A--C Inv. Asso. v. Commissioner

A-C INVESTMENT ASSOCIATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. A--C Inv. Asso. v. Commissioner Docket Nos. 43192, 49682. United States Board of Tax Appeals 24 B.T.A. 582; 1931 BTA LEXIS 1618; November 4, 1931, Promulgated *1618 Held that the petitioning organization was an association taxable as a corporation. John C. White, Esq., for the petitioner. M. M. Mahany, Esq., and E. L. Updike, Esq., for the respondent. VAN FOSSAN *582 These proceedings, which were consolidated for hearing and report, were brought for the redetermination of deficiencies in income taxes for the years 1921 to 1928, inclusive, in the following amounts: Year Deficiency — 1921 — $68.99 — 1922 — 618.16 — 1923 — 1,401.07 — 1924 — 2,226.95 — 1925 — $3,485.25 — 1926 — 4,832.74 — 1927 — 6,642.31 — 1928 — 6,928.50 *583 The respondent added to the respective deficiencies for the years 1921 to 1927, inclusive, the following penalties: 1921, $17.24; 1922, $154.54; 1923, $350.26; 1924, $556.74; 1925, $871.31; 1926, $1,208.18; 1927, $1,660.58. The issue is whether or not during the taxable years the petitioner was an association taxable as a corporation. The parties entered into a stipulation as to the facts, reserving therein the right to introduce further evidence not inconsistent with the facts as stipulated. From the stipulation and the evidence introduced at the hearing*1619 we find the facts as follows: FINDINGS OF FACT. The A-C Investment Association was organized in the year 1920 and during the years in question had its principal place of business in Houston, Tex. The use of the word "unincorporated" after its name was begun on December 18, 1928. In 1920 conditions were such in Houston that there was little opportunity for people of small means to make safe investments of their funds in any other way than by depositing them in the savings banks, which paid interest at the rate of 4 per cent per annum. At that time certain of the employees of Anderson, Clayton & Company, which was a large cotton firm operating in Houston, were being induced to purchase speculative oil stocks of doubtful value and the firm became interested in attempting to relieve a situation which was leading its employees into dangerous investments. Certain of the employees also became concerned over the condition. There were then available for investment, however, first mortgage notes paying interest at the rate of 8 per cent per annum and secured by real estate having a market value of double the amount of the notes. Therefore, at a meeting held September 29, 1920, the*1620 petitioner was organized in order to create a means by which employees of Anderson, Clayton & Company might pool their funds for investment in the 8 per cent mortgage notes and other conservative securities. At that meeting a constitution and by-laws of the association were duly adopted. The first three articles of the constitution read as follows: ARTICLE I. Name. This Association shall be known as the A-C INVESTMENT ASSOCIATION. *584 ARTICLE II. Purpose. This association is formed by the employees of Anderson, Clayton & Co. of Houston, Texas, and affiliated organizations for the purpose of providing investment fund for the mutual benefit of the employees contributing thereto. ARTICLE III. Membership. Membership shall consist of units or shares of a par value of Ten Dollars ($10.00) each. These units may be purchased by any employee of Anderson, Clayton & Co., or of any company in which the controlling interest is owned by Anderson, Clayton & Co. Units are purchasable only for cash and memberships are not transferable. The active control of the affairs of the association was lodged by the constitution in an executive committee consisting*1621 of nine members of the association, to be elected at the annual meeting. The executive committee was directed by the constitution to hold meetings at least once a quarter and at such other times as the by-laws might provide. It was authorized to make loans, purchase property and invest funds in accordance with the by-laws of the association and to delegate its duties and powers to the officers or members thereof. It was provided that the executive committee should elect from its own members a president, vice president, and secretary and treasurer. The constitution also provided for the holding of annual meetings of the association and for the calling of special meetings upon the request of the executive committee or upon the request of 20 members of the association. It is provided further that all members of the association may vote at all meetings either in person or by proxy, and that each member shall be entitled to one vote for each of the units, described in Article III of the constitution, standing in his name. The by-laws which were adopted by the association, after defining the duties of the officers, provide, among other things, that voting rights of the members*1622 of the association shall terminate with the termination of employment of any member thereof by Anderson, Clayton & Company or its affiliated companies. Pursuant to the by-laws as amended, a member may voluntarily withdraw from the association, but in such event shall not be entitled to any profits for the current quarter during which the notice of withdrawal is given, and the executive committee has the right to delay payment of the amount of the withdrawing member's investment for a period of three months from the time the membership is terminated. It is provided that a reserve of 15 per cent of the total funds of the association must be invested in such form as to be convertible into cash within 31 days, in order to meet the demands of withdrawing members. The by-laws *585 as amended also provide that no member may purchase more than 120 units or shares in any one year. However, additional units may be purchased by a member and members of his family. Membership in the association is evidenced by pass books, in which are entered deposits made by employees of Anderson, Clayton & Company and its affiliated companies to purchase the units or shares described in Article*1623 III of the constitution hereinbefore quoted. The amount of the deposits is entered on a deposit slip and in the pass books. These pass books are similar in form to those issued by savings banks in Houston. They contain columns for deposits and the date thereof, separate columns showing withdrawals and columns showing the member's balance. On the inside of the cover of the pass book there is printed a statement containing the following paragraph: This pass book is issued to a member of A-C Investment Association and is nontransferable, except in accordance with the provisions of the constitution and by-laws of said Association. The holder hereof in accepting this pass book agrees to abide by and be bound by all the provisions of the constitution and by-laws of said Association, together with all changes in and amendments to same, and acts in pursuance thereof. On the back of the pass book there is the following printed indorsement: THE A-C INVESTMENT ASSOCIATION HOUSTON, TEXAS THE object of this Association is to promote habits of thrift, and create a spirit of co-operation and mutual interest among the employees of Anderson, Clayton & Company, and to provide a means*1624 of profitable investment of savings. Section 7 of the by-laws as amended provides, among other things, as follows: In the absence of any prescribed form of membership subscription, the pass book issued to members will be evidence of such subscription and shall also be evidence of their interest in the Association * * *. Under the provisions of the by-laws the executive committee designates a person to act as trustee, to whom is conveyed any property purchased by the association, and the executive committee is authorized to require the trustee to make such declarations of trust with respect to the property held by him as in the committee's judgment may be proper. These declarations of trust are not filed of record in any of the public offices in Houston, but are simply held by the association through its executive committee. The investment policy adopted by the executive committee was conservative. It may purchase outright stocks, bonds, real estate or other things of value which will constitute a sound and profitable investment. *586 Between October 5, 1920, and December 31, 1928, the members' accounts increased from $8,590 to $859,535.37. The number of members*1625 increased from 36 in 1920, to 444 in 1927. The financial statements of the association show that the funds of the association have been invested from time to time in real estate mortgage notes, purchased through trust companies and trust departments of banks, industrial bonds, United States Treasury certificates, United States Liberty bonds, stock in building and loan associations, first mortgage loans made directly to the borrower, and loans to members on their pass books. The loans to members on the security of their pass books were inconsiderable in amounts and constituted but a slight fraction of the investments made by the executive committee. The investments made by the association increased from year to year. On December 31, 1920, the assets were $18,763.83. On December 31, 1928, the total assets of the association amounted to $918,217.54. Included in these assets were real estate notes purchased through trust companies and trust departments of banks, amounting to $360,951.55; stock in building and loan associations, $5,000; first mortgage loans taken direct from the borrowers, $521,150.79; and loans to members on pass books, $3,000. The balance of the assets was made*1626 up of cash on hand, accounts of collectible, accrued income and deferred items. Substantial amounts were loaned to members on the security of their real property. Substantially all of the interest earned by the association on its investment was paid out quarterly to the members. No salaries were paid to the officers. The business office of the association was in the office of Anderson, Clayton & Company, and no rent was paid therefor, and the operating expenses, which were small in amount, consisted principally of expenditures for printing, appraisal and recording fees, etc. Under date of November 25, 1921, the treasurer of the association issued a circular directed to the members which read, in part, as follows: The Association would fail in one of its objects if it did not encourage systematic saving. Your officers and Executive Committee would be pleased to see each interest, which is now only one or two units, increased to ten units, or more, during the year. Each member is urged to make regular monthly payments and to set for himself an amount to be paid in during the year. Another object will be defeated if we fail to impress all members with our plan as a safe, *1627 convenient and profitable way of making investments to the full extent allowed each member by our by-laws. Your Committee and officers would like to see the interests of as many members as possible increased to this limit. In 1926 the executive committee of the association promulgated a "Home-Ownership" plan of loans to its members who had been in the employ of Anderson, Clayton & Company or its affiliated companies *587 two years or more. By this plan the association offered to loan up to 80 per cent of the cost value of property, the homes to be limited in cost to $10,000 each and interest on the loans to be charged at the rate of 7 per cent per annum. It was stated in the circular announcing the plan that Anderson, Clayton & Company would guarantee to the association that part of any "Home-Ownership" loan exceeding 55 per cent of the value of the property. At all times during the years in question the present worth of Anderson, Clayton & Company was from $15,000,000 to $20,000,000. On December 5, 1921, the president of the petitioner addressed to the chief deputy collector of internal revenue at Austin, Tex., a letter, of which the following is a copy: DECEMBER*1628 FIFTH, 1921. Mr. F. B. PARSONS, Chief Deputy Collector of Internal Revenue, Austin, Texas. DEAR MR. PARSONS: In October, 1920, a mutual savings association was organized among the employees of Anderson, Clayton & Co., a cotton concern, with its principal office at Houston, Texas. The membership of the association is limited to the employees of that concern and its affiliated concerns, and the employees contribute to the fund, which is used in making loans to employees and to others. It is a mutual association having no capital stock represented by shares, and membership ceases when the employment ceases. The expense of keeping the books and accounts is all borne by the firm of Anderson, Clayton & Co., and quarterly statements are made up showing the results of the adventure. No profits were ascertained during 1920, but beginning January 1, 1921, the quarterly statements have shown a profit. At the close of the year each member will be advised what his proportion of the profit is and that he should account for this in his income tax return. It was their purpose to bring the association within the provisions of the exempted corporations under Section 231 of the*1629 Internal Revenue Act. They certainly seem to come under (2) Mutual savings banks not having a capital stock represented by shares; and they would probably come under (4) under the heading of cooperative banks without capital stock. Will you please advise if it is necessary to make any kind of reports for the association in order to show that they are within the exemption? These exemptions have not been changed by the Act of November 23, 1921. Yours very truly, (Signed) R. C. FULBRIGHT. On December 7, 1921, the chief deputy collector at Austin, Tex., addressed to the president of the association a letter as follows: R. C. FULBRIGHT, c/o FULBRIGHT & CROOKER, Houston, Texas. DEAR MR. FULBRIGHT: Receipt is acknowledged of your letter of the 5th instant concerning the tax liability of a mutual organization organized and operated by employees of Anderson, Clayton & Company. Your are advised that my opinion concerning a matter of this kind would not be worth much unless I could substantiate the same by a Treasury Decision. *588 For your information I am quoting you Office Decision 703 found in Digest of Income Tax Rulings #13 for December, 1920. I believe*1630 this almost exactly fills your case and you can see from the decision that you are not taxable: An association of the employees of the N Company was formed for the purpose of enabling its members to save and borrow money. The members who are limited to the employees of the N Company elect annually a board of trustees to manage their affairs. Each member may subscribe to from 1 to 25 shares of stock which is represented by certificates of deposit. At the end of the year the money paid in, together with the earnings there, is returnable to the members in proportion to the amount each has paid in, but each member has the option of allowing the money to remain on deposit where it accumulates further earnings. Any member may borrow from the association on his promissory note, at rates of interest ranging from 5 to 12 per cent, but in no greater amount than the amount remaining to his credit, plus a sum equal to one month's salary, unless the same is secured by satisfactory collateral. Held, that the shares of stock sold by the association are merely the means to assist the members in accumulating their savings and that they do not constitute capital stock within the accepted business*1631 meaning of that term. The dividends paid thereon are in reality interest on deposits (see 28 Op. A.G. 189; 31 id. 176); and the association is exempt under section 231(2) of the Revenue Act of 1918, as a mutual savings bank not having a capital stock represented by shares. With kindest personal regards. (Signed) by F. B. PARSONS, Collector, Chief Office Deputy. The petitioner did not file income-tax returns for the years 1920 to 1927, inclusive, and no tax has been paid by the association for those years. In January, 1927, the collector of internal revenue for the first district of Texas demanded that the association either render a return or file a claim for exemption. In February, 1927, the petitioner requested that copies of Form 1027 on which to file a claim for exemption be furnished, but was advised at various times between that date and March 28, 1927, that the form was not ready for distribution. On March 28, 1927, copies of the form were forwarded to the petitioner and thereupon the form was filled out and on April 7, 1927, mailed to the collector of internal revenue for the first district of Texas. Petitioner duly filed a return for 1928. *1632 The respondent held that the petitioner was not exempt from taxation and thereafter petitioner was notified of the respective deficiencies in income taxes and the penalties imposed in the amounts hereinbefore stated. OPINION. VAN FOSSAN: The fundamental issue in these proceedings is whether or not the petitioner was an association taxable as a corporation. The word "association" as used in the revenue acts is a term "used throughout the United States to signify a body of persons united *589 without a charter, but upon the methods and forms used by incorporated bodies for the prosecution of some common enterprise. * * * An organized but unchartered body analagous to but distinguished from a corporation." Hecht v. Malley,265 U.S. 144. The petitioner was an unincorporated body of persons. The petitioner's plan, scope and method of operation are definitely and specifically set out in its constitution and the by-laws which were adopted by its members. As stated in its constitution, it was organized for the purpose of providing "an investment fund" for the benefit of the contributing employees of Anderson, Clayton & Company of Houston, Tex., and*1633 the organizations affiliated with that firm. Membership in the petitioner was voluntary. Such membership consisted of "units or shares of a par value of $10 each." Under the provisions of the by-laws as amended any of the employees of Anderson, Clayton & Company or of its affiliated companies might purchase 120 such units each year and might also purchase units for members of their families. No certificates of stock were issued nor did the association have any stated capital stock. Under the by-laws of the association adopted pursuant to the provisions of the constitution, the interest of each member of the association was evidenced by a deposit book in which were entered the amount of deposits made by the member for the purpose of purchasing the units or shares of the par value of $10 each provided for by the constitution. Among other things, the by-laws defined the duties of the officers. The association was governed by an executive committee chosen by the members from the membership pursuant to the provisions of the constitution, each member having one vote for each unit or share owned by him as evidenced by the entries of deposits made in his deposit book. Regular meetings*1634 both of the association and of its executive committee were held. The executive committee performed the same kind of duties as are performed by the directors of business corporations and the duties of the officers were similar to the usual duties of officers of such corporations. Both the investment fund of the petitioner, which was contributed by the members, and the produce thereof increased largely in amount during the taxable years. The operations effecting this result were carried on by the executive committee and the officers. It is true that the association had no capital stock as such but, as was said insimilar circumstances in Sears, Roebuck & Company's Employees' Savings, etc. v. Commissioner, 45 Fed.(2d) 506, reversing 17 B.T.A. 22, there are many kinds of corporations and not all of them have capital stock. The essential facts of the above cited case were quite similar to those of the proceedings now under discussion. The court held that the organization was an association operating as a corporation and taxable as such. *590 In the case of the petitioner the constitution adopted by its members was its fundamental law, its*1635 charter, so to speak. Its by-laws were duly adopted and were in all essentials like the by-laws of any business corporation. Its executive committee was its governing board and its officers conducted its business in a manner similar to that in which the business of a business corporation is conducted. Accounts were kept with its members by the petitioner. Petitioner's members had a large voice in the management of their organization, since, under the constitution adopted by them, they could elect the executive committee. The deposit books referred to in the findings of fact were evidence of the members' interest in the petitioner. The petitioner was engaged in investing the pooled funds of its members for the purpose of securing a profitable return. It invested these pooled funds in real estate mortgage notes, purchased through trust companies and trust departments of banks, industrial bonds, United States Treasury certificates, United States Liberty bonds, stock in building and loan associations, first mortgage loans made directly to the borrower, and in a few small loans made to members on their pass books. Its operations constituted doing business within the definition of*1636 that phrase set forth in Flint v. Stone Tracy Co.,220 U.S. 107. It is our opinion that during the taxable years petitioner was an association taxable as a corporation. But petitioner contends that even if it were an association carrying on business according to the practices of corporations, it was either a mutual savings bank not having a capital stock represented by shares, or a cooperative bank without capital stock, organized and operated for mutual purposes and wtthout profit and is therefore exempt from taxation under the provisions of section 231(2) and (4) of the Revenue Acts of 1921, 1924 and 1926 and section 103(2) and (4) of the Revenue Act of 1928. We are not impressed with this contention. The evidence and petitioner's constitution disclose that the purpose for which the petitioner was organized was to pool the funds of the members for investment. It was not organized for any other purpose. The petitioner's name itself indicates this purpose. The following statement was made by the petitioner's sole witness at the hearing herein: There were plenty of first mortgage notes on real estate, as Houston was a growing city, that paid 8 per cent*1637 interest on which you could get security worth double the amount of the notes. The difference between 4 per cent and 8 per cent was the inducement for organizing a mutual organization, by which the various employees could pool their little savings together and get all that the law could afford in the way of interest. There is nothing to show that at the time of its organization it intended doing a banking business or doing anything other than pooling its members' funds for investment and profit. It made no *591 effort to organize itself as a savings bank or other form of bank under any statute in force in the State of Texas, the State of its location. Although the proof discloses that at the time of its organization its members were advised by counsel learned in the banking law of the State of Texas, the petitioner, nevertheless, failed until 1928 to attempt to comply with the statute controlling individuals, partnerships, associations and common law trusts engaged in the banking business. That statute provided that any such entity should add the word "unincorporated" in brackets to its name. Acts 1905, S.S., p. 11; Acts 1923, p. 422. Vernon's Annotated Texas Statutes, *1638 Revision of 1925, Vol. I, art. 541, p. 418. It is significant that no statutory provision of Texas has been cited authorizing the organization of a savings bank not having capital stock represented by shares, or a cooperative bank without capital stock, organized and operated for mutual purposes and without profit. The Texas statutes provide for the incorporation, operation, regulation and supervision of ordinary commercial banks and trust companies having a capital stock, savings banks having capital stock, savings departments in State banks and trust companies and so-called "Morris Plan" banks. Vernon's Annotated Texas Statutes, Vol. I, Title 16, chs. 1 to 9, inclusive. Nor has any decision of the courts of Texas supporting petitioner's contention that it was either a savings bank having no capital stock, or a cooperative bank without capital stock, organized and operated for mutual purposes and without profit, been referred to. We are of the opinion that in using the words "mutual savings bank having no capital stock" and "cooperative banks without capital stock organized and operated for mutual purposes without profit," as found in the sections of the revenue act hereinbefore*1639 referred to, Congress used those terms in relation to such banks as are commonly so known. See United States v. Cambridge Loan & Building Co.,278 U.S. 255. In the case of National Bank of Redemption v. Boston,125 U.S. 60, the court said: Savings banks are institutions under public management, in pursuance of a great and public policy, organized for the purpose of investing the savings of small depositors. The petitioner is not shown to have been known as a savings bank or to have held itself out to the public as such, nor does its constitution, which states its purpose, indicate that it was organized to act as a savings bank. It was not under any form of public control or supervision, its permissible investments were not controlled by statute, and it was not engaged in any service to the public in general. We are of the opinion that the petitioner was not within the provisions of the statute exempting from tax mutual savings banks not having a capital stock represented by shares. *592 Likewise, we are not persuaded by the contention that the petitioner was a cooperative bank without capital stock, organized and operated*1640 for mutual purposes and without profit, within the contemplation of the phraseology contained in the several revenue acts. It does not appear that such an organization was known to the law of Texas. The petitioner was not known as such a bank. It was organized solely to pool the funds of its members for investment and it was, as we have held, operated for profit, this last fact alone being sufficient basis for denying it the classification asked. The petitioner contends also that the respondent erred in not holding it either a joint venture or a series of revocable trusts, the income from which was duly reported by the several members. A joint venture is "a special combination of two or more persons, where in some specific venture a profit is jointly sought without any actual partnership or corporate designation." Alger Melton,7 B.T.A. 717. The business conducted by the petitioner was not a single enterprise. It was a continuing series of investments of the funds of the association in securities which changed from time to time, and, as disclosed by the provisions of the constitution and by-laws and the facts, its membership was subject to change and did change*1641 by reason of additions and withdrawals. Furthermore, we have held that the petitioner was an association, doing business for profit, upon the methods, forms and practices of a corporation. Petitioner's enterprise was not a joint venture. Nor do we consider that there is merit in the contention that the petitioner constituted a group of revocable trusts, the income of which is taxable to the grantor of the trust. In our opinion there is nothing in the facts which brings these proceedings within the provisions of section 219(g) of the Revenue Acts of 1924 and 1926 or within the same provision of section 166 of the Revenue act of 1928. these sections provide that: Where the grantor of a trust has, at any time during the taxable year, either alone or in conjunction with any person not a beneficiary of a trust, the power to revest in himself title to any part of the corpus of the trust, then the income of such part of the trust for such taxable year shall be included in computing the net income of the grantor. There was no trust agreement of declaration of trust connected in any way with the organization of the petitioner. It is evident too that the contributions of the petitioner's*1642 members were pooled and constituted a common fund for investment. They were not held or invested in separate amounts representing the respective contributions of the members. The facts disclose that the members could withdraw from the association at will, but whatever the liability on the part of the petitioner's executive committee and officers to the individual members created by this fact, there is *593 nothing in the facts or the constitution and by-laws of the petitioner to show that the relationship between any parties to the association was that of trustee and beneficiary. In the Sears, Roebuck & Company's Employees' Savings, etc., case, supra, the court had under consideration whether the employees' saving fund was a trust, and held that it was not, but, as already stated, that on the contrary, the savings fund was an association conducted according to the methods and practices of a corporation. None of the several alternatives suggested by petitioner commend themselves to our judgment or entitle it to the exemption asked. The second issue is whether or not the 25 per centum added by respondent to the deficiencies for the years 1921 to 1926, inclusive, *1643 was properly so added. Section 3176 of the Revised Statutes, as amended, provides in part as follows: In case of any failure to make or file a return or list within the time prescribed by law, or prescribed by the Commissioner of Internal Revenue or the collector in pursuance of law, the Commissioner shall add to the tax 25 per centum of its amount, except that when a return is filed after such time and it is shown that the failure to file it was due to a reasonable cause and not to willful neglect, no such addition shall be made to the tax. Under the above quoted provision no such addition to the tax shall be made "when a return is filed after such time and it is shown that the failure to file it was due to a reasonable cause and not to willful neglect." The sentence is in the conjunctive. Both conditions must exist. There must have been a filing (though late) of a return and there must have been reasonable cause for the failure to file on time. Here the stipulation is that no returns were filed for the years 1920 to 1927, inclusive. The stipulated facts do not make clear whether the form filed in 1927 related to one year only or to all previous years, but even if such*1644 claim for exemption were filed for the entire period, in our opinion such filing would not be equivalent to filing a return required by the statute. The statute is clear and definite that a return must be filed to entitle taxpayer to relief from penalties. Petitioner, therefore, fails to meet one of the two conditions prescribed as prerequisite for relief. The action of respondent in adding 25 per centum of the amount of the tax to the deficiencies determined by him is approved. Reviewed by the Board. Judgment will be entered for the respondent. SEAWELL SEAWELL, dissenting: I do not agree with so much of this opinion as approves the addition of a penalty to the tax for any year, especially for the year 1927.