Commercial Trust Co. v. Commissioner

COMMERCIAL TRUST CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Commercial Trust Co. v. Commissioner Docket Nos. 31926, 31927. United States Board of Tax Appeals 18 B.T.A. 1248; 1930 BTA LEXIS 2494; February 19, 1930, Promulgated *2494 The petitioner was created by a declaration of trust made November 1, 1920. Property of the value of $100,000 was transferred to a sole trustee. Power to terminate the trust was reserved to the beneficiaries. The petitioner was actively engaged in carrying on a business during the years 1922, 1923, and 1924 and filed fiduciary returns for those years. The Lone Star Realty Co. was created by a similar declaration of trust made January 20, 1922. Property of the value of $25,000 was transferred to a sole trustee. The trust carried on an active business during the years 1922 and 1923 and filed fiduciary returns for those years. Held, under the provisions of section 704 of the Revenue Act of 1928, that the petitioner and the Lone Star Realty Co. are taxable as trusts and not as associations during the taxable years 1922 and 1923. Eustis Myres, Esq., and D. F. Reed, Esq., for the petitioner. A. H. Fast, Esq., and Harold D. Thomas, Esq., for the respondnet. SMITH *1248 These proceedings were consolidated by order of the Board for the purpose of hearing and opinion. Docket No. 31927 is predicated upon a deficiency notice dated August 23, 1927, which*2495 states that there has been assessed against the petitioner, under the provisions *1249 of section 279(a) of the Revenue Act of 1926 (relating to jeopardy assessments), income and profits tax, penalty, and interest amounting to $55,506.28 for the taxable years 1922 to 1924, inclusive. Docket No. 31926 is predicated upon a deficiency notice dated August 23, 1927, which states that there has been assessed against the petitioner, under the provisions of section 279(a) of the Revenue Act of 1926, unpaid income and profits tax, penalty, and interest of the Lone Star Realty Co. amounting to $10,749.85 for the taxable years 1922 and 1923, and which states that the assessment represents the petitioner's liability under section 280 of the Revenue Act of 1926 as a transferee of the property of the Lone Star Realty Co. The petitioner alleges numerous errors on the part of the respondent in his computation of the amounts assessed and also alleges that respondent erred in holding that either it or the Lone Star Realty Co. was an association or a joint stock company, or that either was taxable as such during the years involved, inasmuch as the said organizations were trusts whose income*2496 was distributable periodically by a trustee. The petitioner further pleads the bar of the statute of limitations against any liability on the part of the petitioner for the unpaid taxes of the Lone Star Realty Co. for the years 1922 and 1923. Upon motion of counsel for petitioner made at the hearing the issues to be considered at this time were limited to the question (1) whether the petitioner and the Lone Star Realty Co. are taxable as trusts or as associations or joint stock companies during the taxable years involved, and (2) the statute of limitations. The right to a further hearing upon the other issues raised in the petitions and answers was reserved pending the Board's decision on the issues herein submitted. FINDINGS OF FACT. The petitioner was created by a declaration of trust on November 1, 1920, which provided in part: This Declaration of Trust and acceptance thereof made this the 1st day of Nov. A.D. 1920, by Y. O. McAdams, B. M. Luse, E. P. McAdams, W. P. Luse, and Ellah K. McAdams; residents of Dallas, Tarrant and Wichita Counties, Texas, creators of this Trust herein after designated as "Subscribers" and W. P. Luse, resident of Dallas County, Texas, together*2497 with his successor or successors in trust, hereinafter designated as "Trustee." Witnesseth: Whereas, the subscribers have transferred and conveyed and by these presents do hereby assign, transfer and deliver unto the said trustee under the designation of Commercial Trust Company, in trust the sum of $100,000.00 in cash, notes, stock, and real estate; and Whereas, the trustees for the purpose of defining the interest of the cestius que trustent hereinafter designated as "Beneficiaries," and their successors and assigns in said property, hereinafter referred to as "Trust Estate" have *1250 issued to the said beneficiaries, negotiable certificates or evidece of interest to the number of 4000 shares of the par value of $25.00 each, the number of shares issued to each beneficiary being set opposite his name as follows, to-wit: Shares Y. O. McAdams 1,500 B. M. Luse [999] E. P. McAdams [500] Ellah K. McAdams 1,000 W. P. Luse [1] Whereas, the term "Trustee" shall signify all trustees whether the original trustee or his successors, acting at any given time regardless of their number, and the term "Trust Estate" and "property of the trust estate" as used herein, *2498 shall signify the property held by the trustee in trust, hereunder at any time whether the same be money or merchandise, personal or real property, notes or chattels. The term "Beneficiary" or "Beneficiaries" as used herein shall signify the Cestui Que Trust or Cestius Que Trustent holding hereunder of units of interest in the earnings or proceeds of the property of the trust estate at any given time. The trustee was to hold the property and proceeds therefrom - * * * In trust, to manage, invest, re-invest and dispose of the same and to collect, receive and distribute the proceeds therefrom for the benefit of the holders from time to time of the certificates of units of interest from time to time issued and outstanding hereunder, in the manner and subject to the stipulations and limitations herein contained * * *. The declaration of trust further provides as follows: Second: The trustee shall hold the legal title to the trust estate, and it shall be administered at all times by the trustee for the uses and purposes and with the powers and duties created hereby and subject to the terms of this instrument. The said legal title shall rest solely in the trustee. The beneficiaries*2499 as such, shall have rights only in and to their respective pro-ratas of earnings as and when they are distributed by the trustee. * * * Third: The assets now constituting the trust estate and all additions to the same are, and shall be owned and held by the trustee for the transaction of, and the trustee shall have full power to do all things in his judgment necessary and prudent in the management and conduct of, the business of the trust, the same being as follows: The buying and selling of goods, wares and merchandise of any description by wholesale and retail, particularly the buying and selling of real estate, chattles, real estate, notes lending monies, buying and selling stocks and bonds of any kind whatsoever, and the purchase and sale of such goods, wares and merchandise used for such business; and the accumulation and loan of money in the purchase and sale of bills, notes and other negotiable instruments. * * * Fourth: The trustee shall distribute all net income accruing from the business transacted by the handling of the funds and property of the trust estate periodically, at reasonable intervals not more than 12 months apart, reserving only such amounts as may be*2500 necessary to cover contingencies, losses and depletions of the trust estate, so that the corpus of the trust estate shall not be dimiinished thereby. The Trustee may from time to time set apart out of the income of the trust property, as and for a surplus fund, [sic] shall be applicable during the continuance of said trust to any purpose to which money from a *1251 part of the corpus or income may be applied, including distribution among the several cestuis que trustent, as hereinbefore provided. The determination of the trustee made in good faith, as to all questions between "corpus" and "income" shall be final. Fifth: The Trustee shall have the right and power respecting the property of the trust estate that he would have if transacting his own business or if administering an estate belonging to the trustee alone. The trustee shall keep an accurate record of all business and transactions of the trust which shall be open to inspection to interested parties under proper circumstances and at such proper times as may be determined by the trustee. The trustee is expressly empowered to borrow money, execute obligations negotiable or otherwise, and otherwise charge the trust*2501 estate or any part thereof. The enumeration of particular rights and powers herein is intended in nowise to qualify the general rights and powers herein and hereby vested in the trustee. Sixth: That with the consent in writing of at least 2/3 in quantity, of interest of cestuis que trustent hereunder, the trustee may make any change whatsoever in this trust which the trustee may deem proper. Trustee will defray out of the trust estate all the expenses and obligations incurred in administering and liquidating the trust estate, and may charge reasonable compensation for services rendered. The Trustee may form a corporation or corporations and convey to same the trust estate or any part thereof; and hold the considerations accruing therefrom whether the same be in the form of shares, certificates of interest or other things of value, or may distribute the same pro rata among the cestuis que trustent. Seventh: This trust shall continue for the term of 21 years after the death of the last survivor of the said W. P. Luse, at which time the then trustee shall proceed to wind up its affairs, liquidate its assets and distribute the same pro rata among the holders of certificates of*2502 beneficial interest. Provided however, that if prior to the expiration of said period, the holders of at least 2/3 of the said shares of beneficial interest then outstanding shall signify in writing their desire to terminate or renew this trust, then said trust shall either terminate or be renewed and continue in existence for such further period as may be determined not inconsistent with law. * * * Ninth: The Trustee is authorized to sell and deliver to such persons, firms or corporations as the trustee may deem proper such quantities of new units of beneficial interest, for such consideration as the trustee may deem to be to the best interest of the trust estate and to issue certificates therefor, but all funds and property realized shall be solely for the benefit of the trust estate and to discharge such obligations of the trustee and the trust estate as may be lawfully created. * * * Eleventh: The trustee in this trust capacity shall have the right to compensate himself and such other agents or employees as he may designate from time to time out of the trust estate, for all services rendered on behalf thereof, making such compensation either upon a salary basis or upon*2503 basis of commission or both methods. The trustee may with individual funds buy, sell or otherwise deal in units of interest or ownership without liability or obligation to the trust estate. Twelfth: The trustee, when creating any obligation on behalf of the trust estate may notify other parties to the transaction that the business to be transacted is on behalf of the trust estate and that neither the trustee, nor the *1252 owners or holders of units of interests are personally liable for such undertaking, and in written contracts, trustee shall whenever practicable, give notice of the stipulations herein respecting such liabilities. The Lone Star Realty Co. was created January 20, 1922, by a declaration of trust made by D. E. Humphrey, R. H. Sowell, B. M. Luse, E. D. McAdams, and W. P. Luse, designating W. P. Luse sole trustee. The subscribers were to transfer to the trustee cash, notes, stock, and real estate to the value of $25,000 for which they were to receive, in proportion to their contributions to the trust, 1,000 shares or certificates of interest of a par value of $25 each. As far as material to these proceedings the Lone Star Realty Co. was identical with*2504 the petitioner in its organization and operation. Prior to the petitioner's organization representatives of the individuals who later became beneficiaries under the above trust agreements consulted with a former deputy collector of internal revenue in Texas who, in turn, wrote to the Commissioner in Washington, submitting an outline of a proposed trust agreement and a copy of a declaration of trust substantially similar to the declaration of trusts under which the petitioner and the Lone Star Realty Co. were created and requesting his opinion as to the status for taxation purposes of the organization created thereunder. The Commissioner replied under date of July 9, 1920, stating in part as follows: After careful consideration of all the facts hereinbefore set out, the office is of the opinion that the Dallas Electrical Appliance Company is a trust, the entire net income of which is distributable periodically. The trustee will therefore be required to file a return on Form 1041 for every taxable period during which the net income of the trust estate, computed in accordance with Section 219(b) of the Revenue Act of 1918, is $1,000.00 or more, if all the beneficiaries are American*2505 citizens or residents. If at any time any beneficiary of the estate is a nonresident alien, the trustee will be required to file such return, regardless of the amount of the net income of the estate. Upon this return must be shown the name and the address of each beneficiary and his distributable share of the net income of the trust estate, whether such income is distributed or not. Each beneficiary must report in his return of income rendered for each year his distributable share of the net income of the estate for that year. Attached to the Commissioner's letter was a copy of Office Decision 620, reading as follows: A, who had the State agency for the sale of a certain appliance, not having sufficient funds of his own to operate the business and not desiring to form a corporation in which he could not have a controlling interest, associated himself with B and C, who wished to invest their money without assuming the responsibilities of partners. A trust agreement for a stated number of years was entered into under which A was designated as trustee for his own and the other interests. The declaration of trust recited that the parties have paid to the trustee a sum of money*2506 for which he has issued to them negotiable *1253 certificates of beneficial interest. It was stipulated that the beneficiaries should have no right to call for a partition or termination of the trust, and that the death, insolvency or bankruptcy of a beneficiary should not operate to dissolve or terminate the trust or in any way effect the operations thereof. It was further provided that the trustee was to have absolute control over the affairs of the trust and to distribute the net income periodically at intervals not more than a year apart. In short, the trustee was given all rights and powers which would have been his if he were conducting a business of which he was sole owner. In case of the appointment of a new trustee by reason of death, disability or failure to act, a majority in interest were empowered to suggest to the court a successor trustee. Held, that the organization so formed is a trust, the income from which is distributable periodically. The trustee should file returns accordingly, using Form 1041 and showing therein, in addition to the income and deductions of the business, the distributive shares of the owners of the beneficial interests. The beneficiaries*2507 should include as gross income in their personal returns the amounts so shown in the trustee's return to be their distributive shares of the net income of the business whether actually paid to them or not. Thereafter, a firm of attorneys of Dallas, using the Commissioner's letter above referred to and Office Decision 620 as a guide, drew up the declaration of trust under which the petitioner was created. The Lone Star Realty Co. was organized in a similar manner about 18 months later. Both the petitioner and the Lone Star Realty Co. continued to operate under their respective declarations of trust during the taxable years involved. During or at the close of each year the trustee credited to each of the beneficiaries his pro rata share of the trust earnings. The beneficiaries were privileged either to draw out their funds or to leave them in the hands of the trustee. The trustee acting under the instructions of the collector of internal revenue for his district filed fiduciary returns for the petitioner and the Lone Star Realty Co. on forms provided by the collector. The returns for the petitioner and for the Lone Star Realty Co. for the years 1922 and 1923 were filed on*2508 February 26, 1923, and March 15, 1924, respectively. The petitioner's return for 1924 was filed on March 14, 1925. Each of these returns showed the amount of trust income distributable to the beneficiaries. During the taxable years involved each of the beneficiaries of the trusts reported as his individual income the amount of trust earnings shown to be due him in the fiduciary returns filed by the trustee. On August 23, 1927, the respondent notified the petitioner of a jeopardy assessment of $55,506.28 income and profits tax, penalty, and interest for the years 1922, 1923, and 1924, and a jeopardy assessment of $10,749.85 for the years 1922 and 1923 representing the petitioner's liability as transferee for unpaid income and profits tax, penalty, and interest of the Lone Star Realty Co. *1254 OPINION. SMITH: The respondent has determined that both the petitioner and the Lone Star Realty Co. are taxable as associations during the taxable years involved and has assessed the deficiencies so determined against the petitioner. The deficiencies of the Lone Star Realty Co. for the years 1922 and 1923 have been assessed against the petitioner upon its liability as transferee*2509 of the assets of that company. The petitioner contends that neither it nor the Lone Star Realty Co. is taxable as an association for either of the taxable years involved. In this contention it relies chiefly upon the provisions of section 704 of the Revenue Act of 1928, which reads in part as follows: (a) If a taxpayer filed a return as a trust for any taxable year prior to the taxable year 1925 such taxpayer shall be taxable as a trust for such year and not as a corporation, if such taxpayer was considered to be taxable as a trust and not as a corporation either (1) under the regulations in force at the time the return was made or at the time of the termination of its existence, or (2) under any ruling of the Commissioner or any duly authorized officer of the Bureau of Internal Revenue applicable to any of such years, and interpretative of any provision of the Revenue Act of 1918, 1921, or 1924, which had not been reversed or revoked prior to the time the return was made, or under any such ruling made after the return was filed which had not been reversed or revoked prior to the time of the termination of the taxpayer's existence. *2510 The application of this section of the statute was carefully considered by the Board in E. A. Landreth Co.,15 B.T.A. 655, where we held that by virtue thereof an organization similar to the petitioner herein and the Lone Star Realty Co. was taxable as a trust and not as a corporation or association for the years 1921 and 1922. We said in that case that under the rulings referred to in the statute, in effect from the beginning of the calendar year 1922 until December, 1922, the Bureau of Internal Revenue was consistently holding that a taxpayer was taxable as a trust in all cases where the shareholders did not control the actions of the trustees, irrespective of whether the taxpayer was engaged in business under corporate form. See also Wilkens & Lange,15 B.T.A. 1183. In Van Cleave Trust,18 B.T.A. 486, we held that the Bureau rulings in effect up to July 1, 1924, conformed to those of the prior years considered in the Landreth case. After careful consideration of the organization and operation of the petitioner and the Lone Star Realty Co., hereinafter more fully discussed, and the Bureau rulings in effect when the returns*2511 in question were filed, we think that our decisions in the Landreth and Van Cleave Trust cases govern, and we therefore hold that for the taxable years 1922 and 1923 both the petitioner and the Lone Star *1255 Realty Co. are taxable as trusts and not as corporations or associations. See also Woodrow Lee Trust,17 B.T.A. 109. We are unable to determine, from the very confusing record before us, petitioner's status as transferee of the Lone Star Realty Co. However, irrespective of its position in that regard, it is apparent that it is not liable for any additional tax based upon the theory advanced by the respondent, either on its own behalf or on behalf of the Lone Star Realty Co. As to the taxable year 1924, which is also before us, the situation is different. The petitioner filed its return for that year on March 14, 1925. Prior to that date the Bureau of Internal Revenue as a result of the decision of the Supreme Court in Hecht v. Malley,265 U.S. 144, had changed its rulings both for capital-stock tax and income-tax purposes with respect to the differentiation of trusts and associations taxable as corporations. *2512 The decision in the Hecht v. Malley case was rendered May 12, 1924, and was promulgated as a Treasury Decision on May 28, 1924 (T.D. 3599, C.B. III-1). On June 7, 1924, Treasury Decision 3598 (C.B. III-1, 489), amending the capital-stock-tax regulation, was issued, reading as follows: CAPITAL STOCK TAX - LIABILITY OF TRUSTS. TREASURY DEPARTMENT, OFFICE OF COMMISSIONER OF INTERNAL REVENUE, Washington, D.C. To Collectors of Internal Revenue and Others Concerned: In order to give effect to the decision of May 12, 1924, by the United States Supreme Court in the case of Hecht v. Malley and in the other cases named therein (Nos. 99, 100, 101, and 119 - October Term, 1923), article 7 of Regulations 50 (revised edition, approved June 21, 1920) and article 8 of Regulations 64 are amended so as to read as follows: Trusts. - Two distinct classes of trusts are recognized by the Department, namely, holding trusts and operating trusts. Holding trusts are those in which the trustees are merely holding property for the collection of the income and distributing it among the beneficiaries and are not engaged, either by themselves or in connection with*2513 the beneficiaries, in the carrying on of any business. Such trusts are not associations within the meaning of the law and are not subject to the tax. Operating trusts are those in which the trustees are not restricted to the mere collection of funds and paying them over to the beneficiaries but are associated together in much the same manner as directors in a corporation for the purpose of, and are actually engaged in, carrying on some business enterprise. These trusts, whether of the Massachusetts type or otherwise, are to be deemed associations within the meaning of the Act, independently of any control exercised by the beneficiaries, and subject to the tax. D. H. BLAIR, Commissioner of Internal Revenue. *1256 This ruling applicable to the capital stock tax only was extended by the publication on August 11, 1924, of an office decision (I.T. 2061, C.B. III-2, 5), to apply to all titles of the Revenue Acts of 1918 and 1921. I.T. 2061 reads as follows: The general rule in regard to holding trusts and operating trusts which is announced in the decision of the Supreme Court of the United States in the case of Hecht v. Malley and in Treasury Decision 3598*2514 (C.B. III-1, 489) is applicable under all titles of the Revenue Acts of 1918 and 1921. The Revenue Act of 1924 is not mentioned in the office decision (I.T. 2061), but article 1504 of the Commissioner's Regulations 65 based on the 1924 Act was then in effect, having been approved October 6, 1924, which reads as follows: Association distinguished from trust. - Holding trusts, in which the trustees are merely holding property for the collection of the income and its distribution among the beneficiaries, and are not engaged, either by themselves or in connection with the beneficiaries, in the carrying on of any business, are not associations within the meaning of the law. The trust and the beneficiaries thereof will be subject to tax as provided in articles 341-347. Operating trusts, whether or not of the Massachusetts type, in which the trustees are not restricted to the mere collection of funds and their payments to the beneficiaries, but are associated together in much the same manner as directors in a corporation for the purpose of carrying on some business enterprise, are to be deemed associations within the meaning of the Act, regardless of the control exercised by the*2515 beneficiaries. [Cf. article 1504, Regulations 62.] The effective date for income-tax purposes of the adoption by the Bureau of Internal Revenue of the principle embodied in the Hecht v. Malley case is discussed at length in General Counsel's Memorandum 6417 (C.B. VIII-1, 152). The conclusion therein reached is stated as follows: It is apparent from the foregoing that under the strict letter of section 704(a), the date of publication of Hecht v. Malley as a Treasury decision could well be taken as the date when its principle first became effective for income tax purposes, on the theory that the Treasury decision revoked or modified all prior inconsistent income tax rulings (and inconsistent income tax regulations, too, if there had been any such). However, the spirit of the subsection requires that taxpayers be protected who filed returns as trusts in reasonable reliance on the Department's attitude at the time. Hecht v. Malley was a capital stock tax case, and though, on strict theory, under the general definition in the Revenue Acts that "the term 'corporation' includes associations, joint-stock companies, and insurance companies," the essential*2516 elements of an association for income tax purposes and for capital stock tax purposes must be the same, it can not be siad, in view of the fact that income tax regulations and capital stock tax regulations, defining the term "association," were both in existence in somewhat different language, that either the publication of Hecht v. Malley as a Treasury decision, or the publication of Treasury Decision 3598, supra, amending the capital stock tax regulations, made it clear to taxpayers that a business trust, uncontrolled by its beneficiaries, was, for income tax purposes, "considered [by the Treasury Department] to be taxable as a * * * corporation * * * under the *1257 regulations in force." That it was so considered was made entirely clear, however, by I.T. 2061, supra, and it is, therefore, the opinion of this office that August 11, 1924, the date of publication of that ruling, is, under section 704(a), the effective date of Hecht v. Malley, for income tax purposes, with respect both to regulations and rulings. It suffices to say that the Commissioner's regulations and the rulings of the Bureau of Internal Revenue referred to in the Landreth case and*2517 others had been "reversed or revoked" in so far as necessary for the adoption by the Bureau of the principle embodied in the Hecht v. Malley decision prior to the time the petitioner filed its return for the calendar year 1924, and that the petitioner is not entitled to relief for that year under section 704 of the Revenue Act of 1928. We must now inquire whether under the existing law, giving due consideration to Hecht v. Malley, supra, and other cases, the petitioner is taxable as a trust or as an association in the year 1924. This question in substantially similar form was considered at length by the Board in several cases decided prior to the enactment of the Revenue Act of 1928 and therefore without reference to section 704 of that Act. The decisions in these cases have been rendered partially ineffective by operation of section 704 but, as in the instant case, where the relief provisions of section 704 are not applicable, they may be accepted as controlling. In Durfee Mineral Co.,7 B.T.A. 231, we reached the conclusion, after careful consideration of *2518 Crocker v. Malley,249 U.S. 223; Hecht v. Malley, supra;Burk-Waggoner Oil Assn. v. Hopkins,269 U.S. 110, and other cases - * * * That the better rule and the one used by the courts to-day in classifying such an organization either as a trusteeship or a partnership is the double test of (1) control, and (2) doing business, especially the latter, and that applying such double test would result in confining trusteeships to those declarations of trust where there is no control in the shareholders and the trust is not engaged in doing business. See also Anderson Steam Vulcanizer Co.,6 B.T.A. 737; E. A. Landreth Co.,11 B.T.A. 1; Trustees for Gonzolus Creek Oil Co.,12 B.T.A. 310; Alexander Trust Property,12 B.T.A. 1226; Woodrow Lee Trust,14 B.T.A. 1420; and Extension Oil Co.,16 B.T.A. 1028. In view of the foregoing, it appears that there are present many factors indicating that for the year 1924 the petitioner was taxable as an association and not as a trust. Admittedly, it was engaged in carrying on an active business*2519 during that year, but due to the state of the record, to which we have referred previously, it is not entirely clear upon what basis its business activities were predicated. *1258 Since a hearing on the issues relative to the merits of the additional tax asserted for the year 1924 was reserved at the hearing of these proceedings, an order will be entered restoring Docket No. 31927 to the calendar for further hearing with respect to the taxable year 1924, and our decision as to petitioner's taxable status for that year will be reserved until the conclusion of that hearing. Reviewed by the Board. Judgment of no deficiency for 1922 and 1923 will be entered on each docket.