Fidelity-Bankers Trust Co. v. Commissioner

FIDELITY-BANKERS TRUST COMPANY, TRUSTEE, FOR HUGH W. SANFORD ET AL., AND FIDELITY-BANKERS TRUST COMPANY, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Fidelity-Bankers Trust Co. v. Commissioner Docket No. 83421. United States Board of Tax Appeals 37 B.T.A. 142; 1938 BTA LEXIS 1079; January 21, 1938, Promulgated *1079 1. A syndicate was formed for the purpose of purchasing property owned or thereafter acquired by a bank and then holding, managing, controlling, leasing, encumbering, and selling the property for the benefit of the bank and holders of certificates of beneficial interest in the enterprise. Provision was made for centralized control and continuity of the syndicate, the introduction of additional participants, and limited liability of the certificate holders. The holders of the certificates were to receive annually not less or not more than 6 percent of the face amount of their certificates as a return on their investments, payment of which the bank guaranteed to the certificate holders in consideration of the right to receive earnings in excess thereof. The syndicate carried on activities pursuant to the agreement. Held, that the syndicate was an association taxable as a corporation. 2. The amounts paid by the bank to the trustee for the syndicate under its guarantee to the certificate holders of a return of 6 percent per annum does not constitute taxable income to the petitioner. 3. The petitioner has failed to prove that the imposition of a 25 percent penalty was*1080 error. Forrest Andrews, Esq., for the petitioner. George D. Brabson, Esq., for the respondent. DISNEY *143 This proceeding involves the redetermination of the following deficiencies and penalty: Fiscal year ended Deficiency Penalty October 31, 1932 Income tax $1,287.13 $321.78 October 31, 1933 do 2,408.45 Do Excess profits tax 875.80 The issue is whether the petitioner is an association taxable as a corporation, and, if so, whether amounts received undefr a certain guarantee constitute taxable income. FINDINGS OF FACT. The Fidelity-Bankers Trust Co., a Tennessee corporation (hereinafter referred to as the Trust Co.), has been engaged in the general banking and trust business at Knoxville, Tennessee, since its incorporation in 1914. Its principal activity consists of making loans secured by first mortgages or deeds of trust upon real property of the borrower situated in or near Knoxville, and the issuance and sale of its corporate interest-bearing bonds secured by the mortgages and deeds of trust so obtained by it. Such securities as were not used as collateral for the payment of bonds were sold*1081 to the public. Collections of interest and principal on real estate loans were used to pay obligations under the bonds, which were a direct obligation of the Trust Co. The outstanding real estate loans and bonds of the Trust Co. on October 31, 1931, were $12,515,909 and approximately $9,000,000, respectively. In 1931 the bonds were maturing at the rate of from $150,000 to $200,000 per month. The number of defaults on mortgage loans due to failure of the borrowers to pay principal, interest, and taxes increased after 1929, with the result that the Trust Co., in order to protect its investment, was required to and did acquire title to a large quantity of real estate through foreclosure proceedings. The inability of the Trust Co. to dispose of such property by sale or redemption deprived the Trust Co. of income with which to meet maturing interest and principal on outstanding bonds. The Trust Co. relieved the situation somewhat by the sale of notes secured by foreclosed property and by borrowing money. The Trust Co. estimated that the shortage of collections of principal and interest on real estate loans to meet bond obligations would be about $800,000 in 1931. To avoid financial*1082 embarrassment and probable receivership proceedings, it was necessary for the Trust Co. to acquire additional funds to meet its needs. Arrangements were made to acquire up to $510,000 from 19 individuals and a company, substantially all of whom were stockholders or directors of the *144 Trust Co., under the terms of an agreement styled a declaration of trust, executed on October 20, 1931. The material provisions of the instrument recite that the persons and company who are to furnish the money, hereinafter referred to as subscribers, are "desirous of organizing a syndicate to be known as the FIDELITY REALTY COMPANY, for the purpose of acquiring, encumbering, leasing and selling certain real estate and/or other properties belonging to and/or to be hereafter acquired by the Fidelity-Bankers Trust Company"; that the subscribers subscribe for and agree to pay upon call of a majority of the "syndicate owners" certain specified amounts for the purposes set forth in the agreement, for which the Fidelity-Bankers Trust Co., trustee, shall issue "participating certificates of ownership in said syndicate" according to the amount paid in by the subscribers, the certificates to be transferable*1083 by endorsement and delivery; that others may become interested in the "syndicate" with the consent of a majority of the "syndicate owners"; that the trustee "shall purchase, receive, hold, manage, control, lease, encumber and/or sell such properties" as directed in writing by a majority of the "syndicate owners" and that the "syndicate" shall have power to sell property owned by it only on terms and prices agreeable to the Trust Co., subject, however, to the proviso that, if the Trust Co. objects to the terms of a sale, a majority of the members of the syndicate shall have the right to sell the property upon such terms after first offering it to the Trust Co.; that the trustee shall hold title to "all properties purchased for the benefit of the syndicate owners"; that after the subscribers have been repaid the principal "of their investments in the syndicate, together with rents from the real estate acquired, or from any other source of income, equal to the rate of 6% per annum, payable semiannually, on the principal of their investments," all profits of the syndicate are to be paid to the Trust Co., in consideration of which anticipated profits the Trust Co. guaranteed "to the syndicate*1084 owners" a return in the same amount on their investments, subject to a right to reimbursement out of earnings of the syndicate as soon as the funds were available; that the certificates and any accruals thereunder are payable by the Trust Co. or the trustee on demand made on or after November 1, 1936, and that the Trust Co. shall have the right to redeem all of them, or part of them, with the consent of all of the "syndicate owners", at any time prior thereto; that the "trust" was in no event to be effective for a period longer than 21 years; that all moneys of the syndicate derived from the sale of property "shall be disbursed to the syndicate owners pro rata, or reinvested by the trustee, as directed in writing by a majority of the syndicate *145 owners" and the Trust Co.; that the "owners of the syndicate certificates hereunder are not and shall not be personally liable for any obligations incurred by the trustee" and that "only the properties belonging to the syndicate or trust herein created shall be liable for such obligations and that notice to this effect shall be stated in every bond, note, contract, or other written obligation made by the trustee hereunder"; that the*1085 "syndicate certificate holders shall have the right to make its own rules and regulations for the transaction of its business"; that the term "a majority of the syndicate owners" used in the instrument shall mean a "majority of the dollar ownership" of the face amount of outstanding certificates; and that no charge shall be made by the trustee for its services. The agreement was signed by the subscribers and the Trust Co. in its corporate capacity and as trustee. The subscribers were called upon from time to time to pay a proportionate part of their subscriptions and up to the close of 1932 did pay $392,000 on their subscriptions. Excepting the total amount of $25,000 paid by one subscriber in 1935 and 1936, nothing was paid after 1932. The trustee, pursuant to provisions of the agreement of October 20, 1931, issued to each subscriber a certificate, having the caption "Fidelity Realty Company" and certifying that the person named therein had paid a specified amount to the trustee "and is a participating owner of an interest in the Fidelity Realty Co., a syndicate, to said extent" under the terms of the agreement of October 20, 1931. At a meeting of the subscribers held on*1086 October 29, 1931, an executive committee of five members, four of whom were directors of the Trust Co., with three alternates, were elected "to conduct the affairs of the syndicate", in accordance with the terms of the "Syndicate Agreement." Thereafter the executive committee and the subscribers met on calls made whenever necessary and adopted resolutions respecting sales and purchases of property and other activities within their powers. The minutes of the meetings refer to them as meetings of the subscribers or executive committee of the "Fidelity Realty Company Syndicate." The Fidelity Realty Co., a syndicate, hereinafter referred to as the syndicate, acquired by purchase from the Trust Co. such notes and real property as funds received from subscribers permitted. Between November 5, 1931, and the close of 1932 the trustee, in accordance with directions given to it by the syndicate, purchased from the Trust Co. for the account of the syndicate, notes and parcels of real property at a cost of $452,073.97, and in connection therewith assumed mortgages in the amount of $43,650. The prices paid for the items of property were approved in advance by a committee of the syndicate *1087 *146 in order to protect the investments made in certificates of the syndicate, and represented the value of the property. The trustee did not acquire property for the syndicate from any other source. The real property was conveyed by deed to the "Fidelity-Bankers Trust Company, Trustee for the Fidelity Realty Company." On February 16, 1932, the syndicate authorized the trustee to borrow amounts aggregating $41,700 from the Trust Co. on the security of fourteen specified parcels of real estate and to execute in its name, notes and deeds of trust evidencing the loans. In December 1932 the syndicate guaranteed payment of $32,500 borrowed by the Trust Co. from the Reconstruction Finance Corporation, and as security for its guarantee received a deed of trust covering the equity of the Trust Co. in certain property. The activities of the syndicate were conducted with third parties in the name of the trustee. The trustee never acquired or sold property for the syndicate without authority from the syndicate. The syndicate had no officers or employees. Its accounts were kept in the trust books of the Trust Co. like other trust accounts of the Trust Co. Separate minute books*1088 were kept to record the meetings of the members and committees of the syndicate. The minutes were written by an officer of the Trust Co., pursuant to authority given by provisions of the agreement of October 20, 1931. The trustee kept a separate book to record the certificates issued to members of the syndicate. The trustee rented and otherwise managed the properties of the syndicate. During the fiscal year ended October 31, 1932, the expenses incurred by the trustee for taxes, interest, repairs, and insurance upon the property it held for the syndicate were $2,156.06 in excess of receipts of $6,682.95. For the fiscal year ended October 31, 1933, the income of the properties exceeded expenses by $4,474.06. During the respective years the Trust Co. paid to the trustee the sums of $12,165.75 and $13,041.94 under its guarantee to the certificate holders of a return of 6 percent on the face value of their certificates. The trustee made payments semiannually to the certificate holders equal to 6 percent per annum on the face amount of their certificates. The syndicate is still functioning under the agreement of October 20, 1931, and owns from 75 percent to 80 percent of the*1089 property acquired by it. From November 1, 1933, to the time of the hearing herein the sum of $146,000 was paid in redemption of outstanding certificates. The syndicate was in the taxable years an association taxable as a corporation. At some undisclosed time the Fidelity-Bankers Trust Co. filed a fiduciary return for the fiscal year ended October 31, 1932, as trustee for the syndicate. *147 The deficiency notice forming the basis for the petition filed herein was mailed to the "Fidelity-Bankers Trust Company, Trustee, Fidelity Realty Company." OPINION. DISNEY: The deficiency involved herein was determined against the Fidelity-Bankers Trust Co. as trustee for the Fidelity Realty Co. No determination was made against the Fidelity-Bankers Trust Co. in its individual capacity and the Board has no jurisdiction as to it. Accordingly the proceeding is dismissed in so far as it relates to the Fidelity-Bankers Trust Co. in its individual capacity. . The petitioner contends that the Fidelity Realty Co. had no existence in fact, arguing that the designation was merely a loose term to describe the parties who had subscribed*1090 to the fund; that the income from the property constituted earnings of the Trust Co., as the equitable owner of the property of the syndicate; that the certificates issued to the subscribers for the amount of their paid-in subscriptions were nothing more than receipts given as evidence of a promise to pay a specified amount of interest at stated intervals, and, in general, that the agreement created the relationship of borrower and lender between the Trust Co. and the certificate holders. The evidence of record establishes beyond doubt that the parties to the organization did adopt a name for their venture and subsequently recognized their act. A group formed to carry on a business venture may not avoid being classed as an association, taxable as a corporation, by failing to select an official name under which to conduct the activities of their organization. . The purpose of the group is determined by the instrument they signed. . The agreement shows the formation of an organization to engage in the business of acquiring, encumbering, leasing, and selling*1091 property belonging to or thereafter acquired by the Trust Co., with a central form of management controlled through transferable certificates evidencing ownership of beneficial interests; limited liability of participating members; and a continuation of the enterprise uninterrupted by death of a certificate holder or by transfer of ownership of beneficial interests. These terms of the agreement are characteristic of an association under the guides set forth in . The fact that the venture was to terminate on a specified date or could be terminated prior thereto, is not determinative of the question. . The terms of the agreement were broad enough to permit the syndicate to acquire from the Trust Co. for the purpose of the enterprise, property other than real estate obtained through foreclosure proceedings. *148 The only limitation upon the right was that the acquisition be property then owned or thereafter acquired by the Trust Co. This broad power gave the syndicate a wide range within which to exercise its activity. That one of the dominating purposes*1092 of the organization was profit is definitely shown by the provision of the agreement guaranteeing the participating members an annual return of 6 percent on the face value of their certificates of beneficial interest. This was a minimum and maximum return to the certificate holders. If the earnings of the syndicate exceeded such an amount, the excess was distributable to the Trust Co. as profits. The activities of the pool were in pursuance of the agreement signed. Considering both the purpose expressed in the agreement and the activities of the syndicate, as above set forth in our findings of fact, we conclude and hold that the respondent did not err in holding the petitioner to be an association taxable as a corporation. During the taxable years the earnings of the syndicate were insufficient to give the certificate holders a return of 6 percent on their investments, and as a result the Trust Co. paid to the trustee for the syndicate under its guarantee to the certificate holders amounts equal to the deficiencies. The consideration cited in the agreement of October 20, 1931, for the payments made by the Trust Co. was the right of the Trust Co. to annual profits of the syndicate*1093 exceeding 6 percent of the paid-in subscriptions. The respondent treated the amounts so received from the Trust Co. as gross income of the syndicate. The amounts were paid to the trustee for the certificate holders under an obligation running directly from the Trust Co. to the certificate owners. The amounts do not constitute taxable income of the syndicate. . On this issue the respondent is reversed. The respondent imposed a penalty of 25 percent because of the failure of the syndicate to file a return within the time prescribed by law. The imposition of a 25 percent penalty is mandatory in case a taxpayer fails to file a return. ; affd., ; ; affd., ; certiorari denied, . If we could treat the fiduciary return filed by the Trust Co. as trustee for the syndicate as a return of the petitioner, the answer would not be different. It does not appear that such return was filed within the time provided for by statute*1094 and no evidence was offered to establish that the failure to file the return at such time was due to reasonable cause or not due to willful neglect. The imposition of the 25 percent penalty was proper and is sustained. Reviewed by the Board. Decision will be entered under Rule 50.