Commissioner of Internal Revenue v. Prouty

• Decision Date: 01 November 1940
• Docket Number: No. 3603.,3603.
• Citation: 115 F.2d 331
• Parties: COMMISSIONER OF INTERNAL REVENUE v. PROUTY.
• Court: U.S. Court of Appeals — First Circuit

115 F.2d 331 (1940)

COMMISSIONER OF INTERNAL REVENUE v. PROUTY.

No. 3603.

Circuit Court of Appeals, First Circuit.

November 1, 1940.

Loring W. Post, of Washington, D. C. (Samuel O. Clark, Jr., Sewall Key, and Joseph M. Jones, all of Washington, D. C., on the brief), for Commissioner of Internal Revenue.

Allison L. Newton, of Boston, Mass. (Douglas L. Ley, of Boston, Mass., on the brief), for Olive H. Prouty.

Before MAGRUDER and MAHONEY, Circuit Judges, and PETERS, District Judge.

MAGRUDER, Circuit Judge.

In 1923 Olive H. Prouty, the taxpayer herein, set up three trusts. Between 1923 and 1931 the grantor, by virtue of power reserved to her, made various amendments to the trust instruments. The Commissioner ruled that the gifts were not complete in 1931; that under Section 501 of the Revenue Act of 1932, 47 Stat. 245, as amended by Section 511 of the Revenue Act of 1934, 48 Stat. 758, 26 U.S.C.A. Int.Rev. Acts, pages 580, 769, gift taxes became due upon amendment of each of the trusts on January 2, 1935, whereby the grantor finally relinquished all reserved power to revoke or amend the trust instruments. Upon petition for redetermination of the deficiency, the Board of Tax Appeals held with the taxpayer that the gifts had been completed prior to the enactment of the gift tax in 1932, and decided that there was no deficiency in gift taxes for the year 1935. The correctness of this decision by the Board is now before us on petition for review.

After the amendments in 1931 each of the three trust instruments contained a provision reserving to the grantor a power to revoke or amend, with the written consent of her husband, Lewis I. Prouty, during his lifetime, and thereafter, alone. As a condition precedent to the exercise of this power in a given calendar year, the grantor had to serve upon the trustee, during the preceding year, a formal notification of intention to revoke or amend.

Section 501 (c) of the Revenue Act of 1932 provided:

"The tax shall not apply to a transfer of property in trust where the power to revest in the donor title to such property is vested in the donor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition of such property or the income therefrom, but the relinquishment or termination of such power (other than by the donor's death) shall be considered to be a transfer by the donor by gift of the property subject to such power, and any payment of the income therefrom to a beneficiary other than the donor shall be considered to be a transfer by the donor of such income by gift."

This subsection was repealed in 1934, 48 Stat. 758, for the reason, as explained in the committee reports, that "the principle expressed in that section is now fundamentally part of the law by virtue of the Supreme Court's decision in the Guggenheim case. * *" H.Rep. 704, 73d Cong., 2d Sess. (1934), p. 40; Sen.Rep. 558, same session, p. 50. In Burnet v. Guggenheim, 288 U.S. 280, 53 S.Ct. 369, 77 L.Ed. 748, which arose under the gift tax of 1924, the Supreme Court, without the aid of specific language in that Act, had reached the result which was expressly provided for in Section 501 (c) of the 1932 Act. In view of this legislative history Treasury Regulations 79 (1936 ed.) quite properly provide, notwithstanding the repeal of Section 501 (c), as follows:

"Art. 3. Cessation of donor's dominion and control.—

"* * *

"As to any property, or part thereof or interest therein, of which the donor has so parted with dominion and control as to leave in him no power to cause the beneficial title to be revested in himself, the gift is complete. But a transfer (in trust or otherwise), though passing both legal and beneficial title, is still in essence merely formal so long as there remains in the donor a power to cause the revesting of the beneficial title in himself, and the gift, from the standpoint of substance, remains incomplete during the existence of the power. A donor shall be considered as having the power to revest in himself the beneficial title to the property transferred if he has such power in conjunction with any person not having a substantial adverse interest in the disposition of the property or the income therefrom. A trustee, as such, is not a person having a substantial adverse interest in the disposition of the trust property or the income therefrom. The relinquishment or termination of the power, occurring otherwise than by the death of the donor (the statute being confined to transfers by living donors), is regarded as the event which completes the gift and causes the tax to apply. * * *"

If, therefore, Lewis Prouty is determined to be a person not having a substantial adverse interest in the disposition of the trust corpus or income therefrom, the gifts were not complete in 1931 and gift taxes accrued in 1935 upon the grantor's unqualified relinquishment of her power to revoke or amend.

We shall refer first to Trusts Nos. 2 and 3, because in them we think it clear that Lewis did not have a substantial adverse interest as of 1931.

In Trust No. 2 the grantor declared herself trustee of certain securities, with direction to the trustee to pay out of the net income the sum of $2,500 a year to Lewis I. Prouty during his lifetime, "and to add the balance of the net income to the principal and invest it as a part thereof during the lifetime of Lewis I. Prouty, with full power and authority in the sole and uncontrolled discretion of said Olive Higgins Prouty as long as she shall be the Trustee hereunder from time to time to pay to said Lewis I. Prouty and said Jane Prouty a daughter, or either of them, in such proportions as the said Trustee may see fit the whole or any part of the principal of the trust fund if said Trustee deems it necessary or advisable for the maintenance, support and welfare of said Lewis I. Prouty and said Jane Prouty or either of them. * * *" It was provided that Lewis would succeed as trustee if he outlived the grantor; but in that event Lewis as trustee would not be empowered to make any payments to himself, other than the annuity, though he could in his "sole and uncontrolled discretion" make payments of the whole or any part of the principal to Jane Prouty if he deemed it advisable for her maintenance, support and welfare. At Lewis' death the property was to pass to Jane, with various remainders over. The power in the grantor to amend or revoke the trust, with the consent of Lewis, has already been mentioned.

Trust No. 3 was the same as Trust No. 2, except that Richard Prouty, a son, was substituted for Jane.

So far as the annuity is concerned, the Commissioner conceded that an effective gift thereof in each trust had been made prior to the passage of the Revenue Act of 1932. Accordingly, in determining the deficiency, he subtracted the value of the annuities, calculated on the basis of Lewis' life expectancy, and subjected the remaining value of the corpus of each trust to the gift tax. This method of apportionment might be objected to on the ground that if the annuity constituted a substantial adverse interest, it was an interest in the whole of the corpus out of the net income of which the annuity was payable, so that the gift should be treated as having been completed in 1931 as to all the trust res. But such an interpretation would afford an obvious facility for tax evasion, particularly with respect to the grantor's income tax in the application of the comparable provisions of Section 166 dealing with revocable trusts.¹ To the extent that a proposed partial revocation would leave Lewis' annuity intact, he would have no substantial countervailing interest tending to induce him to withstand the grantor's wishes. We think that the Commissioner was justified in deducting the capital value of the annuity and in treating the transfer in 1935 upon relinquishment of the power as being a gift merely of the remainder of the corpus after such deduction. Therefore, in considering whether Lewis had a substantial adverse interest in Trusts Nos. 2 and 3, we may leave out of account the annuities to him provided in these trusts. Cf. Kaplan v. Commissioner, 1 Cir., 66 F.2d 401; Paul W. Litchfield v. Commissioner of Internal Revenue, 39 B.T.A. 1017.

The only other interest which Lewis had in the corpus of Trusts Nos. 2 and 3 was the possibility that, under the provision previously quoted, his wife, as trustee, might in her "sole and uncontrolled discretion" pay over to him such portions of the principal as she might deem advisable for his maintenance, support and welfare. But the main purpose of the trust was to accumulate the income during Lewis' lifetime, and the record does not suggest the existence of circumstances indicating any likelihood that Lewis would ever receive anything by virtue of this provision. Certainly Lewis, while receiving aggregate annuities of $7,500 from the three trusts, could never obtain a court decree compelling the trustee to give him something under this discretionary power. That such a remote and speculative possibility of gain does not constitute a "substantial adverse interest" was ruled by this court on quite similar facts in Fulham v. Commissioner, 1 Cir., 110 F.2d 916, 918.

Another point was stressed by the Board in connection with Trusts Nos. 2 and 3, namely, that in each case the corpus at the death of Lewis was to go to his children. "It is natural to assume," said the Board, "that his desire and concern for the support, maintenance, and welfare of his children after his death would prompt him to resist any effort on the part of the grantor of the trust to alter, amend or revoke that part of the trust so as to revest in her title to such property." No doubt this is an interest of a sort. But we think the phrase "substantial adverse interest," as it was used in Section 501 (c) of the Revenue Act of 1932 and as it is used in Sections 166 and 167, 26 U.S.C.A. Int.Rev. Acts, pages...