. Association Taxable as a Corporation -- Trust. -- A trust created to execute a lease on a tract of coal deposit land and pay royalties to a group of beneficial owners was not taxable as a corporation. R. O. Crockett, Esq., for the petitioners. L. W. Creason, Esq., for the respondent. Harron, Judge. HARRON *900 Respondent originally determined deficiencies in income and excess profits taxes for the year 1937 in the respective amounts of $ 4,327.07 and $ 4,326.52. Respondent has conceded error in one determination and now agrees that the deficiencies are not greater than $ 3,566.73 and $ 282.34. The only issue involves the question whether the trust is an association taxable as a corporation under section 1001 of the Revenue Act of 1936. Petitioners filed a fiduciary income tax return for 1937 with the collector for the district of North Carolina. FINDINGS OF FACT. Sometime prior to 1934 a tract of land located in Buchanan County, Virginia, was held as follows: 6,008.5 acres were held by Hugh MacRae, trustee for various persons, and 808.5 acres were held by several individuals. The tract of land was owned jointly*188 by three individuals prior to 1887. During subsequent years several persons acquired interests in the tract through gifts and inheritance, and in 1934 about 35 persons, mostly heirs at law, owned interests in the tract of land. The owners of the interests in this property, with the exception of one who lived in China, lived in various sections of the eastern part of the United States. The property is located in mountains. Its only substantial value is in the coal which underlies it. Prior to the year 1936 the only income derived from the property was from the sale of timber. In 1934 Hugh MacRae, representing all of the owners of the various interests in the 6,817 acres of land, entered into negotiations with the Page-Pocahontas Coal Corporation, hereinafter called Page, under the terms of which Page would acquire the right to mine coal. Page, as a condition precedent to the acceptance of a lease, required that the parties in interest execute a trust agreement whereby trustees would be appointed to receive the royalties accruing from such lease. On August 30, 1934, Hugh MacRae, trustee, and others, granted to Page an option to lease the mining rights to the coal under the 6.817*189 acres of land. On November 19, 1934, Page duly exercised the option. As of June 17, 1935, a deed and declaration of trust was executed by and between all of the owners of the interests in the above mentioned property and Nelson MacRae, Julian W. Morton, and R. O. Crockett, as trustees. The real estate and interests in minerals and timber were conveyed to the trustees, subject to the terms of the trust. This action was taken pursuant to the requirement of Page. (Nelson MacRae died subsequent to the hearing in this proceeding and R. M. Sheppard was appointed successor trustee.) The trust instrument provided that trust certificates were to be issued as evidence of the interests of the grantors under the trust *901 and in the royalties which might accrue from the properties. A total of 6,817 shares, represented by such trust certificates, or one share for each acre of property, were to be issued to the owners of the beneficial interests. Such certificates were to be transferable on the transfer books kept by the trustees as a record of the ownership of the certificates. The trustees were empowered to sell or lease the property and to receive the proceeds and accruing royalties*190 or moneys, except, however, that the trustees could not sell any of the trust property without first obtaining the permission of the holders of at least 4,546 shares of certificates of interest. It was also provided that the trustees "shall not engage themselves in operating, mining, digging or removing such coal and minerals." The trustees were empowered to do those things deemed necessary to properly execute the trust, and to defend and protect the trust and its property. The trustees were required to keep accurate books of account and to make annual settlements on their accounts before the Commissioner of Accounts in Buchanan County, under the law of Virginia applicable to trustees. Any moneys which the trustees might receive were to be applied as follows: (1) To the payment of taxes and levies upon the property; (2) to discharge the expenses of executing the trust, including compensation to the trustees in the amount of 5 percent of such moneys; (3) to pay all debts, costs, fees, charges, and expenses incurred in the discharge of the trust; and (4) to distribute the residue of such moneys pro rata to the holders of the trust certificates. In the event of the incapacity or resignation*191 of any trustee, the remaining trustees could appoint a successor trustee. The holders of the trust certificates were required to pay the taxes and assessments upon the trust real estate and the costs, fees, and expenses incident to the preparation and execution of the trust in proportion to their interest in the trust, provided that such charges had not been previously paid by the trustees out of funds in their hands. All of the owners of the beneficial interests under the trust ratified the giving of the option for a lease to Page. The trustees were directed to execute and deliver a lease to Page pursuant to the opinion. Trust certificates representing 6,817 shares were issued to the individual grantors of the trust in accordance with their respective interests in the tract of land. Nelson MacRae kept the certificate transfer book and a combination check register and journal wherein all receipts and disbursements of the trust were recorded. As the trustees did not have any office, the trust books were kept by Nelson *902 MacRae in his private desk in the office of Hugh MacRae & Co., where he was employed. On January 14, 1936, the trustees leased the coal and mineral rights*192 under the trust lands to Page pursuant to the option. The lease was for a period of 10 years with automatic renewals of 40 years in case all the merchantable coal was not removed. The lease was to terminate when all the workable and merchantable coal had been mined. The lessee was to pay stated royalties for each ton of coal mined to the trustees. Such royalties were to be paid after the end of each quarter of the year. The lessee was to deduct $ 1,500 a year from royalties to apply on state and county taxes on coal and on lands leased, and, beginning with the operating period, was to pay the residue of taxes due during the life of the lease. Also, the lessee was to pay taxes on all improvements placed on the property. In 1936 the trustees conveyed a right of way to the Norfolk & Western Railway Co. for its railroad to the present tipple of the lessee so that the coal in the leased premises might be removed. The lease contemplated that Norfolk would construct a line over the property to carry off the coal mined. The trustees received the sum of $ 828.50 for this right of way. Also, in 1936, the trustees conveyed a right of way for electric power lines to the Appalachian Electric*193 Power Co. to carry power to the coal mines, and they received the sum of $ 1,265.50 therefor. Page mined 12,479 tons of coal in 1936 and 298,623 tons in 1937, total, 311,102 tons. The royalty per ton paid was 13 cents. The trustees received $ 1,622.27 in 1936 and $ 38,820.99 in 1937 (which included $ 1,500 of royalties retained by Page to pay taxes, as the lease prescribed), total, $ 40,443.26. The total received from royalties and the sales of the rights of way was distributed by the trustees as follows: $ 1,952 was paid for 1935 taxes on the trust real estate; $ 650 was paid to a real estate agent. W. L. Dennis, for his services in connection with making the lease; $ 592.92 was paid to R. O. Crockett, attorney, for expenses incurred; and $ 1,000 was paid him for services rendered in the preparation and execution of the option for the lease, the trust instrument, and the lease; $ 600 was paid to H. A. Kiser, engineer for services for one year; $ 2.20 was paid for a check book; $ 185.81 was paid to the trustees in compensation for their services as allowed by the trust instrument; $ 35,789.25 was distributed to the holders of certificates of interest. At the end of 1937 the trustees*194 had on hand a balance of $ 265.10. The trust does not have an office, officers, or bylaws. There has never been a meeting of certificate holders. After making the lease and selling the rights of way nothing remained for the trustees to do except to receive royalties and distribute them to the beneficiaries of the *903 trust. Royalties from the mining operations are received quarterly and distributions thereof are made promptly to the beneficiaries. In 1937 such distributions were made on the same date the royalties were received in some instances and within ten days in others. During each year the trustees pay a mining engineer, Kiser, to check on the actual tonnage of coal mined and to compute from that the amounts of royalties due to the trust. Kiser makes this check at least four times a year. The trustees are entitled to receive 5 percent of the trust receipts for trust expenses and their commission. The fee for Kiser's services and the trustees commission are the chief, if not the only, expenses of administering the trust. The trust has no employees. During 1936 and 1937 a few certificates of interest were transferred at the request of the holders to their children*195 and to R. O. Crockett. Petitioners filed a capital stock tax return for 1937 under protest. OPINION. The question is whether the trust is an association taxable as a corporation. Each party contends that the criteria laid down by , 1 support his respective claim. The beneficiaries of the trust were the fee owners of interests in a tract of land which originally was jointly owned by three persons, through whom almost all of the trust beneficiaries received their interests. To make the tract of land attractive to a coal mining company, they pooled their interests by placing them in a trust for the sole purpose of negotiating a lease of the entire tract to the coal company and to receive their royalties*196 through the agency of a trustee. The trust instrument evidences no intention to actively engage in a business and contains a clause prohibiting the trustees from carrying on coal mining operations. The purpose of the owners was to dispose of the underlying coal through the instrumentality of a lease to the Page-Pocahontas Coal Corporation in consideration for the payment of royalties on coal mined. The coal company would not have entered into a lease of the tract of land unless the several owners of interests, some of which were small, pooled their interests in a trust for obvious practical reasons, chiefly because of the complexity of paying royalties directly to the several owners of interests or to their heirs, in the event of death, because of the difficulties of negotiating separate and multiple leases directly with the various owners and the legal complexities which would arise upon the death of the various owners. The tract of land had to be dealt with as a whole to make any coal mining operations practical. The *904 purpose of the trust was to effect the lease. The trustees executed the lease with the approval of the beneficiaries. Thereafter, the only activities*197 carried on by the trustees were to hold legal title to the property, to receive the royalties, to ascertain that the royalties due under the lease were paid, to keep records, and to distribute the net receipts to the beneficiaries after deducting the nominal 5 percent for trustees' commission and necessary expenses. In other words, the trustees were to do no more than collect income earned by property under the operation of the lessee and distribute it to the beneficial owners of the property. The lessee was the entity which engaged in economic activity for profit. The function of the trust and the trustees was not of such character as to constitute the carrying on of a business enterprise for profit. "The mere receipt of income from leased property and its distribution to cestuis que trustent amounts to no more than receiving the ordinary fruits that arise from the ownership of the property and does not constitute doing business." ; certiorari denied, . As in the Cleveland Trust Co. case, the trustees were not holding and operating property*198 for profit. See also, Commissioner v. Gibbs-Preyer Trusts Nos. 1 & 2, : ; Wyman Building Trust (#1), ; ; T. C. 726. Cf. . The facts do not support respondent's view that the trust was created for the purpose of mining and selling coal. Also, the trust was not created to sell real estate. In 1936 the trustees sold a right of way to a utility company and a right of way to a railroad company, but those transactions were special and the trust does not contemplate any other similar transactions. Under the lease to Page the lessee is given the right to transport coal mined across the leased premises; it is given limited surface privileges necessary to use in mining, including the right to erect inclines, slopes, tipples, houses for employees, power houses, lines for the transmission*199 of electric power, and the privilege of building, maintaining, and operating tramways, railroads, and other roads; and the lease was to become void if at the end of three years no standard gauge coal-carrying railroad was constructed to the premises. Under the trust instrument the trustees were given authority to sell or grant rights of way for railroad and public utility companies. That was, clearly, to enable the trustees to perform the necessary legal grants requisite to the lessee's carrying out the terms of the lease. The issuance of trust certificates, or certificates of interest, to the grantors of the trust was strictly in proportion to their ownership of interests in the tract of land and facilitated their receiving royalties in *905 proportion to their interests as cestuis que trustent. The trust instrument stated that the grantors of the trust were the beneficial owners of the real estate, and coal and mineral rights in stated proportions, which represented the respective interests which were derived from the original three joint owners of the tract through inheritance and gift, and the trust certificates, issued at the rate of one share for each acre of property, *200 were issued in the identical proportions. The use of trust certificates as the formal evidence of interests in a trust and rents and royalties which may accrue from property owned by the trust are not the test of an association. The trust was intended to have a life contemporaneous with the life of the lease to Page. The situation presented here resembles that in , in that if it were not for the declaration of a trust, there would have been the simple case of owners of land appointing an agent to make a lease and collect royalties for the owners of the fee interests, receiving as compensation for its services a fixed percentage of the royalties. The trustees were a conduit through which the income earned by the leased premises flowed to the owners thereof. It is held that the trust is not an association taxable as a corporation. Decision will be entered for the petitioners. Footnotes 1. See also, ; ; .↩