Opinion ID: 1824973
Heading Depth: 1
Heading Rank: 2

Heading: capital gain dividends from investment trusts

Text: With respect to the capital gain dividends declared by regulated investment companies, [10] the stipulated facts show that the predecessor trustees purchased 200 shares of Century Shares Trust, which is a Massachusetts trust [11] and not a corporation, and 300 shares of Manhattan Bond Fund Trust, which is a corporation. By exchange, the stock of the Manhattan trust became 217 1/3 shares of Diversified Investment Fund, Inc., a regulated investment company, also doing business as a corporation. As shareholders of these investment companies, the trustees received the following capital gain dividends: [12] (1) (2) (3) (4) (5) Fund Paid in Cash Paid in Cash Paid in Shares Cash Realized prior to after after 3-16-51 on Sale of 3-16-51 3-16-51 Shares in Column (4) Century $ 377.00 $ 1,123.22 58 shares $ 1,510.32 Manhattan 51.00 105.62 4 shares 24.62 Diversified ..... 76.00 5 shares 43.05 ________ __________ __________ $ 428.00 $ 1,304.84 $ 1,577.99 Regulated investment companies or, as they are sometimes called, investment trusts, organized for the purpose of dealing in securities, are a development of comparatively recent years providing a diversification of investment for the investing public. [13] With respect to legal structure these funds or companies, as they are sometimes called, ordinarily are divided into three groups, namely, those where (1) the corporation which issues its stock or debentures invests the proceeds in securities of widely diversified kinds, where no strict trust is involved at all; (2) the corporation which deposits stocks with a trustee and issues certificates of interest in such stocks, where there is a true trust used as part of the investment set-up; (3) the Massachusetts or business trust which holds securities in trust and issues certificates of participation, giving the owners thereof equitable interests in the deposited securities. [14] A Massachusetts trust has been defined as follows:    `Massachusetts trust'    is used generally to denote an unincorporated organization created for profit under a written instrument or declaration of trust, the management to be conducted by compensated trustees for the benefit of persons whose legal interests are represented by transferable certificates of participation, or shares. [15] We are concerned here with corporate entities and a Massachusetts trust. During the time involved, these investment companies [16] distributed to the Gardner Trust the sum of $3,310.83 in so-called capital gain dividends. Of this sum, $3,010.54 was distributed by Century Shares Trust, a Massachusetts trust, and $300.29 was distributed by investment companies operating as corporations. Of the $3,010.54 distributed by Century, $2,633.54 was distributed subsequent to 1951, the effective date of § 501.47, and $377 was distributed prior to 1951. Of the $300.29 distributed by corporations, $249.29 was distributed subsequent to 1951 and $51 was distributed prior thereto. The trial court found, without objection by the parties, that the distribution made by the corporate investment companies prior to 1951, which were all cash dividends, must be allocated to income; that those declared subsequent to 1951, which were optional dividends, [17] must be allocated to income by virtue of § 501.47, subd. 4. The trial court refused to allocate the $377 received from Century prior to 1951, which were also cash dividends, to income under judicial precedent and also refused to allocate the $2,633.54 received from Century subsequent to 1951, which were optional dividends, to income under § 501.47, subd. 4. In short, the trial court was of the opinion that capital gain dividends received from a Massachusetts trust must be handled on a basis different from those received from an incorporated trust. The main thrust of the appeal centers on this question. Earnings of a regulated investment company, whether a Massachusetts trust or a corporation, are of two kinds. Income received from securities held by the fund is distributed as income, and there is no difficulty with that. The idea that dividends paid out of earnings of regulated investment companies could be considered a capital gain instead of income probably had its inception in the Revenue Act of 1942, under which it was made possible to pay taxes on such distributions at a lower rate as capital gains than as income. [18] However, accounting for income tax purposes is not always the same as accounting for trust purposes. [19] Whether capital gain dividends constitute principal or income for trust purposes has caused a great deal of difficulty, and a lively debate has ensued. These dividends are derived from the profit or gain made in the purchase and sale of securities due to the appreciation in value thereof while held by the fund. For discussions pro and con, see Shattuck, Capital Gain Distributions, Principal or Income ?, 88 Trusts and Estates 160, and Young, A Dissent on Capital Gain Distributions, Id. 280. [20] Determination of this question depends, at least in part, on what concept of ownership we are willing to employ. Is the shareholder in the fund merely one of many pooling his investment resources so as to obtain professional help in buying and selling securities under an arrangement in which each shareholder owns an undivided interest in all the securities held by the fund, or is his ownership limited to his shares in the investment company and the company as a separate legal entity the owner of the securities? In an article by David C. Ewart, trust officer of The Merchants National Bank of Boston, 95 Trusts and Estates 1025, we find the following: In essence a share of a Mutual Fund represents a true participation in a pool of investments managed for the participants. This is true whether the shareholder has equitable title to an undivided fractional interest in the portfolio as in the case of a Fund which is a trust, or whether he has a fractional participation or fractional ownership which falls short of legal ownership as in the case of a Fund organized as a corporation. When a trustee properly buys shares of a Mutual Fund, he is buying investment management of and diversification of risk in a group of securities which on the whole he might himself buy. He should account for the dividends and avails of those shares, after the management charge has been taken out, just as he would if he had bought the underlying securities directly. If we accept this concept of ownership, there is much to be said for holding that capital gain dividends are part of the capital and allocable to principal. However, it is doubtful that the argument cannot be rebutted. Many of the indices of ownership are absent. The ordinary purchaser of shares in such investment companies in all probability considers his ownership limited to the shares he purchases. But we need not reach a final determination of this issue, for we believe that the legislature has left us with a workable solution without so doing. Absent controlling statute, [21] the decisions that have considered this question are unanimous in holding that such capital gains constitute income and should be paid to the income beneficiaries of a trust if there is no direction in the instrument to the contrary. [22] As far as we have been able to determine, none of the decisions, or any of the other authorities discussing this subject, draw any distinction between capital gain dividends distributed by a Massachusetts trust or a fund organized as a corporation. Such capital gains are commonly distributed either in cash or, at the option of the shareholder, in cash or additional shares of the investment fund. Exercise of this option really amounts to the purchase of additional shares of the fund from the cash that the shareholder is entitled to receive. Cash or shares so accepted at the option of the trustee should therefore be treated alike. The Uniform Principal and Income Act, § 5(1), provides:    Where the trustee shall have the option of receiving a dividend either in cash or in the shares of the declaring corporation, it shall be considered as a cash dividend and deemed income, irrespective of the choice made by the trustee. Restatement, Trusts (2 ed.) § 236(c), reads: If the trustee has the option of receiving a dividend either in cash or in shares of the declaring corporation, the dividend is income irrespective of the choice made by the trustee. Minn. St. 501.47, subds. 3, 4, and 5, read: Subd. 3. All disbursements of corporate assets to the stockholders of a corporation, which are designated by the corporation as a return of capital or as a division of corporate property, shall be deemed principal. Subd. 4. Where a trustee shall have the option of receiving a dividend, either in cash or in the shares of the declaring corporation, such dividend shall be considered a cash dividend and shall be deemed income irrespective of the option selected by the trustee. Subd. 5. Subject to the provisions of subdivisions 2, 3, and 4, all dividends, including ordinary and extraordinary dividends and dividends payable in share or other securities or obligations other than those of the declaring corporation, shall be deemed income. (Italics supplied.) The difficulty in this case, viewed in the light of the trial court's decision, is that our statute seems to deal only with dividends from a corporation. [23] It does not mention or expressly deal with a Massachusetts trust. As far as the dividends received from an investment company organized as a corporation are concerned, we agree with the trial court that § 501.47, subd. 4, controls. With respect to dividends received from the Massachusetts trust, the common law or decision law of the state is controlling if we hold that the statute is limited to corporate entities. We have no controlling decision law. The only case relied on in part by any of the parties is In re Trust under Will of Koffend, 218 Minn. 206, 15 N.W. (2d) 590, where we recognized the rule that ordinarily gains in value of investments represent an increase of capital and are to be credited to principal rather than to income. That case is not controlling here. It simply states the general rule that an appreciation in stock held by a trustee belongs to capital and not to income. The difference here is that the gain in value is not in the shares held by the trustee but in the shares held in the portfolio of the investment company and constituting its principal stock in trade. The exception to the general rule is noted in Rosenburg v. Lombardi, 222 Md. 346, 160 A. (2d) 601. In Lovett Estate (No. 2) 78 Pa. D. & C. 21, 24, in holding that a capital gain dividend of Wellington Fund, Inc., an open-end investment company, should be treated as income, the court said: The portfolio assets of an investment company are not regarded as permanent assets of fixed capital by the managers of the company; the securities held are treated by the managers as funds to be turned over in the normal management of the business. Selling a portfolio asset is but a normal incident in the business. In other words, the securities held which are bought and sold in the normal course of business of an investment company constitute, in a sense, its stock in trade. Frequently, what it makes on the buying and selling of such securities constitutes its main profit. In Cohan and Dean, Legal, Tax and Accounting Aspects of Fiduciary Apportionment of Stock Proceeds: The Non-Statutory Pennsylvania Rules, 106 U. of Pa. L. Rev. 157, 183, we find the following statement: For apportionment purposes, it would seem unreal to view a share in a mutual fund as a pro rata ownership of the securities; rather, it would seem that mutual fund shares should be treated like any other investment, and that realized increments within the fund are income, for the mutual fund is, after all, in the business of investing money and spreading risk capital in such a way as best to afford a broad basis of investment. Possibly, if we distinguish between the ownership of shares in the fund and ownership of the securities held by the fund, we will have less difficulty in arriving at a workable rule. Under § 501.47, subd. 4, our legislature has adopted the view that where dividends may be received in either cash or shares of a corporation, at the option of the trustee, they shall constitute income. We see no reason why this statutory provision should not apply to capital gain dividends received from regulated investment companies. Nor is there any logical reason why the same rule should not apply to a Massachusetts trust operating exactly as does the corporate entity, even if we hold that the statute governs only dividends received from a corporation. There is much to be said for adopting a rule under which our case law is in harmony with our statutory law in the field of trust administration. There being no controlling decision in the state, we are now at liberty to apply the same rule to capital gain dividends received from a Massachusetts trust as the legislature has applied to an investment company organized as a corporation. We therefore hold that where capital gain dividends are distributed by a regulated investment company, whether organized as a Massachusetts trust or as a corporation, and may be received by the trustee at his option either in cash or in shares of the investment fund, such capital gain dividends constitute income and are to be distributed to the income beneficiary in a case such as we have here. That portion of the trial court's order which directs that stock dividends received from corporations whose stock is held by the trustees be allocated to principal is affirmed. That portion of the trial court's order which directs that capital gain dividends receivable in cash or stock at the option of the trustees from regulated investment companies whose shares are held by the trustees be allocated to principal is reversed. MR. JUSTICE OTIS took no part in the consideration or decision of this case.