Dutton v. Commissioner

*1152 The respondent has asserted deficiencies in income taxes for the years 1924, 1925, and 1926, in the respective amounts of $7,500.14, $6,370, and $5,400. The single issue raised by the pleadings is whether the petitioners constitute an "association" taxable as a corporation, or whether they are taxable as a trust.

At the hearing the parties filed a stipulation covering all the material facts, from which we make the following findings of fact.

FINDINGS OF FACT.

Prior to September 30, 1920, the*2512 Ontra Cafeteria Co., an Illinois corporation, owned and operated two cafeterias in Chicago, Ill. Its capital stock, in the total amount of $100,000, was held by three stockholders.

On September 30, 1920, the following declaration of trust was executed by Mary L. Dutton, Jane LeFurgy, and W. E. Lindblad, who are the petitioners herein:

Parties: This Agreement and Declaration of Trust (hereinafter designated as "Declaration of Trust"), made and entered into in the City of Chicago, State of Illinois, on this Thirtieth day of September 1920 by and between Mary L. Dutton, Jane LeFurgy and W. E. Lindblad, all of the City of Chicago, State of Illinois, (hereinafter designated as "Trustees"), party of the first part, and each and every one of the holders, from time to time, of certificates for shares of beneficial interest (hereinafter designated as "Beneficiaries"), parties of the second part, Witnesseth That:

Recitals: Whereas, it is proposed to deliver to the Trustees certain sums of money, and it is proposed to convey, assign, transfer and deliver to the Trustees certain securities and certain other property; and

Whereas, it is the purpose and intention that the Trustees*2513 shall purchase and thereafter manage and conduct the business heretofore conducted and carried on by Ontra Cafeteria Co., a corporation organized and existing under and by virtue of the laws of the State of Illinois, and any other business or transaction, such as by the Trustees may be considered advisable and as tending to enhance the value of the beneficial interests in the Trust hereby created.

Declaration of Trust: Now, Therefore, the Trustees hereby declare that they will hold the said sums of money, securities and property that may be acquired by them as aforesaid, as well as all other property which they may acquire as such Trustees, together with the proceeds and avails thereof, in Trust, to hold, manage and dispose of the same, and to collect, receive and distribute the net income thereof, for the benefit of the Beneficiaries, from time to time, whose interests are represented by certificates for shares of beneficial interest issued hereunder, in the manner and subject to the stipulations herein contained, to-wit:

ARTICLE I.

Name: Insofar as may be practicable and convenient, the Trustees shall manage the Trust, execute all instruments of writing and do and*2514 perform all other things relating to this Trust under the name of "Ontra Cafeteria." And every duly authorized instrument executed in such name shall have the same effect as if executed in the name of the Trustees.

*1153 ARTICLE II.

Powers and Duties of Trustees: Section One: The Trustees are authorized and empowered: (a) To buy, acquire, hold, own, sell, lease, manage, conduct and operate cafeterias, restaurants and all manner of eating houses; to exercise any and all rights incident to the ownership and possession of such places of business.

* * *

(k) To make such by-laws, rules and regulations to govern the management of the Trust Estate as they shall deem advisable and to select one of their number to act as President, one to act as Treasurer and one to act as Secretary of this Trust, delegating to each of said officers such duties as they may, from time to time, determine.

* * *

ARTICLE IV.

Purchase of Shares by Trustees: Each Trustee may acquire, own, hold and dispose of shares of beneficial interest in this Trust to the same extent if he were not a Trustee, without being disqualified to act as a Trustee, and while owning and holding such shares*2515 on his personal account, as a Beneficiary, shall be entitled to the same rights, privileges and interests as any other beneficiary, and as a Beneficiary shall be chargeable with no liability because he is both a Trustee and a Beneficiary. Each Trustee, notwithstanding the fiduciary position which he holds, may deal with himself as Trustee in relation to the Trust Estate as freely as if he or she were not a Trustee hereunder.

ARTICLE V.

Obligations Limited to Trust Property: Section One: No recourse shall at any time be had, under, or upon any note, bond, contract, instrument, certificate, undertaking, obligation, covenant, or agreement issued or executed by the Trustees under or pursuant to the terms of this Declaration of Trust or anyone managing the Trust Estate or by any agent, representative, or employee of the Trustees, or by reason of anything done, or omitted to be done by them or any of them, against the Trustees individually or against any agent, representative or employee, or any Beneficiary or the holder of any other security issued by the Trustees, either directly or indirectly, by legal or equitable proceeding, or by virtue of any suit or otherwise, it being*2516 expressly understood and agreed that (a) this Declaration of Trust and all obligations and instruments executed thereunder are executed pursuant hereto by the Trustees; that (b) any acts done or omitted to be done by them are solely the obligations, instrument, acts and omissions of, or in respect of, the Trust Estate, and that (c) all the obligations, instruments, liabilities, covenants and agreements, acts and omissions of the Trustees as Trustees and of the Trustees as Beneficiaries, shall be enforced against and be satisfied out of the Trust Estate only, or such parts thereof as, under the terms and provisions of this Declaration of Trust, shall be liable for or chargeable therewith. And all personal liability of the Trustees, both as Trustees and as Beneficiaries and of all of their agents, representatives and employees and of the Beneficiaries, to those dealing with this Trust, is hereby expressly waived and negatived. The Trustees and their agents, representatives and employees are not authorized to contract any debt or do anything which will charge the Beneficiarcies or bind any or all of them personally.

* * *

*1154 ARTICLE VI.

Certificates: Section One: *2517 During the continuance of this Trust, the beneficial interests therein and hereunder shall be solely evidenced by certificates for shares of beneficial interest. Such shares in the first instance, shall be divided into One Thousand (1,000) beneficial interest shares.

Dividends: Section Two: The Trustees may, in their absolute discretion, retain as a part of the corpus of the Trust Estate, the entire net income, or any part thereof, for any calendar year, or the Trustees may, in their absolute discretion declare dividends on the beneficial interest shares at such rate per share per annum as they may deem advisable, payable then or thereafter, out of the net income of said Trust Estate, retaining as a part of the corpus of the Trust Estate, the remaining net income, or any part thereof.

Liquidation: Section Three: In case of the liquidation of this Trust, the proceeds of liquidation shall be divided among the holders of the beneficial interest shares in proportion to their respective holdings.

Form of Beneficial Interest Certificate: Section Four: As evidence of the ownership of the said beneficial interest shares, the Trustees shall cause to be issued to each Beneficiary*2518 a negotiable certificate or certificates, * * *

* * *

Distribution: Section Five: The Trustees may, from time to time distribute to the Beneficiaries such income, proceeds or other parts of the Trust Estate as they may determine, but all distribution of the income, proceeds, or other parts of the Trust Estate and the amount and conditions of payment and distribution thereof, among the Beneficiaries, shall rest in the absolute discretion of the Trustees, whose decision in the matter shall be final. The Trustees may retain, undistributed, such sums as they may deem proper to create a sinking, reserve, surplus or contingent fund.

* * *

Section Eleven: The Trustees may from time to time, in their discretion for the purpose of increasing the Trust Estate, issue further certificates for shares of beneficial interest with such rights and priorities in the Trust Estate and upon such terms and conditions as they may determine. All such payments received and certificates issued shall be subject to this Declaration of Trust.

ARTICLE VII.

Successors - Election by Trustees: The death of a Trustee during the continuance of this Trust shall not operate to determine the Trust. *2519 Upon the death, resignation, inability, incapacity or refusal of any of said Trustees to act under this Agreement and Declaration of Trust the remaining Trustees shall elect a successor to said Trustee. * * *

Election by Shareholders: If all of the Trustees should meet death in a common disaster or if, for any reason, all of the Trustees shall, at one and the same time, resign, refuse or shall be unable to act, or become incapable to acting, then, and in that event, the holders of the beneficial interest shares shall elect trustees to fill the vacancies so created. A majority vote of the beneficial interest shares shall be necessary to so elect any Trustee.

ARTICLE VIII.

Duration of Trust: This Trust shall continue for a period of Twenty One (21) years, provided that if during said period of Twenty One (21) years the Trustees shall decide to terminate this Trust, then in such event this Trust *1155 shall terminate on the date so fixed by the Trustees, at which time the Trustees shall proceed to wind up its affairs, liquidate its assets and distribute the same, or to sell the assets and distribute the proceeds thereof, among the Beneficiaries according to their*2520 respective interests.

ARTICLE IX.

Amendment: This Declaration of Trust may be amended or altered by the Trustees, in any particular whatsoever, but not so as to affect the validity or effect of anything previously done by the Trustees, * * *

ARTICLE X.

* * *

IN WITNESS WHEREOF, Mary L. Dutton, Jane LeFurgy and W. E. Lindblad, parties of the first part hereto, have hereunto set their hands and seal in token of their acceptance of the Trust hereinabove mentioned, and each holder, from time to time of a certificate or certificates for shares of beneficial interest issued hereunder, assets hereto, by accepting such certificate or certificates and agrees to be bound by all the terms, conditions, limitations and restrictions of this DECLARATION OF TRUST.

MARY L. DUTTON, (Seal.)

JANE LEFURGY, (Seal.)

Trustees.

85 - No. 6994718 - Filed for Record Nov. 16, A.D. 1920 at 11:37 A.M.

JOSEPH F. HAAS, RECORDER.

On the same day that the above instrument was executed the trustees purchased and received the entire assets of the Ontra Cafeteria Co. for a consideration of $100,000. A bill of sale of the property in favor of the above trustees*2521 was executed by Mary L. Dutton and Jane LeFurgy as president and secretary.

The Ontra Cafeteria Co. thereupon proceeded to reduce its capital stock from $100,000 to $1,000, by filing with the Secretary of State of Illinois the certificate and documents necessary to accomplish that purpose. Since that time the corporation has ceased to function as an active corporation and has so stated in all of its annual reports to the Secretary of State since that date. The capital stock of $1,000 is now held by Mary L. Dutton, Jane LeFurgy and W. E. Lindblad. The corporation is kept alive to protect the name of "Ontra Cafeteria" so that no other corporation in Illinois may use that name.

Beginning with October 1, 1920, and including the taxable years in question, the Trustees of said Ontra Cafeteria Trust have operated the business Formerly conducted by the Ontra Cafeteria Co.

The Ontra Cafeteria Trust from the time of its creation has filed fiduciary income-tax returns and the beneficiaries under the trust have included in their individual income-tax returns their distributive shares of the net income shown on the fiduciary returns and have paid the tax due thereon.

*1156 *2522 The fiduciary returns for the years 1924, 1925, and 1926, respectively, were filed with the collector of the first district of Illinois on the following dates: for 1924, on or before March 15, 1925; for 1925, on or before March 15, 1926; and for 1926, on or before March 15, 1927. Such returns disclose income for each of the years, which resulted from the operation of the cafeteria business acquired from the Ontra Cafeteria Co., as follows:

The Supreme Court rendered its decision in the case of Hecht v. Malley,265 U.S. 144, on May 12, 1924. Treasury Decision 3598 (C.B. III-1, p. 489), with respect to taxability of trusts, was issued and approved on June 7, 1924, and I.T. 2061 (C.B. III-2, p. 5) was issued on July 10, 1924. The regulations promulgated under the Revenue Act of 1924 were approved on October 6, 1924.

The following communication was sent from the Commissioner's*2523 office to the internal revenue agent in charge at Chicago with reference to the petitioner's tax liability for the years 1920 and 1921:

WASHINGTON, April 28, 1924.

IT:CA:2442-4

Internal Revenue Agent in Charge, Chicago, Illinois.

In re: Ontra Cafeteria Co., Chicago, Illinois.

Reference is made to your report dated February 2, 1924, relative to an examination of the tax liability of the above named organization for the years 1920 and 1921.

You are informed that this concern has been held to be a Trust from October 1, 1920 and taxable under Section 219 of the Revenue Acts of 1918 and 1921. You are therefore requested to render a supplemental report showing separately the income for the corporation from January 1, to September 30, 1920, and the income for the Trust for the balance of the year 1920.

This matter should be given precedence over new examinations in order that the case may be closed at an early date.

(Signed) C. M. JUSTICE,

Assistant Deputy Commissioner.

The appeal of Mary L. Dutton, Jane LeFurgy, and W. E. Lindblad, Trustees of Ontra Cafeteria, a Trust, Docket No. 20295, was closed in accordance with the following stipulation, filed on*2524 November 26, 1928:

*1157 STIPULATION

It is hereby stipulated and agreed by and between the above-named taxpayer and the Commissioner of Internal Revenue, acting by and through their respective attorneys, that there is no deficiency in tax for the year 1922 nor for the year 1923, and further, that the Board may enter an order of redetermination in accordance with the above.

OPINION.

LANSDON: The only question to be determined in this proceeding is whether the petitioners are taxable as a trust or as a corporation. The deficiencies involved herein result from the respondent's determination that the Ontra Cafeteria Trust was in fact an association taxable as a corporation in accordance with section 2(a) of the Revenue Acts of 1924 and 1926.

The petitioners contend that the Ontra Cafeteria is taxable as a trust and that in any event, since they were considered to be a "pure trust" by the Commissioner at the time the return for 1924 was made, they are entitled to the relief provided for in section 704(a) of the Revenue Act of 1928, which provides as follows:

If a taxpayer filed a return as a trust for any taxable year prior to the taxable year 1925 such taxpayer shall*2525 be taxable as a trust for such year and not as a corporation, if such taxpayer was considered to be taxable as a trust and not as a corporation either (1) under the regulations in force at the time the return was made or at the time of the termination of its existence, or (2) under any ruling of the Commissioner or any duly authorized officer of the Bureau of Internal Revenue applicable to any of such years, and interpretative of any provision of the Revenue Act of 1918, 1921, or 1924, which had not been reversed or revoked prior to the time the return was made, or under any such ruling made after the return was filed which had not been reversed or revoked prior to the time of the termination of the taxpayer's existence.

Similar questions were before the Board in Van Cleave Trust,18 B.T.A. 486; E. A. Landreth Co. et al.,15 B.T.A. 655; and Wilkens & Lange,15 B.T.A. 1183. In the Landreth case we found for the petitioner and held that up to and including the period July-December, 1922, the Bureau of Internal Revenue was consistently ruling that irrespective of whether the taxpayer was engaged in business under a form similar*2526 to that of a corporation, it was taxable as a trust where the shareholders could not control the actions of the trustee. We extended the above pronouncement in the Van Cleave case to include the period to July 1, 1924, and held that the petitioner in that case was entitled to be taxed as a trust. We are here called upon to decide a similar question with respect to the year 1924, the tax return for which was filed on or before March 15, 1925.

The regulations promulgated under the Revenue Act of 1924 were approved on October 6, 1924, and provide that "All rulings inconsistent *1158 herewith are hereby revoked." Article 1504 of Regulations 65 provides:

Association distinguished from trust. - Holding trusts, in which the trustees are merely holding property for the collection of the income and its distribution among the beneficiaries, and are not engaged, either by themselves or in connection with the beneficiaries, in the carrying on of any business, are not associations within the meaning of the law. The trust and the beneficiaries thereof will be subject to tax as provided in articles 341-347. Operating trusts, whether or not of the Massachusetts type, in which*2527 the trustees are not restricted to the mere collection of funds and their payments to the beneficiaries, but are associated together in much the same manner as directors in a corporation for the purpose of carrying on some business enterprise, are to be deemed associations within the meaning of the Act, regardless of the control exercised by the beneficiaries.

The parties have stipulated that I.T. 2061 (C.B. III-2, p. 5) was issued on July 10, 1924, and that Treasury Decision 3598 (C.B. III-1, p. 489) was issued on July 7, 1924. It is clear from the following quotation of Treasury Decision 3598 that the Internal Revenue Bureau's position was thereby reversed:

Trusts. - Two distinct classes of trusts are recognized by the Department, namely, holding trusts and operating trusts.

Holding trusts are those in which the trustees are merely holding property for the collection of the income and distributing it among the beneficiaries and are not engaged, either by themselves or in connection with the beneficiaries, in the carrying on of any business. Such trusts are not associations within the meaning of the law and are not subject to the tax.

Operating trusts are those in*2528 which the trustees are not restricted to the mere collection of funds and paying them over to the beneficiaries but are associated together in much the same manner as directors in a corporation for the purpose of, and are actually engaged in, carrying on some business enterprise. These trusts, whether of the Massachusetts type or otherwise, are to be deemed associations within the meaning of the Act, independently of any control exercised by the beneficiaries, and subject to the tax. (Italics ours.)

I.T. 2061 provides:

The general rule in regard to holding trusts and operating trusts which is announced in the decision of the Supreme Court of the United States in the case of Hecht v. Malley and in Treasury Decision 3598 (C.B. III-1, 489) is applicable under all titles of the Revenue Acts of 1918 and 1921.

The facts disclose that for the years 1920 and 1921 the petitioners were considered to be taxable as a trust. For the years 1922 and 1923 the petitioners filed income-tax returns as a trust, which were subsequently rejected by the Commissioner and deficiencies were asserted taxing them as an association. After an appeal to the Board had been filed and after the*2529 Revenue Act of 1928 had been approved, the parties stipulated that there were no deficiencies for the years 1922 and 1923.

We conclude that the petitioners were not considered to be taxable as a trust under the regulations in force at the time the return for *1159 1924 was made or under any ruling of the Commissioner or any duly authorized officer of the Bureau of Internal Revenue which had not been reversed or revoked prior to the filing of the return, and that they are not entitled to the relief provided for in section 704 of the Revenue Act of 1928.

The petitioners contend that the Ontra Cafeteria is a trust within the meaning of section 219 of the Revenue Acts of 1924 and 1926, and that it is taxable as such and not as a corporation. This Board and the courts have passed upon similar questions on numerous occasions and it has uniformly been held where the trustees, through corporate or association forms, are engaged in carrying on a business and are not merely holding property for the collection and distribution of income therefrom that they constitute an association taxable as a corporation, irrespective of the control exercised by the beneficiaries. *2530 Hecht v. Malley,265 U.S. 144; Burk-Waggoner Oil Association v. Hopkins,269 U.S. 110; Little Four Oil & Gas Co. v. Lewellyn, 29 Fed.(2d) 137; White v. Hornblower, 27 Fed.(2d) 777; J. W. Pritchett et al., Trustees,17 B.T.A. 1056; Extension Oil Co.,16 B.T.A. 1028; E. A. Landreth Co., supra;Alexander Trust Property,12 B.T.A. 1226; Durfee Mineral Co.,7 B.T.A. 231; and Anderson Steam Vulcanizer Co.,6 B.T.A. 737.

The petitioners, as trustees, are engaged in carrying on a business in much the same manner as directors of a corporation, and, upon authority of the above cases, which we think are controlling here, the determination of the respondent that they are taxable as a corporation is approved.

Decision will be entered for the respondent.