Opinion ID: 1509551
Heading Depth: 1
Heading Rank: 1

Heading: Was the syndicate a taxable association?

Text: We are concerned here with a trust. Taxability as an association or corporation no longer turns on technical differences in organizational structure [4] nor on the degree of control given to beneficiaries in management of trust affairs. [5] Simulation by unincorporated organizations of corporate forms and approximation of corporate advantages by skillful use of trust and contract devices have brought legislative classification with technical corporations for taxation and other purposes, and like action independently by courts. [6] But not all trusts are taxable as corporations. Under the pertinent statutes only those engaged in doing business for profit or income are so taxed. A trust does not engage in business, for purposes of the tax, if its sole or principal object and activities are: (1) preservation of specified property; [7] (2) liquidation of a trust estate; [8] (3) distribution of income derived from another source. [9] Clearly the same rule should apply if its function is exclusively to service the security for a loan. The ultimate question is whether the trust performs some nonbusiness [10] function of this sort or operates a business enterprise as a going concern. But often the conditions of modern business make the distinction close. Preservation, liquidation, and securing of loans frequently approach the proportions of conducting a business. Years and voluminous transactions, which often are profitable, may be required. Nor is the distinction between making a loan or loans and engaging in the business of lending money always simple. The modern corporate mortgage or deed of trust, with elaborate provisions for creditors' intervention in management under long-term financing, coupled with the issuance of limited participations to shareholders by the corporate mortgagor, has blurred the old sharp distinctions between giving security and doing business, creditor and owner, managing entrepreneur and creditors' committee. Accordingly, a particular arrangement may present inconsistent and perplexing analogies. The conversion or perversion, as the case may be, of the trust from its historic conserving function to entrepreneurial purposes has been a perpetual source of such conflicts in other matters than taxation. [11] Whether therefore a particular arrangement of this sort creates basically a debtor-creditor relation, with incidental provisions for security, or establishes a business enterprise as an independent entity requires something more than impressionistic answer. Where the technical form of organizational structure, the activities actually conducted, and the purpose of the organizers, both as expressed in the documents and as carried out consistently, point to a single basic function, the solution is not difficult. It becomes so when these elements or some of them are in conflict. It is possible still to draw a corporate mortgage or deed of trust, even a complicated one, which will be that and nothing more. But when men reach out for legal advantages by technical arrangements which confuse not only functions but forms, and are not consistent with their real objectives, or if so, those objectives are conflicting, only confusion can result for them and, unfortunately, too often for the law. Formerly the Board and the courts stated that the crucial test must be found in what the trustees actually do, not in the mere existence of long unused broad powers. [12] But recent Supreme Court decisions have shifted emphasis to simulation of corporate attributes [13] and the purpose for which the trust is organized as expressed in the creative instruments. [14] The language quoted concerning the latter factor from Helvering v. Coleman-Gilbert Associates [15] has brought a shift in the policy of the taxing authorities, [16] and was the basis of the Board's decision in this case. [17] It is not necessary to assume from the recent decisions that the language of the trust instrument as to purpose will be conclusive in all cases, or that actual activities or unexpressed purposes always will be irrelevant. But when the expressed objectives and powers are appropriate to conducting a business enterprise, and all or most of them actually are carried out and exercised, the existence of an unexpressed intention not to engage in business cannot counteract their effect and amounts to no more than a misconception of the nature of the activity or an intention to escape taxation. There are circumstances in which the distinction of function is so shadowy that the technical arrangements entered into must be controlling, and that is true though the parties may not have understood them and their consequences fully or had actual intentions which were contradictory. [18] A further statement of the facts is necessary for application of these principles. The motivation for creating the trust was to provide relief for the Trust Company. It was on the verge of crashing and carrying down with itself other important financial institutions. Normal financial arrangements could not be made. No single individual could or would supply the amount required. The subscribers were interested as shareholders and directors in the Trust Company, some of them heavily, and some also in other institutions endangered by threat of its failure. Not from pure altruism therefore, but because their vital interests were at stake, they were ready, willing and able to aid. But they were neither ready and willing nor able to do so individually. No one offered to lend any sum separately to the distressed concern, with or without security. The record shows clearly that individual loans were regarded by all as impracticable, undesirable, and insufficient for the essential purpose. Joint action was required, and was taken. But it was not taken in the usual form of loan and security by way of mortgage or deed of trust. The customary legal techniques for handling loans and security by mere joint adventurers or co-lenders also were inadequate. The plan evolved was designed admirably to provide a maximum of immediate and future relief to the Trust Company and at the same time a minimum of risk with a guaranteed return to the rescuers. It was embodied in the trust agreement. This was a tri-party contract, executed by (1) the subscribers; (2) the Trust Company in its private corporate capacity; (3) by it also as trustee for the syndicate. The agreement created the trust, not along lines customary in making loans or securing them, but with all the usual characteristics of a business trust. Modifications adapted the mechanism to the peculiar objectives of the particular situation. The agreement, of itself, created no relation of debtor and creditor between any subscriber or all of them and the Trust Company. The subscribers made no contract to advance any sum to the Trust Company. They agreed merely to pay to the trustee the sums set opposite their names, not on demand of the Trust Company, whether in its private capacity or that of trustee, but on call of a majority of the syndicate associates. All advances were so made. When made, they did not become automatically the property, legally or in equity, of the Trust Company (except in its capacity as trustee for the syndicate). To accomplish that, further action by the majority of the associates was required. Only when they had approved a further and aggregate advance to the Trust Company by the syndicate, and taken additional property from it in exchange, whether by way of security or otherwise, did it receive the funds freed from the limitations of the trust. The advances by individual members, therefore, had none of the characteristics of individual loans, either to the syndicate or to the Trust Company. They were subscriptions to the capital of the syndicate. The entire arrangement for syndicate collection and disposition of the funds subscribed was inconsistent with either individual debtor-creditor relationships with the Trust Company or a single one in the nature of a joint adventure. The activity was associational, not individualistic. It involved capital, contributions to capital and use of capital in dealings with the Trust Company, not a single loan or several loans made through an intermediary by the contributories. [19] This in itself is sufficient to dispose of the contention that the syndicate is not a taxable association, since all of the arrangements for securing the syndicate's advances to the Trust Company are colored in legal character by the nature of the basic transaction, i. e., the assembly of capital by individual contributions, and use in transactions of a business character with third persons. The peculiar fact here that the syndicate was organized to do business with a single customer does not convert that business into loans from its members to its customer. That would be true even if it could be admitted that the business between the syndicate and the customer consisted only of loans and not of purchases and sales or resales. [20] But the basic conclusion is supported also by the general scheme, both in its corporate characteristics of structural organization and in the doing of business, as well in actual operations as in formal provisions of the agreement. The latter disclose all of the corporate attributes which business trusts commonly simulate, including provisions for continuity of the enterprise regardless of changes in individual constituency, centralized management, limitations of individual liability, transferability of shares and declaration of broad business objectives. [21] These more than comply with the requirements of Morrissey v. Commissioner, supra note 5. The prescribed corporate mores were carried out in actual operations by meetings of the subscribers, election of an executive committee of five, numerous meetings by it, the keeping of formal syndicate minutes, the formal adoption of resolutions by the associates and the executive committee, etc. At various times, on calls of the executive committee, the subscribers paid in to the trustee $417,000 and received certificates of ownership in the syndicate. Under directions from the syndicate, the trustee over a period of years purchased from the Trust Company property and notes costing $452,073.97 and assumed mortgages aggregating $43,650. The conveyances, in absolute form, were made to the Fidelity-Bankers Trust Company, Trustee for the Fidelity Realty Company, and were recorded. In 1932, the syndicate borrowed $41,700 from the Trust Company, giving security in its own name, and guaranteed payment of $32,500 borrowed by the Trust Company from the Reconstruction Finance Corporation, receiving security from the Trust Company. The trustee rented and otherwise managed the numerous properties acquired by the syndicate, subject in all respects to the approval of its executive committee or the specified majority of certificate holders. All this constituted something more than the mere making of loans by the syndicate subscribers to the Trust Company. It was a regular and continuous course of business. The transactions were largely purchases and sales, not lendings and the giving of security, in form and in substance. If they had been the latter, they would have constituted a business of lending money, not the mere making of occasional loans. The syndicate was a business enterprise, not a mere security device. Its business was distinct in function, form and legal arrangement from that of the Trust Company. Had it not been so, the syndicate would not have been formed. It was likewise separate from the private affairs of syndicate members. They made it so intentionally and advisedly  for purposes of securing themselves in investment and return, if not for those of paying taxes. Separation of entities often is merely formal, but here it was both formal and substantial, in constituency, in objectives, in control, in liabilities, in property and, we think, therefore, in subjection to taxation. This conclusion is not overcome by the peculiar modifications introduced into the trust agreement to fit it to the particular situation. These included, among others, provisions limiting syndicate purchases to property acquired from the Trust Company or approved by it; requiring its approval of the consideration to be given for them (which would be necessary in any event); giving it a first option to repurchase properties acquired by the syndicate on terms offered by others and the right to purchase all (but not less) of the outstanding syndicate certificates at par and accrued rentals; and the unusual guaranty by the Trust Company of a six per cent return to the subscribers, in exchange for which it was given the right to take all syndicate profits exceeding that amount, which was, to say the least, of highly doubtful value. It is of course unusual for a business enterprise to limit its business so largely to a single customer; to contract its profits in excess of a specified figure away from its owners to another; to receive a guaranty that they will amount to that figure; and to give its single customer so large a voice in its management. From this, it is contended strenuously that the whole arrangement was one for loans with security, that the profits were interest, the deeds were mortgages, the certificates of ownership were evidences of debt, and the syndicate a legal nonentity. But labels are not so potent, especially when devised after the fact to contradict the consistently contrary terms of the instrument and its clearly stated purposes and functions. It is true that these modifying provisions create relations of great intimacy and interdependence between the syndicate and the Trust Company. But they are not those of identity nor is the intimacy nearly so great as exists commonly between holding corporations and their subsidiaries, which admittedly are separate taxable entities. [22] The modifying features cannot be given the effect of obliterating the fundamental structural organization and function without doing violence to the instrument of creation, expertly drawn and executed by men of great business experience and capacity, and to their expressed intentions carried out in their conduct. Had this suit been one by a creditor of the Trust Company seeking to attach or levy upon syndicate property or by their individual creditors attempting to secure like relief, or by syndicate creditors attempting to reach their individual property, they would have been the first to assert the syndicate's independence both of the Trust Company and of themselves. The basic fallacy is in the assumption that because the Trust Company ultimately was relieved from its distress by the formation and operations of the syndicate, those operations became no more than loans to it by the syndicate subscribers. This confuses motivation with method and ignores the partial character of the motivation. Six per cent profit secured as this was by transfers of specific property, whether absolute or by way of mortgage, and the general credit of the Trust Company as well, also had its motivating part and, in such times, one that cannot be ignored. That the syndicate and its members were willing to limit the profits distributed to them in order to be sure of getting them does not convert them into interest. Limited stock participations are now too common to permit such a conclusion. [23] The syndicate was a taxable entity within the statute's meaning. [24] It follows that the tax was assessed properly on the profit realized in 1933 from operating the syndicate properties. II. We think the Board correctly held that the guaranty runs directly to the certificate holders, not to the syndicate as such. It is part of the entire provision relating to profits [25] and its meaning must be determined from that provision as a whole. The language is susceptible of several interpretations regarding the obligee intended. [26] But the argument has been limited to the two views here presented. Several factors may be said to support the view that the guaranty was intended to run to the syndicate. It was part and parcel of the syndicate's agreement with the Trust Company. It was given expressly in consideration of the syndicate's promise to pay to the corporation all profits exceeding the certificate holders' guaranteed six per cent, and to reimburse the Trust Company for the guaranty payments if and when accumulated profits should be available for such a purpose. The phrase in its aforesaid capacities used in the provision obligating the Trust Company to purchase the certificates on or after November 1, 1936, [27] implies that the Trust Company was a party to the guaranty both in its private capacity and as trustee. The method used for payment was by crediting the aggregate amounts due under the guaranty to the trustee's account with the Trust Company and disbursements to individual certificate holders from that account. But that view makes the trustee both guarantor and obligee of the guaranty. [28] The mode adopted for payment was consistent with mere convenience in disbursement and bookkeeping under an obligation running directly to the syndicate members. The subscribers also were parties to the agreement and gave up their rights to profits exceeding six per cent in exchange for the guaranty of that amount. We do not believe they intended the payments to go into the general assets of the trust, thereby become subject to payment of expenses and other obligations, and perhaps never become available to them. Further, the guaranty expressly includes return of both principal and income. The guaranty of principal can have no pertinence to transactions between the syndicate and the Trust Company. It can relate reasonably only to the capital contributions made to the syndicate by its members. We think the same obligee was intended for both guaranties. Except for the phrase in its aforesaid capacities, the entire provision is consistent with an intention to make the guaranty run only and directly to the certificate holders, not circuitously through the entity with the consequence that the payments might never reach the members. The language of the guaranty clause, in addition to its capacity as trustee, etc., means not that the corporation executed two guaranties, one to the syndicate and another to the individual subscribers, but that in addition to the obligations assumed under the entire instrument as trustee, it also obligated its private and general corporate credit by a separate and independent guaranty to the individuals. The situation bears some analogy to the guaranty by a holding corporation of specified limited dividends upon shares of its subsidiary. That the shareholder receives under the guaranty exactly what he would have received had the subsidiary earned profits which it did not earn does not make the guaranty payments income of the subsidiary. The Board rightly applied the principle of New England Power Co. v. Commissioner, 1932, 25 B.T.A. 195. The decision of the Board is affirmed on both appeals. Affirmed.