Collateral Equities Trust v. Commissioner

COLLATERAL EQUITIES TRUST, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Collateral Equities Trust v. Commissioner Docket No. 92360. United States Board of Tax Appeals 39 B.T.A. 834; 1939 BTA LEXIS 973; April 25, 1939, Promulgated *973 1. Under Erie Railroad Co. v. Tompkins,304 U.S. 64, the law of the State of Ohio controls the status of stock ownership in that state. 2. The term paid for but not evidenced by certificates (later issued). 3. Petitioner was not, during the taxable year, a personal holding company under the provisions of section 351 of the Revenue Act of 1934. Hugh E. Wall, Jr., Esq., for the petitioner. C. C. Holmes, Esq., for the respondent. VAN FOSSAN *834 This proceeding was brought to redetermine a deficiency in the income tax of the petitioner for the year 1934 in the sum of $896.71 with a penalty of $224.18 for failure to file a timely return. The primary issue is whether or not the petitioner was a personal holding company within the meaning of section 351(a) of the Revenue Act of 1934 and thus subject to the surtax imposed by that section. A subordinate issue is the liability of the petitioner for a penalty, added by section 291 of that act, for the failure to make and file a return within the time prescribed by the Commissioner pursuant to law. The petitioner also challenges the constitutionality of section 351*974 as being violative of the Fifth Amendment to the Constitution. FINDINGS OF FACT. Certain facts were stipulated substantially as follows: The petitioner is an investment trust created by a trust agreement, dated March 27, 1934, executed by Collateral Equities, Inc., a corporation organized and existing under the laws of the State of Ohio, hereinafter called the Depositor, and the Winters National Bank & Trust Co., a national banking association organized under the laws of the United States, having trust powers and authorized and qualified under the laws of the State of Ohio to conduct a trust business, having its principal place of business in the city of Dayton, Ohio, hereinafter called the Trustee. The trust agreement was a voluminous document setting forth the functions and duties of the Trustee, the rights of the certificate holders, and the restrictions over the management of the trust fund. It provided for the semiannual distribution of currently distributable funds available for distribution on February 15 and August 15 of *835 each year, to each certificate holder in proportion to his holdings. There was only one type of beneficial interest in the petitioner, *975 as represented by the certificate for shares issued by the petitioner and held by the persons hereinafter enumerated. Prior to 1934 Greene & Brock, brokers of Dayton, Ohio, had sold to a comparatively large number of their clients shares in a New York investment trust, known as Collateral Trustee Shares called the New York Trust. Greene & Brock and their customers who had made investments in the New York Trust became dissatisfied with the management of the New York Trust and early in 1934 steps were taken to form an investment trust under local management. On March 21, 1934, Collateral Equities, Inc., was organized, the principal object of the corporation being to function as a selling organization of beneficial interests in the investment trust to be known as Collateral Equities Trust, the petitioner in this proceeding. Simultaneously with the execution of the trust agreement of March 27, 1934, the Depositor deposited with the Trustee certain common stocks which were to comprise the primary list of the trust's portfolio. Upon such deposit with the Trustee of these stocks by the Depositor, the Trustee issued and delivered to the Depositor certificates for 1,000 shares of*976 Collateral Equities Trust. Early in 1934 Greene & Brock, acting as the agent for the Depositor and the petitioners, solicited their customers who had previously invested in the New York Trust for the purpose of exchanging, at no cost to the investors, their certificates therein for shares in the new Collateral Equities Trust, the petitioner. In accordance with this offer, the following, among others, subscribed to the plan prior to July 1, 1934, and deposited with Greene & Brock, on the respective dates set forth below, their certificates in the New York Trust: Date of deposit of C.T.S. "A" Certificate Number of with Greene Date of new No. Name shares & Brock certificate [102] Samuel Tourkow (See Note 1) 1,000 5-23-34 7-27-34 [103] Greene & Brock (See Note 2) [450] 6-12-34 7-27-34 [104] Greene & Brock [800] 6-12-34 7-27-34 [105] Greene & Brock 1,950 6-14-34 7-27-34 [106] Greene & Brock [200] 6-14-34 7-27-34 [107] Greene & Brock [200] 6-14-34 7-27-34 [108] Greene & Brock [200] 6-14-34 7-27-34 [109] Greene & Brock [200] 6-14-34 7-27-34 [110] Greene & Brock [200] 6-14-34 7-27-34 [111] Greene & Brock [200] 6-18-34 7-27-34 [112] Greene & Brock [200] 6-18-34 7-27-34 [113] E. C. Halteman [930] 6-13-34 7-27-34 [114] Jennie McQuigg [25] 6-13-34 7-27-34 [115] Louis and Florence Buisch [140] 4-20-34 7-27-34 [116] Chas. S. Grimm [200] 6-15-34 7-27-34 [117] Catherine Baker [50] 6-15-34 7-27-34 [118] Clarence Paxton [25] 6-13-34 7-27-34 [119] Robert Graf [100] 6-15-34 7-27-34 [120] Nora K. Vanden [20] 6-16-34 7-27-34 [121] Auguste E. Martin [50] 6-16-34 7-27-34 [122] Carl Martin [50] 6-16-34 7-27-34 [123] B. J. Thill [150] 6-18-34 7-27-34 [124] Peter Kundert [400] 6-18-34 7-27-34 [125] George Geis [160] 6-19-34 7-27-34 [126] Helen Geis [75] 6-19-34 7-27-34 [127] Alma Peebles [500] 6-19-34 7-27-34 [128] John R. Kundert [200] 6-19-34 7-27-34 [129] Carl Unger [100] 6-19-34 7-27-34 [130] Robert H. Dicks [545] 6-21-34 7-27-34 [131] William E. Stoecklein 1,000 6-21-34 7-27-34 [132] William E. Stoecklein [375] 6-21-34 7-27-34 [133] John V. McGregor [75] 6-21-34 7-27-34 [134] Mary McGregor [175] 6-21-34 7-27-34 [135] Samuel L. Finn [220] 6-21-34 7-27-34 [136] J. A. Oneth [200] 6-21-34 7-27-34 [137] E. W. Grabeman [100] 5-25-34 7-27-34 [138] Mrs. Helen Goodenough 1,060 6-22-34 7-27-34 [140] C. F. Goodenough (See Note 3) 2,575 6-22-34 7-27-34 [139] Mrs. Bertha G. O'Brien (See Note 4) 1,000 6-23-34 7-27-34 [141] Mrs. Florence F. O'Brien (See Note 4) 1,000 6-23-34 7-27-34 [142] Rachel I. Schneider [50] 6-23-34 7-27-34 [143] Frederick Gantner [100] 6-23-34 7-27-34 [144] Frederick Gantner [100] 6-23-34 7-27-34 [145] Ernest Dickey 2,000 6-23-34 7-27-34 [146] James and Lora Moore [400] 6-23-34 7-27-34 [147] J. Luther Sellers 1,000 6-25-34 7-27-34 [148] J. Luther Sellers 1,000 6-25-34 7-27-34 [149] J. Luther Sellers 1,000 6-25-34 7-27-34 [150] J. Luther Sellers [500] 6-25-34 7-27-34 [151] J. Luther Sellers [500] 6-25-34 7-27-34 [152] J. Luther Sellers [600] 6-25-34 7-27-34 [153] Paul H. Rutherford [325] 6-26-34 7-27-34 [154] Bernard W. Brown [25] 6-27-34 7-27-34 [155] David P. Haber [200] 6-29-34 7-27-34 [156] Carl L. Bauman 2,100 6-30-34 7-27-34 [167] Frederick Seybold [200] 5-28-34 8-14-34 [168] Lucille Glaser [35] 6-26-34 8-14-34 [169] Franklin Marro [170] 6-28-34 8-14-34 [170] John D. Laufersweiler [110] 6-29-34 8-14-34 [171] John Neary, Sr 1,000 6-29-34 8-14-34 [182] Daisy T. Greene [25] 6-29-34 8-14-34 [256] Paul B. Shaw [25] 6-29-34 8-14-34 [269] Miss Helen Geis [40] 6-29-34 8-14-34 Total shares subscribed to prior to July 1st 28,605 *977 *836 Explanation of notes: Note 1. The 1,000 shares held by Samuel Tourkow were purchased for cash on May 23, 1934. Note 2. The 4,600 shares held in the name of Greene & Brock belonged to customers of the brokerage firm; Certificate Nos. 103-4 to J. H. and B. E. Dohner; certificate No. 105 to O. J. House; certificate Nos. 106 to 109 to John *837 J. O'Connell; certificate No. 111 to F. H. Renneker; certificate No. 112 to John Q. Sherman. No. 3. Mrs. Helen Goodenough and C. F. Goodenough are husband and wife. No. 4. These certificate holders are sisters-in-law. For the purpose of determining the ownership of shares in Collateral Equities Trust within the meaning of section 351(b), (c), (d), and (e) of the Revenue Act of 1934 it is agreed that: (a) J. H. and B. E. Dohner, owning certificate Nos. 103 and 104, are husband and wife. (b) H. and C. F. Goodenough, owning certificate Nos. 138 and 140, are husband and wife. (c) Mrs. Bertha G. O'Brien and Mrs. Florence F. O'Brien, owning certificate Nos. 139 and 141, are the wives of brothers and are not otherwise related. (d) No other shareholders, other than those mentioned, who owned sufficient number*978 of shares as to make their relationship material to the issue whether at any time during the last half of the taxable year 50 percent or more in value of the outstanding shares in the petitioner were owned by or for not more than five individuals, are related to any other shareholders within the degrees set forth in section 351(b) and (e) of the Revenue Act of 1934. The petitioner made no election to report its income upon a fiscal year basis and, not having done so, it filed its first return on or before March 15, 1935, on form 1120 for the calendar year 1934 with the collector of internal revenue at Cincinnati, Ohio. The petitioner filed form 1120-H with the collector of internal revenue at Cincinnati, Ohio, under protest, May 19, 1938. The record discloses the following additional facts: Greene & Brock desired to form a trust which would be directed and managed by that firm. There was no intention on the part of the Trustee that the securities held by the trust should be restricted to a few, but, on the contrary, the trust was so devised that a great number of investors might participate in securing diversified investments under central management. Neither Greene & Brock, *979 the petitioner, nor anyone involved in the transactions had any intention of making the petitioner a personal holding company. The petitioner was formed to take the place of the New York Trust under the agreement between the holders of the New York Trust certificates and Greene & Brock, which provided for an exchange of those certificates for similar certificates of the petitioner. The petitioner was formed also for the purpose of effecting such a change. The certificates to be issued by the petitioner were not delivered by the printer until after July 1, 1934. The lot of 27,000 shares issued to individuals was signed in July to have them out of the *838 way before the fixed distribution date, August 15. The remaining shares to be issued by that date, or 1,605 shares, were not actually issued until August 14, 1934. Over a period of years Greene & Brock had sold to 200 or 300 investors between 55,000 and 70,000 shares in the New York Trust. Prior to July 1, 1934, investors holding 28,605 shares had agreed to convert their New York Trust shares into shares in the petitioner. All such investors carried out their agreement. Practically all holders of New York Trust*980 shares in the vicinity of Dayton had signified verbally in their intention so to exchange their shares. The several transactions had not been completed because some investors were away on vacation and others had not been able to go to their safety deposit boxes. In order to facilitate the detail work, Greene & Brock instructed its cashier to pick out 26,000 or 27,000 shares and ship them to the Empire Trust Co. to secure the release of the underlying securities. The petitioner's officers made its return on form 1120 because it was not formed as a holding company, had not been so conducted, and, as they believed, never was that kind of a company. At the suggestion of its accountants, on May 18, 1938, the petitioner signed a return as a holding company on form 1120 H and endorsed thereon its protest that the return was being filed only at the request of the Internal Revenue Department but that the petitioner still contended that it was not a personal holding company. The respondent based the application of section 351 upon the certificates owned by the following shareholders: Shares J. Luther Sellers 4,600 Mr. and Mrs. C. F. Goodenough 3,635 Ernest Dickey 2,000 Carl L. Bauman 2,100 W. E. Stoecklein 1,375 13,710 *981 OPINION. VAN FOSSAN: Issue is joined in the case as to whether taxpayer was, in the taxable year, a personal holding company under the provisions of section 351 of the Revenue Act of 1934. 1 *982 *839 The petitioner concedes that at least 80 percent of its gross income for 1934 was derived from royalties, dividends, interest, annuities, and gains from the sale of stock or securities, but denies that on the crucial date, July 27, 1934, 50 percent in value of its outstanding stock was owned, directly or indirectly, by or for not more than five individuals. It also denies that it is, or any time during its existence was, a personal holding company. The respondent's position is that on July 27, 1934, only 27,000 shares of the petitioner's such shares were owned by five individuals. The petitioner is an association taxable as a corporation. Its certificates of beneficial interest correspond to the stock certificates of a corporation. The principles governing the status and incidents of stock ownership, therefore, are applicable to the issuance and ownership of the shares in the petitioner. Respondent argues that, since certificates had been issued on July 27, 1934, in exchange for only 27,000 of the 28,605 shares which the New York Trust investors had deposited with Greene & Brock, such 27,000 shares constituted the only meaning of the statute. *983 The petitioner contends that the expression contained in section 351(b)(1)(B) must be construed according to the law of the State of Ohio, and cites Erie Railroad Co. v.Tompkins,304 U.S. 64. It asserts that under the state law stock is when subscribed and paid for, that all the 28,605 shares in the petitioner were subscribed and paid for, and that hence the 13,710 shares owned by five individuals are less then the 50 percent of the outstanding stock required to render the statute operative. We are of the opinion that petitioner's contention must be sustained. In Erie Railroad Co. v. Tompkins, supra, the Supreme Court has recently said: Except in matters governed by the Federal Constitution or by Acts of Congress, the law to be applied in any case is the law of the State. And whether the law of the State shall be declared by its Legislature in a statute or by its highest court in a decision is not a matter of federal concern. There is no federal general common law. Congress has no power to declare substantive rules of common law applicable in a State whether they be local in their nature or "general", be they commercial law or a part*984 of the law of torts. And *840 no clause in the Constitution purports to confer such a power upon the federal courts. * * * The established rule in Ohio is stated in 10 Ohio Jurisprudence, paragraph 173, page 287, as follows: There is a marked and obvious distinction between the stock of a corporation and the certificate representing the stock. The certificate of shares of stock in the corporation is not the stock itself, but is a mere evidence of the stockholder's interest in the corporate property which issues such certificates, 1 representing the interest which the owner and holder of it has in the entire assets of the corporation. 2 At page 291, paragraph 196 of the same volume the law applicable to the situation before us is further stated as follows: In the absence of statutory or charter requirements, no certificate of stock is necessary to attest the rights of the shareholders; such certificate, when issued, is merely an evidence or acknowledgment of the*985 owner's interest in the property of the corporation, but is not property itself. The issurance thereof is by no means essential to the creation of the relation of stockholder; one may be the owner of stock without any certificate to evidence the fact. The certificate is authentic evidence of title to the stock, but it is not the stock itself, or necessary to its existence; a subscriber becomes a stockholder from the moment he subscribes to the stock. Thus the right to vote, or to make transfers, exists, although no certificate has been issued. The cases supporting the law thus expressed are: Ball v. Towle Manufacturing Co.,67 O.S. 306; 65 N.E. 1015; Cincinnati, N. O. & C.R.R. Co. v. Third National Bank,1 O.C.C. 199; Simmons Hardware Co. v. Stokes,16 O.C.C. 145; Royce v. Tyler,2 O.C.C. 175. In Simmons Hardware Co. v. Stokes, supra, the court said: A man may own an interest in corporate property as a shareholder, he may vote as a member, he may transfer his stock without a certificate, his interest in the assets and his liability for its debts do not appear to depend*986 on his possession of a certificate - all this has often been declared by the courts. The certificate is not the title, the title exists without the certificate and independent of it. The respondent's own regulations, article 25, Regulations 71, applicable to stamp taxes, recognize the same principle: is deemed to be issued when it is subscribed for and the subscription is accepted by the corporation. We hold the 28,605 shares in the petitioner, hereinabove mentioned, to be agreement of exchange had been consummated; only the manual issuance of a small part of the certificates remained to be done. All rights of ownership had attached. It follows that respondent must *841 be reversed. Less than 50 percent in value of the outstanding stock in petitioner was owned by five individuals and consequently it does not come under the provisions of section 351. In view of the conclusion we have reached above, it is unnecessary to discuss other contentions of the parties. It likewise follows that petitioner is subject to no penalty. Decision will be entered for the petitioner. Footnotes 1. SEC. 351. SURTAX ON PERSONAL HOLDING COMPANIES. * * * (b) DEFINITIONS. - As used in this title - (1) The term exempt from taxation under section 101, and other than a bank or trust company incorporated under the laws of the United States or of any State or Territory, a substantial or surety company) if - (A) at least 80 per centum of its gross income for the taxable year is derived from royalties, dividends, interest, annuities, and (except in the case of regular dealers in stock or securities) gains from the sale of stock or securities, and (B) at any time during the last half of the taxable year more than 50 per centum in value of its outstanding stock is owned, directly or indirectly, by or for not more than five individuals. For the purpose of determining the ownership of stock in a personal holding company - (C) stock owned, directly or indirectly, by a corporation, partnership, estate, or trust shall be considered as being owned proportionately by its shareholders, partners, or beneficiaries; (D) an individual shall be considered as owning, to the exclusion of any other individual, the stock owned, directly or indirectly, by his family, and this rule shall be applied in such manner as to produce the smallest possible number of individuals owning, directly or indirectly, more than 50 per centum in value of the outstanding stock: and (E) the family of an individual shall include only his brothers and sisters (whether the whole or half blood), spouse, ancestors, and lineal descendants. * * * ↩ 1. Ball and the American Exchange Bank et al. v. The Towle Manufacturing Co.,67 O.S. 306↩. 2. Marble v. Van Wert National Bank,3 O.C.C. 464, 20 C.D. 265↩.