DocketNumber： Docket No. 95762.
Judges： Kjern
Filed Date： 9/5/1940
Status： Precedential
Modified Date： 11/2/2024
*966 1. On the facts petitioner is an association taxable as a corporation.
2. Petitioner made a lease of land though to be oil producing. The lessee in partial consideration for the lease paid to petitioner a cash bonus. No oil was discovered on the premises and they were reconveyed to petitioner.
3. On the facts, the fair market value of certain land payment contracts transferred to petitioner, as of the time of transfer, was the face amount of the balances due thereon.
4. Amount paid by petitioner as an assessment on bank stock owned by it is not deductible as a loss in the year of payment.
*681 This case involves a deficiency in taxes of the Porter Property Trustees, Ltd. (hereinafter referred to as the petitioner), resulting from respondent's determination for the year 1935, as follows:
| Income tax | $1,458.59 |
| Excess profits tax | 653.06 |
| Surtax on personal holding company | 3,134.66 |
| Penalty of 25 percent for failure to file a personal holding company return | 783.67 |
*967 *682 The petitioner raised four assignments of error in its petition, but as no evidence was presented on the claim for a deduction of legal fees, the claim having been denied by the respondent in his answer, we must assume that this claim has been abandoned. The principal question is whether petitioner is taxable as an association under section 801(a)(2) of the Revenue Act of 1934, as respondent contends, or as a trust; and secondary questions, are whether petitioner derived income from sale contracts during the year 1935 in the amount of $1,627.10, as respondent determined, and whether it is entitled to a deduction, denied by respondent, for tis payment of $2,202.50 in that year because of an assessment levied against the stockholders of a certain defunct bank.
The facts were stipulated in part and in part developed from testimony at the hearing.
FINDINGS OF FACT.
J. Howard Porter, John C. Porter, and Paul D. Porter, are the trustees of the petitioner, Porter Property Trustees, Ltd., an express trust, created by a written instrument dated February 28, 1935. Before February 28, 1935, the entire outstanding capital stock of the James Porter Investment Co., a Delaware*968 corporation, consisting of 2,808 shares, was owned and held by James Porter and Katie E. Porter, husband and wife, and members of their family. The following table shows the interest and relationship of each stockholder:
| Name | Relationship | Shares held |
| James Porter | Father | 685 |
| Katie E. Porter | Mother | 1,858 |
| Paul D. Porter | Son | 50 |
| B. F. Shumway | Nominee for father | 65 |
| W. N. Dennison | Husband of daughter (Elizabeth) | 50 |
| Rebecca P. Wells | Daughter | 50 |
| James Howard Porter | Son | 50 |
| John C. Porter | Son | 0 |
| Elizabeth P. Dennison | Daughter | 0 |
| Total | 2,808 |
On February 28, 1935, and for some time before then, the James Porter Investment Co. was the owner of certain personal property, and also held in fee simple certain land, mainly agricultural and unimproved, and situate in Kern County and San Luis Obispo County, California, Nobles County, Minnesota, and Grundy County, Iowa. This land was acquired by the James Porter Investment Co. at the time of its incorporation in 1930, from James Porter and Katie E. Porter in exchange for its capital stock. Such of its personal property as was not acquired by that company in a like manner, and at the smae time, was acquired*969 by the company in the course of its ordinary business activities afterwards but before February 28, 1935. Certain *683 of these lands had been improved before and during the period held by the company, and farming operations were carried on by leaseholders for profit on part of these lands while they were owned and held by the company.
On February 28, 1935, James Porter, Katie E. Porter, Paul D. Porter, F. B. Shumway, W. M. Dennison, and James Howard Porter, as grantors, and James Howard Porter, Paul D. Porter, and John C. Porter, as trustees (hereinafter sometimes referred to as the trustees), executed and entered into a written "Conveyance and Contract" agreement, incorporated herein by reference, the relevant parts of which are later set out, by which the trust involved herein, known as the Porter Property Trustees, Ltd., was created. By the terms of the trust instrument, the trustees were selected and appointed by the grantors, and were therein designated and described as the board of trustees and were authorized to act under and use the trade name of Porter Property Trustees, Ltd. There were transferred and conveyed to the trustees at the time of creation of the trust*970 1,723 shares of the capital stock of the James Porter Investment Co., which constituted all the shares shown in the table above, except the 685 shares in the name of James Porter and 400 of the 1,858 shares in the name of Katie E. Porter. On the day of their constitution as such, February 28, 1935, the trustees, acting in their collective capacity, acquired ffom James Porter the 685 shares noted above in consideration for their assumption of his debt in the amount of $52,000.
The interests of the respective trust beneficiaries are described in the trust instrument as "expectancy fractions." Article 15 of the trust instrument provides as follows:
ART. 15. REGISTRATION & DORMANT FRACTIONS:
Expectancy Fractions under this administration shall at first be allotted in the records of the Board under instructions delivered to the Board by James Howard Porter. Should fractions appear dormant thereby, while held dormant they shall not be reckoned with when apportioning in distributions, such being computed solely by or upon the fractions registered as to beneficiaries at time of making each distribution. Dormant fractions, their usefulness being contingent upon possible future conveniences, *971 remain subject to the discretion of the Trustees.
Pursuant to the provisions of "ART. 15" of the trust instrument, under instructions from James Howard Porter, expectancy fractions were allotted in the records of the board of trustees as follows:
| Paul D. Porter | 290/1000 |
| John C. Porter | 290/1000 |
| Rebecca P. Wells | 65/1000 |
| Elizabeth P. Dennison | 65/1000 |
| James Howard Porter | 290/1000 |
| Total | 1000/1000 |
*684 Immediately after the trustees had acquired the 2,408 shares of the James Porter Investment Co. on February 28, 1935, as set forth above, they exchanged them with that company for all its assets (except one parcel of real estate situate in Grundy County, Iowa, known as the Porter Homestead), subject to its then outstanding liabilities. Shortly thereafter the company was liquidated and dissolved.
Included among the assets of the company thus acquired were certain land sale contracts which provided for future payments by the purchasers, some of them not becoming due and payable until after their acquisition by the trustees. At this time the company was treating with the Standard Oil Co. for the lease by the latter*972 of a part of these lands situate in Kern County, California. The negotiators had by then reached an agreement for the execution of a lease which was to be executed by the James Porter Investment Co. for the use and benefit of the Porter Porperty Trustees, Ltd., and then to be assigned to the trustees. This was accordingly done. Under its terms the lessee was obligated to explore, develop, and drill certain wells on the leased land for oil or gas of commercial quality and in commercial quantity. This was done but no oil or gas was found, and the lessee quitclaimed its interest to the trust in the year 1938. Under the terms of this lease agreement certain oil and gas royalty interests were retained by the lessor, in addition to the bonus paid by the lessee for the execution of the lease.
The trust instrument provided for the following additional matters: (1) The trustees were given the power to sell and to convey and deliver any, all, or such of the trust properties as they might see fit, in their discretion; (2) the trustees were authorized to add to their number and to choose their successors, provided that the number of trustees should at no time exceed five; (3) the trustees*973 and/or their successors were to hold the trust properties throughout the existence of the trust; (4) the trust was to continue indefinitely for any lawful term; (5) the trustees were authorized to act together, informally over their individual signatures, or collectively, under the name of Porter Property Trustees, Ltd., through duly authorized officers of their board; (6) the trustees, acting as the board of trustees, were authorized to delegate to, by proper resolution, any member or members of the board the necessary authority to transact any and all business of the trust, including the execution of deeds, conveyances, and other instruments in writing; (7) the trustees, in whom "legal and equitable title to all estate properties are vested", were made the absolute owners of the trust properties, with full powers of management thereof; (8) provision was made for regular and special meetings of the board of trustees; (9) the trustees were authorized to engage in any lawful business; to own real estate and personal property in any of the *685 several states, without limit; to buy, sell, improve, exchange, assign, convey and deliver, and to grant trust deeds, and to mortgage*974 or otherwise encumber for obligations; to own stock in or entire charters of corporations; and to engage the trust funds and properties in any industry or investment in their discretion, hoping thereby to make gain for the trust; (10) the trustees were authorized to and did adopt a common seal; (11) the trustees were authorized to regard the trust instrument as their guide, and to supplement the same from time to time by proper resolutions written into the office records of the board of trustees, or to adopt formal bylaws or rules of business conduct; (12) the trustees were authorized to elect a presiding officer, or president, and to select and appoint a board secretary, and to delegate duties and authority to them; (13) the trustees were authorized to fix and pay all compensation of officers, agents, and employees, and to pay to themselves such reasonable compensation as might be determined by a regular act of their board; (14) the trustees were required to keep a faithful financial record of all business transactions, and the name and address of each known beneficiary; (15) all income and trust funds, when collected or paid over to the trustees, were to constitute a fund from which*975 the trustees should pay trust obligations, reinvest or distribute to the beneficiaries, in their discretion; (16) the personal liability of the trustees was limited to the value of the trust funds and properties; ( 7) the filing of a copy of the trust instrument in the public records of some designated county was to be constructive notice to the world of such specific personal liability limitations of the trustees, and that all persons, corporations, or companies extending credit to, contracting with, or having claims against the trustees must look only to the funds and properties of the trust for payment or discharge of such obligations; (18) the trustees might provide for annual or other meetings of the trust beneficiaries to hear and discuss reports and forecasts; (19) while they might adopt resolutions of protest or commendation, no act of the beneficiaries, as such, should be mandatory or interfere with the right of the trustees exclusively to manage the business affairs and control the trust funds and properties; (20) the death of a beneficiary should not entitle his legal heirs or representatives to demand any partition of or interest in or distribution from the trust funds*976 or properties, but his legal heirs might succeed to his interest; (21) changes in beneficiaries from any cause should be duly noted by the trustees on their records; (22) the trustees might at any time, in their discretion, and from any available trust funds, make partial distributions to beneficiaries, and ultimately, upon termination of the trust, should distribute the entire residual trust funds to the beneficiaries in accordance with their proportionate interests; (23) the trust was irrevocable; (24) the beneficiaries might be called by the *686 trustees to meet annually or at other times and they might adopt resolutions but no act of the beneficiaries should be mandatory on the trustees.
James Howard Porter has been, since the trust's inception in 1935, the president of its board of trustees and, with the two other trustees, has managed its business during the same period. He has been more active than the other trustees in its management. He confers informally with the other trustees. Farm lands owned by the trust are leased to farmers for profit. James Howard Porter executes all leases on behalf of the trust and he attempts to negotiate only such leases as will*977 prove profitable to the trust. The affairs of the trust were carried on during the year 1935 in accordance with the terms of the trust instrument. Of the amount of $63,596.29 determined by respondent to have been derived by the trust from "oil royalties" during the year 1935, $46,000 represents a bonus received by the trust from the Standard Oil Co. of California as consideration for the execution of the lease already mentioned.
The James Porter Investment Co. sold certain land on installment contracts before February 28, 1935, and on that day transferred the contracts to the petitioner. The fair market value of these contracts at the time of this transfer was equal to the face amount of the balances due thereon. In 1935 petitioner received payments in the aggregate amount of $5,749.50 on account of the contracts.
The James Porter Investment Co. was the owner of an undisclosed number of shares in the Morrison Savings Bank of Morrison, Iowa, before February 28, 1935, and on that day transferred these shares to the petitioner. In 1932 or 1933 a receiver of the bank was appointed and at an undisclosed date the receiver levied an assessment on all the bank's shareholders. Petitioner*978 paid $2,202.50 in 1935 in full satisfaction of its share of the assessment, pursuant to a notice of assessment received by it in the taxable year, which notice was the first notice given of such assessment.
In arriving at the adjusted net income of $13,061.10 for the year 1935, as shown by the notice of deficiency, the Commissioner determined that petitioner had a gross income of $74,794.64, for that year, derived as follows:
| Farm income | $1,580.12 |
| Payments Land contracts | 8,652.89 |
| Oil royalties | 63,596.29 |
| Miscellaneous income | 106.19 |
| Interest | 859.15 |
| Gross income | 74,794.64 |
In the deficiency notice the Commissioner determined that in 1935 petitioner was an association taxable as a corporation within the meaning of section 801(a)(2) of the Revenue Act of 1934 and *687 articles 801-2 and 3 of
Your protest contends for a deduction, not claimed in your return, for an amount of $2,202.50 stockholder's liability incurred by the James Porter Investment Company but paid by you in the taxable year, in connection with the ownership of certain stock in the Morrison Savings Bank, Morrison, Iowa. The payment made has been disallowed as a deduction for income tax purposes for the reason that it has not been substantiated as a loss properly deductible under the provisions of Section 23(f) of the Revenue Act of 1934.
Within the time provided by law the petitioner trust filed an individual income tax return for the year 1935, under Title I of the Revenue Act of 1934, disclosing thereon a net income of $7,192.38 and a tax liability of $337.31. No other return was filed by petitioner for the year 1935, and as a consequence respondent notified the petitioner of a penalty as follows:
Inasmuch as you failed to file a return on*980 Form 1120H as required by Article 351-8 of Regulations 86, 25 per centum of the tax computed under Section 351(a) has been added thereto in conformity with the provisions of Section 351(c) and Section 291 of the Revenue Act of 1934.
OPINION.
KERN: The principal issue is whether the petitioner, Porter Property Trustees, Ltd., was an association taxable as a corporation, or a trust. On the theory that it was an association, respondent claims the personal holding company surtax and nonfiling penalty.
The question is no longer novel, having received consideration from the Supreme Court in several cases, in the latest of which,
"Association" implies associates. It implies the entering into a joint enterprise, and, as the applicable regulation imports, an enterprise for the transaction *688 of business. This is not the characteristic of an ordinary trust * * *. Such beneficiaries do not ordinarily, and as mere cestuis que trustent, plan a common effort or enter into a combination for the conduct of a business enterprise. * * * But the nature and purpose of the cooperative undertaking will differentiate it from an ordinary trust. In what are called "business trusts" the object is not to hold and conserve particular property, with incidental powers, as in the traditional type of trusts, but to provide a medium for the conduct of a business and sharing its gains. Thus a trust may be created as a convenient method by which persons become associated for dealings in real estate * * *.
The Court then went on to mention other forms of business enterprise in which the association might be used. It then pointed out that "The inclusion of associations with corporations implies resemblance; but it is resemblance*982 and not identity." "Mere formal procedure" was not to be made "a controlling test." The revenue act's definition embraces more than joint stock companies. And "while the use of corporate forms may furnish persuasive evidence of the existence of an association, the absence of particular forms, or of the usual terminology of corporations, cannot be regarded as decisive." Trustees may act as directors, and the trust terms serve as bylaws. Control by the beneficiaries, the Court pointed out, had in the earlier case of
Having laid down these principles, the Court then proceeded to examine the facts of the case before it, of a trust created for the development of a tract of land by building golf courses and club houses, surveying and selling lots, and the like, which was effected by issuing transferable certificates of beneficial interest. The Court thought it a business enterprise, even if no new tracts were acquired: "Its character was determined by the terms of the trust instrument. It was not a liquidating trust; it was still an organization for profit, and the profits were still coming in. The powers *689 conferred on the trustees continued and could be exercised for such activities as the instrument authorized."
The companion cases decided by the Supreme Court the same day dealt*984 with situations not unlike that of the Morrissey trust. In
Further citations seem unnecessary in view of the fundamental test so clearly laid down by the Supreme Court. That is, whether there is a business purpose back of the trust's creation and continuance. A glance at the history of the present trust leaves no doubt that there was here such a purpose. James Porter and his wife owned certain agricultural lands in California and Minnesota, some of which were actively*985 farmed. In 1930 they created a corporation and took its shares in exchange for these lands, the only other shareholders being Porter's two sons, daughter and son-in-law, and an outside nominee. The use of the corporate form no doubt had its advantages, but it also had certain disadvantages from the standpoint of tax rates. In 1935 a trust was substituted for the corporation, taking over all its assets except the Porter Homestead, which apparently went to Porter's wife, for her name does not reappear among the holders of the trust's "expectancy fractions." The new trust beneficiaries are still the members of Porter's family, although their relative interests have changed somewhat since the corporation was dissolved. All these facts show, we believe, one increasing purpose to retain the advantages of centralized control, limitation of liability, and others associated with the corporate form in carrying on actively the business of farming lands and distributing the income therefrom.
We may stop a moment here to note those provisions of the trust to which petitioner points as distinguishing it from a business association. It is said that the trustees have exclusive management and*986 may fill vacancies, and that the beneficiaries have no voice in the trust's control; that the trustees may not sell any interests in the trust estate and that the beneficiaries' interests are nontransferable; *690 that the trustees have had no formal meetings and that the beneficiaries have never been consulted on the affairs of the trust. The claim of nontransferability of "expectancies" has not, we think, been clearly established. But we do not think these points are vital, for they go merely to the outward form of the trust, which, on one side, may approximate the form of a corporation or, on the other, that of a strict trust; and it is not the particular form of doing business so much as the business purpose which must determine. In other words, the statute is intended to hit a trust even strict in form if it is at the same time conducted for profit. Such is the teaching in
We are of the opinion that petitioner was an association and therefore taxable as a corporation.
Assuming, without deciding, that because petitioner was an association taxable as a corporation it should also be considered as a corporation within*989 the meaning of section 35 (b)(1) of the Revenue Act of 1934, which defines "personal holding company", it is necessary, in order to conclude that petitioner was such "personal holding company", to find that "80 per centum of its gross income for the taxable year is derived from royalties * * *." It appears from the stipulation of the parties that petitioner's gross income for the taxable year was $74,794.64. Of this amount respondent determined that $63,596.29 was derived from oil royalties. However, it appears from the respondent's determination of deficiency that of this latter amount $50,800 represented bonuses paid to petitioner as lessor by the Standard Oil Co. and the Texas Co. As to the bonus paid by the Standard Oil Co., amounting to $46,000, we have evidence in the record and stipulations to the effect that a dry hold was drilled on the property leased, that no oil or gas was produced from the leased premises, and that three years after the taxable year the lessee reconveyed the premises to petitioner by quitclaim deed. Thus, it is apparent that the bonus received by petitioner in return for the lease in question was not paid and could not have been paid from any share*990 in the oil or gas produced under the lease reserved by the lessor, that it was not "payable proportionately to the use made of the right by the grantee", and was not "based upon the amount of mineral or oil taken from the ground", and was not "a share of the product * * * reserved by the owner for permitting another to use the property." Therefore, we conclude that such a bonus payable to the lessor in a definite sum and in no way contingent upon or payable from the production of oil or gas from the leased premises is not a "royalty" within the meaning of section 351 of the Revenue Act of 1934.
We turn now to the next issue. Respondent contends that petitioner derived income*991 to the extent of $1,627.10 in the taxable year from land sale contracts, and that the evidence adduced at the hearing was insufficient to establish error in respondent's determination of this *692 sum. The respondent, in his deficiency notice, determined that petitioner received land contract payments in 1935 in the aggregate amount of $5,749.50, and he accordingly treated a certain percentage of each payment as representing a reportable profit during that year, with the result reached above.
The land held had been sold by the James Porter Investment Co. on the installment plan and the contracts were transferred by that corporation to the trust on February 28, 1935. The question turns on the proof of fair market value of these contracts on that basic date, and respondent submits that his determination has not been overcome by adequate proof.
Petitioner introduced evidence to the effect that the land contracts were worth on the basic date an amount not less than the face amount of the outstanding balance then due on them. James Porter testified that he had sold substantial tracts of land in Canada and about 35,000 acres in California on his own account on installment*992 contracts, although he had never discounted them or bought them. He had, however, as a banker some knowledge of the value of such contracts put up by borrowers as collateral security. Porter testified that he knew personally the contract purchasers and the tracts sold, and that the land contracts taken over by petitioner were worth not less in the market than the face amount still due on them. James Howard Porter was then called by petitioner and testified as to the amounts due on various specific contracts on dates near February 28, 1935.
Respondent introduced no evidence on this point.
On this issue we sustain petitioner's contention.
The last question may as quickly be disposed of. Petitioner claims a deduction of $2,202.50 for the taxable year in respect of the payment in that year of that amount on account of a double liability assessment levied against the shareholders of a bank. The James Porter Investment Co. was the owner of an uncertain number of shares of the stock of the Morrison Savings Bank, of Morrison, Iowa, before February 28, 1935, which on that day were transferred to petitioner. The bank went into receivership in 1932 or 1933, and the assessment was*993 levied on shareholders accordingly, the petitioner receiving a notice of the assessment in 1935, and it thereupon paid the sum claimed in deduction. The petitioner trust paid the assessment immediately in 1935 on the first call made upon the bank's shareholders.
This is all the evidence and it is obviously insufficient to establish this expenditure as a deductible loss. Ordinarily, the payment of an assessment on bank stock is to be considered as a contribution to capital, and is not deductible, any loss in such a case being incurred when the stock is sold or becomes worthless.
No evidence being before us as to the deduction of $4,516.72 claimed for legal fees and expenses in the same year, it must also be denied.