Commissioner of Int. Rev. v. North American B. Trust

• Citation: 122 F.2d 545
• Decision Date: 14 August 1941
• Docket Number: No. 237.,237.
• Parties: COMMISSIONER OF INTERNAL REVENUE v. NORTH AMERICAN BOND TRUST.
• Court: United States Courts of Appeals. United States Court of Appeals (2nd Circuit)

122 F.2d 545 (1941)

COMMISSIONER OF INTERNAL REVENUE v. NORTH AMERICAN BOND TRUST.

No. 237.

Circuit Court of Appeals, Second Circuit.

August 14, 1941.

Samuel O. Clark, Jr., Asst. Atty. Gen. (Sewall Key and Michael H. Cardozo, IV, Sp. Assts. to Atty Gen., of counsel), for petitioner.

Claude A. Hope, of New York City (Delafield, Marsh, Porter & Hope and James C. Mulligan, all of New York City, of counsel), for respondent.

Before L. HAND, AUGUSTUS N. HAND, and CHASE, Circuit Judges.

L. HAND, Circuit Judge.

I distinguish the case at bar from Commissioner v. Chase National Bank, 122 F.2d 540 handed down at the same time, because here the "Depositor" had it in his power in effect to change the investment of certificate holders at his discretion, as I shall try to show. In Commissioner v. Chase National Bank, supra, each "Unit" consisted of sixteen shares in each of thirty specified companies; and each later "Unit" had to be made up of exactly that number of shares in each of those companies. Therefore, no matter how many "Units" were added, the investment of each certificate holder remained the same; the "Depositor" had no power to change them, they were "frozen," so to speak, for the duration of the trust. It is true that the "Supplemental Agreements" gave larger powers to the "Depositor" than he originally had had to "eliminate" a company, and, so far, it can be said that he had "managerial" powers; but they were far less than those of most trustees stricti juris. True, it was possible, and it always is possible in trusts of this kind, for a beneficiary to sell out and substitute another in his place; and that certainly does make them in some sense "associations." But it does not alone bring them within the statute, else the whole discussion in Morrisey v. Commissioner, 296 U.S. 344, 56 S.Ct. 289, 80 L.Ed. 263, was unnecessary. In Lewis & Co. v. Commissioner, 301 U.S. 385, 57 S.Ct. 799, 81 L.Ed. 1174, the court spoke of "the introduction of new participants" into the trust (301 U.S. at page 388, 57 S.Ct. at page 801, 81 L.Ed. 1174) as an important consideration, and it certainly is, since without it the chief resemblance to a corporation disappears; but that feature alone is not in my judgment enough. Article 801-3 of Regulations 86 itself concludes by saying that it is "the purpose and activity" of the enterprise that determines whether it is a trust.

The reason why I think that in the case at bar the taxpayer is liable is because as I have said the "Depositor" really had power to vary the investments. This arose for the following reasons. He was to select the bonds which should make up a given unit — in this instance called an "Interest" — and when he did so he could not change its composition except for reasons which arguendo I shall assume did not give him "managerial" powers. So far the venture was not unlike that in Commissioner v. Chase National Bank, and could not be said to give an opportunity to take advantage of variations in the market; but the important difference was that in making up another unit the "Depositor" was not confined to the same bonds that he had selected for the first; and so on, for as long as new money came in. Even so, possibly the scheme might have been a "trust" if each unit had remained water-tight, so to speak; that is, if a certificate holder had been confined to the securities of his own unit. But that was not the case; on the contrary the bonds of all units constituted a single pool in which each certificate holder shared according to his proportion of all the certificates issued. Thus, every time the "Depositor" made up a new unit, composed of different bonds from the preceding units, he reduced the interest of existing certificate holders in the bonds which they had up till then owned, and substituted in the place of the interest so taken an interest in new bonds. That meant that the "Depositor" had power, though a limited power, to vary the existing investments of all certificate holders at will, for as long as any new money came in; and in this way to take advantage of market variations to improve the investments even of the first investors. It is true that this was far from the full powers of the manager of an investment trust, but it was a broad enough power when coupled with the free "introduction of new participants" and with the power to "eliminate" bonds which had become undesirable, to turn the venture into a "business," i. e. a method of profiting by the rise and fall of securities.

Reversed.

AUGUSTUS N. HAND, Circuit Judge.

What I have said on the appeal from the orders in Commissioner v. Chase National Bank, 2 Cir., 122 F.2d 540 applies a fortiori to the above appeal which ought, therefore, to be reversed. I should concur unreservedly in the opinion of Judge LEARNED HAND in the present proceeding were it not for the fact that he distinguishes Commissioner v. Chase National Bank from the case at bar. While there are factors here which give added weight to the classification of the arrangement as an association, I think the arrangement in Commissioner v. Chase National Bank also created an association for income tax purposes. Reversed.

CHASE, Circuit Judge (dissenting).

This petition to review a decision of the Board of Tax Appeals expunging a deficiency in the income taxes of the respondent for the fiscal year ending August 31, 1936 involves questions similar to those raised by the petition in Commissioner v. Chase National Bank 122 F.2d 540 in which the decision of the Board, 41 B.T.A. 430, has been affirmed in an opinion handed down herewith. The Commissioner determined the deficiency on the ground that respondent was taxable as a corporation under Sec. 801(a) (2) of the 1934 Act, 26 U.S.C.A. Int.Rev.Acts, page 790. The Board, following its former decision, reversed the Commissioner.

The facts were stipulated and were found by the Board as follows:

"City Bank Farmers Trust Company, hereinafter referred to as `the Trustee,' is a trust company duly organized and existing under the Banking Law of the State of New York. Distributors Group, Incorporated, hereinafter referred to as `the Depositor,' is a corporation duly organized under the laws of the State of Delaware and doing business in New York City.

"On September 1, 1932, a trust agreement was entered into between the Depositor, the Trustee, and the Registered Holders, from time to time, of North American Bond Trust certificates, hereinafter referred to as `the Holders.' The trust set up pursuant to this agreement was known as the North American Bond Trust.

"By the agreement, and simultaneously with its execution, the Depositor was required to deposit with the Trustee 311 bonds of $1,000 each, conforming to requirements more fully set out below. The deposit was to be accompanied by a sum in cash equivalent to the face amounts of coupons which had matured on or prior to the date of deposit and on or after September 1, 1932. Simultaneously with the deposit, the Trustee was to issue certificates representing 360 equal, undivided, equitable interests in the deposited bonds each interest to be registered in a name to be designated by the Depositor.

"At any time prior to the termination of the agreement, the Depositor might cause additional interests to be created for the account of others. In order to create such an interest, the Depositor had to deposit with the Trustee an amount equal to the then value of an interest. These values were to be determined every business day by the Depositor, using listed prices on the New York Stock and Curb Exchanges, where available, or the best available information. To the value of the bonds thus found was added the cash held by the Trustee as part of the deposited property, including currently distributable funds, and the value of each interest was determined by dividing this total by the total number of interests.

"Having found the total amount to be deposited, the Depositor was then required to buy an eligible bond especially for the purpose, accompanying it with a bill of sale from the seller stating the fact of such special purchase, and to deposit it with the Trustee with unmatured coupons attached, together with a sum in cash equal to the amount of any moneys then held by the Trustee as currently distributable funds, applicable to the number of interests to be credited, and additional cash equal to the face value of coupons maturing prior to the date of deposit and on or after the first day of the current semi-annual period. In case the cost of the bond plus the cash above specified did not equal the then value of an interest, the Depositor was required to deposit sufficient additional cash to make up the difference.

"Each deposit was to be accompanied by a memorandum from the Depositor, upon which the Trustee might conclusively rely, showing the amount to be deposited and certifying that the bond was eligible.

"Upon receipt of the deposit, the Trustee was then to issue a certificate of interest to the person or corporation for whom the interest had been created. The bonds and cash received were commingled with the previous deposits into one trust fund, each interest ranking pari passu with every other interest outstanding. The certificates were not assignable, except by operation of law, by reason of the death of the holder, or by and to the Depositor. The right to surrender a certificate and receive its cash equivalent, however, might be freely assigned.

"The Depositor was entitled to collect a fee for causing the interest to be created and to exact a commission in case it acted as broker in the purchase of the bond.

"All the cash received by the Trustee in connection with deposits, except the cash required if the cost of the bond, etc., did not equal the value of an interest, was to be credited to currently distributable funds, and income, earnings and interest upon the deposited property was to receive the same treatment. It was also...