Court Opinion

ID: 4608560
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:42:57.599077+00
Date Added: 2024-06-11T07:53:43.673671
License: Public Domain

THE CLEVELAND TRUST COMPANY, TRUSTEE OF THE TRUST ESTATE KNOWN AS GARFIELD BUILDING SITE TRUST, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Cleveland Trust Co. v. CommissionerDocket No. 88715.United States Board of Tax Appeals39 B.T.A. 429; 1939 BTA LEXIS 1033; February 14, 1939, Promulgated *1033  The taxpayer was taxable as an association under sections 13 and 801 of the Revenue Act of 1934.  David A. Gaskill, Esq., and Earl P. Schneider, Esq., for the petitioner.  Elmer L. Corbin, Esq., for the respondent.  LEECH*429  This is a proceeding to redetermine a deficiency of $5,690.96 in petitioner's income tax for the calendar year 1934.  The issue is whether petitioner, as trustee of land and a building located at 322 Euclid Avenue, Cleveland, Ohio, is taxable as an association under sections 13 and 801 of the Revenue Act of 1934, or whether it is taxable as an ordinary trust under section 161 of the same revenue act.  *430  FINDINGS OF FACT.  Prior to 1923, a 12-story building had been erected on the premises known as 322 Euclid Avenue, Cleveland, Ohio, which had been used by various institutions as banking quarters.  As a result of a merger of the Cleveland Trust Co. and the Garfield Savings Bank of Cleveland, the Coeveland Trust Co. acquired the property be deed dated February 15, 1923.  After that merger, the Cleveland Trust Co. had no business use for the property.  The State Banking & Trust Co. desired to obtain the*1034  use of the premises for its banking quarters.  Negotiations between these parties resulted in an agreement that the State Banking & Trust Co. would pay to the Coeveland Trust Co. the value of the building in cash and that the necessary further financing of its acquisition of the use of the premises would be arranged under what was locally known as land trust certificate financing.  This plan was in general use in Cleveland, Ohio, and the vicinity, in financing real estate, as a substitute for the issuance of mortgage bonds in order to avoid double taxation under the then effective Ohio personal property tax law.  Prusuant to that plan, after payment of the value of the building in cash to the Cleveland Trust Co. on November 15, 1924, the premises were leased to the State Banking & Trust Co. for 99 years, the lease to be renewable in perpetuity.  The lessee also received a 10-year option to buy the property for $550,000.  Under the lease, which provided for an annual rental of $30,000, the lessee was required to pay taxes, keep up insurance and maintain the building in good repair.  Thereafter, and on the same day, the Cleveland Trust Co. declared itself trustee of the fee of these*1035  premises, subject to the above mentioned lease.  The trust instrument provided that the petitioner held the described premises, subject to the lease, in trust, for the use and benefit of all present and future holders of certificates of equitable ownership therein; that the trustee would pay over quarterly to the record holders of the certificates their proportionate shares of rents or other income received by the trustee from the trust estate, after deducting the trustee's compensation and expenses; that the beneficial interests in the trust estate should be divided into 535 shares, evidenced by certificates of equitable ownership in the premises trusteed; that the trustee should keep suitable books of registration of such interests and the certificates representing them; that duplicate certificates should be issued upon proper proof of destruction or loss of such certificates; that no beneficiary should have any legal title to the trust property, real or personal, but only an equitable interest therein; that no beneficiary should have the right to call for a partition of the trust estate during the continuance of the trust; *431  that no transfer by operation of law of the*1036  interest of a beneficiary during the continuance of the trust should terminate the trust nor entitle the legal representative of a deceased beneficiary to an accounting or to any action in the courts or otherwise against the trust estate or the trustee, but that the executors, administrators, or assigns of any deceased beneficiary should succeed to the rights and be subject to the liabilities of the decedent; that notwithstanding any transfer by operation of law of any interest of a beneficiary, the trustee should be protected in his payment of distributions under the trust to the personal representative of any deceased beneficiary and that the rights of such a transferee should be enforceable against and binding upon such personal representative and not against the trustee or trust estate; that the compensation of the trustee for its services as such should be $575 annually, to be deducted from the rents collected by it, in addition to which it was authorized to incur necessary expenses in connection with the printing of the trust instrument, the certificates of equitable ownership, and such books and records as were necessary in connection therewith; that the trustee warranted neither*1037  the title to the premises nor the validity of the lease and did not guarantee its performance; that the trustee undertook to exercise only ordinary care in collecting and distributing rentals and carrying out and distributing the proceeds of a sale; that the trustee should have the exclusive right to manage and control the estate as it deemed for the best interests of the beneficiaries, free from all control by the beneficiaries, as fully as though the trustee were the sole legal and equitable owner of the estate, and should not be subject to any obligations to the beneficiaries other than those especially assumed in the trust instrument; that the trustee could make agreements modifying, amending, or supplementing the lease in its sole discretion; that it could likewise settle claims either in contract or tort against it or the proceeds derived from the trust estate; that the trustee should be protected in acting upon any written document believed by it to be genuine and signed by the proper party; that the trustee should be indemnified from the trust estate for any personal liability in the administration of the trust except such as arose from its personal and willful default; that*1038  the trustee should be exempt from liability for any act of commission or omission in the execution of the trust, so long as it acted in good faith, nor was it personally liable for such acts by any of its officers or employees though it was not obliged to give bond for the performance of the trust; that it could borrow funds to meet temporary exigencies in connection with the management of the trust estate but could not thereby bind either the trustee or the beneficiaries personally; that the trustee could advise with legal counsel and the trustee should be protected in any bona fide action taken consistent *432  with such advice; that the obligation of the trustee in the payment of money to the certificate holders was limited to the petitioner as trustee; that in the event of default by the lessee and the termination of the lease became necessary or advisable in the opinion of the trustee, notice should be given to the registered holders of certificates, upon which these holders had the right to advise the trustee whether the property should be offered for sale, or whether another lease thereof should be made, if possible; and, in the event of the failure of a majority in interest*1039  of the outstanding certificates to express their wishes, or, if the trustee should find, after making reasonable efforts, that it was impractical to comply with such wish of the certificate holders, the trustee should have full authority to sell, lease, manage, operate or otherwise dispose of the premises, as it might deem advisable for the best interests of the certificate holders; that upon the exercise by the lessee of its option to purchase or upon the sale by the trustee, upon receipt of the purchase price, after deducting all necessary expenses, including reasonable compensation to the trustee for its services in connection with the completion of the sale, and the distribution of the net proceeds to the certificate holders, the trustee should distribute such proceeds to the record certificate holders; and for successive trustees.  It was contemplated that the annual rental of $30,000 to be received under the lease would be sufficient to yield to the holder of each $1,000 certificate into which the beneficiaries' interest in the estate was divided, an income of 5 1/2 percent or $55 per year, after the payment of the trustee's fee, and, upon the exercise of the option to purchase*1040  by the lessee, the option price of $550,000 would be sufficient to distribute to each certificate holder approximately $1,028.  The certificates of beneficial ownership were delivered to and sold by the Cleveland Trust Co. at $1,000 per certificate.  The prospectus issued by that company recited that the land had been appraised at $555,000 and the building at $455,000.  Each certificate was entitled "Trustee's Certificate of Equitable Interest The Garfield Lot" and recited that its holder was an owner of a 1/535 of the beneficial interest and ownership in such premises, which were discribed in detail, and entitled to receive the rents and profits therefrom during the continuance of the trust, as provided in the trust agreement.  The certificate further recited that the premises were subject to a 99-year lease, renewable in perpetuity, that the trustee would pay over to the certificate cate holder his proportionate share of the rents and proceeds from the sale of the trust estate and that the certificate was transferable.  The certificate holders had no organization among themselves and never held any meetings.  The State Banking & Trust Co., lessee, was thereafter merged into*1041  the Union Trust Co. of Cleveland, which assumed its obligations as *433  such lessee.  In March 1933, a conservator was appointed for the Union Trust Co. and about June 15, 1933, the Superintendent of Banks of the State of Ohio took over possession of the assets of the Union Trust Co., for liquidation, that institution having been determined to be insolvent.  There was no default in the lease until after the appointment of the conservator for the Union Trust Co.  Upon that default, the petitioner, about July 6, 1933, retained counsel for the purpose of collecting delinquent rentals and advising the trustee with respect to its rights in the situation occasioned by the closing of the Union Trust Co.  The Superintendent of Banks of Ohio, charge of the liquidation of that company, commenced an action in the Common Pleas Court of Cuyahoga County, Ohio, to abandon the lease which had been assumed by the Union Trust Co.  In that action, the petitioner asserted that the Superintendent of Banks had no legal right to abandon the lease.  This action was settled on March 15, 1934, by the payment of $75,000 to petitioner by the Superintendent of Banks of Ohio, as such liquidator, the release*1042  by petitioner of the Superintendent of Banks from all claims and liabilities because of the lease, and the assignment to Three Twenty-two Euclid, Inc., with the consent of the trustee.  This corporation was newly formed by petitioner, all the stock of which was held by a nominee of the petitioner, for the benefit of the trust.  Three Twenty-two Euclid, Inc., never had any salaried officers or employees.  Its officers and directors were officers or employees of the Cleveland Trust Co. and its books of account were kept by an officer of the Cleveland Trust Co.  This new corporation was organized for the purpose of taking over the leasehold estate and to preserve its continuity until another long term tenant for the property could be obtained.  At and prior to the assignment of the lease to Three Twenty-two Euclid, Inc., the first floor of the premises was under lease to the Lerner Shops of Ohio, Inc., a ladies' apparel shop, and a portion of the basement was rented to L. Dingelday as a shoe shining shop.  No other portions of the building were then occupied and, because of the narrow width of the building, it could not be operated economically.  Under lease dated January 25, 1935, and*1043  later modified as of April 16, 1936, Three Twenty-two Euclid, Inc., leased the entire premises to Lerner Shops of Ohio, Inc., for 20 years.  This lease provided for an annual rental of $35,000 for the first 10 years and $40,000 for the last 10 years; with the demolition of the building then on the property and the construction of a new building suitable to the needs of the lessee, to the construction of which the lessee should contribute $25,000.  The new building was constructed under a general contract between *434  Three Twenty-two Euclid, Inc., and the Geo. Rutherford Co., at a total cost of approximately $135,000, of which $25,000 was paid by the lessee and the remainder by Three Twenty-two Euclid, Inc., partially out of its own funds and the balance financed by the petitioner.  Prior to the execution of the lease with the Lerner Shops of Ohio, Inc., the collection of rents from the two tenants then occupying the premises was made by the Cleveland Trust Co.  Expenses incident to the maintenance of those portions of the premises not occupied by the two sublessees were, during that period, paid by the Cleveland Trust Co., and were only such as were necessary to preserve*1044  the property pending the finding of a long term lessee.  After the construction and occupancy of the new building, the rent was paid to Three Twenty-two Euclid, Inc., and that corporation paid to the petitioner the rental on the original 99-year lease.  Except for the activities detailed, neither the petitioner nor Three Twenty-two Euclid, Inc., engaged in any other material activities during the several years mentioned, including that of 1934, except the collection and distribution of rentals to the certificate holders.  The petitioner reported the income received and distributed to the certificate holders during the year 1934 on a fiduciary income tax return and paid a tax on undistributed income of the trust for that year in the amount of $799.77.  During the year 1934, the petitioner received no income other than the item of $75,000, mentioned above, which was received in settlement of the litigation occurring upon default in the original lease.  During that year the petitioner distributed to certificate holders the sum of $29,425.  All stipulated facts, not detailed above, are included herein by reference.  OPINION.  LEECH: The Commissioner has determined the deficiency*1045  here by taxing the petitioner as an association under sections 13 and 801 of the Revenue Act of 1934.1 The only question submitted here is whether, upon the facts found, the petitioner was taxable as an association.  The term "association" is not defined by statute.  Regulations have been promulgated by the respondent, and much has been said by the courts and the Board about the pertinent meaning and application of the term.  However, the Supreme Court, in the comparatively *435  recent case of , 2 laid down the criteria by which we are controlled.  *1046  Undoubtedly, though the question is factual, in examining the facts, it is important to note those upon which most emphasis must be placed.  Thus, it now seems settled that the purpose for which the trust is set up is probably the most important single fact.  This would follow from the discussion of Chief Justice Hughes in the Court's opinion in the Morrissey case, supra. It was there said: What, then, are the salient features of a trust - when created and maintained as a medium for the carrying on of a business enterprise and sharing its gains - which may be regarded as making it analogous to a corporate organization?  And, in determining whether the purpose of a trust is the "carrying on of a business enterprise and sharing its gains," the Board, on the authority of that case and its companions, has held that the powers granted the trustee in the trust instrument, rather than those activities in which the trust engaged during the particular tax years, shall be considered.  . So here, the activities of the trust in which it actually engaged during the taxable year 1934 are not controlling.  Nor is it decisive that*1047  the petitioner has not yet, in any year, actually carried on activities which would constitute it a business enterprise, although it may be doubted that the activities in which this trust actually engaged after the tax year did not characterize it so.  The dominating fact here is that the trust, under the instrument creating it, had the power not only to collect and distribute the rent from the leased premises, but could also lease or dispose of these premises.  And those powers were not merely incidental to the conservation of the trust property, as in , where the property was trusteed for the purpose of preserving it intact for a definite period to insure the payment of an obligation of the creators of the trust.  In this case the converse is true.  Here the property was to be conserved for the purpose of leasing and selling it for profit.  Its conservation was incidental to the primary purpose of leasing and sale.  The lease was renewable in perpetuity.  The trust was, likewise, potentially perpetual.  It was to terminate, only, upon the sale of the premises and the distribution of the net proceeds therefrom.  Although*1048  little financial risk was involved by investment in these certificates of beneficial ownership, it is nevertheless true that no repayment of nor return on that investment was obligatory at all events.  Nor was the amount of any repayment or return limited except by the net rentals and net proceeds from the sale of property.  The reason the Cleveland Trust Co. created this trust was for the advantageous disposition of the banking premises for which it no *436  longer had use.  But the conclusion seems just as inescapable here that it was created with the powers to lease and sell for the purpose of affording investors therein a medium by which to carry on the business of leasing and selling such property and sharing in the profits of that business.  The fact that its operations were limited to the original trust property does not change the picture. We think that the petitioner was created and maintained as a medium for carrying on a business enterprise and sharing its gains.  *1049 . In addition to this purpose of the trust, what are some of its other salient features bearing upon the question at issue?  The title to the property embarked in this business enterprise was held by a trustee, as a continuing entity, during the existence of the trust which, by its terms, was perpetual; there was centralized management by the trustee, representing the beneficiaries; the death of beneficiaries neither terminated nor interrupted the continuity of the enterprise; means were provided for the transfer of beneficial interests and for the introduction of a large number of participants without affecting that continuity; and the personal liability of the participants was, at least partially, limited to the property embarked in the undertaking.  The determination of the respondent is affirmed.  Decision will be entered for the respondent.Footnotes1. SEC. 13.  TAX ON CORPORATIONS.  (a) RATE OF TAX. - There shall be levied, collected, and paid for each taxable year upon the net income of every corporation, a tax of 13 3/4 per centum of the amount of the net income in excess of the credit against net income provided in section 26.  SEC. 801.  DEFINITIONS.  (a) When used in this Act - * * * (2) The term "corporation" includes associations, joint-stock companies, and insurance companies.  ↩2. See also ; ; and . ↩