Fidelity-Bankers Trust Co. v. Helvering

• Decision Date: 04 March 1940
• Docket Number: 7272.,No. 7271,7271
• Citation: 113 F.2d 14
• Parties: FIDELITY-BANKERS TRUST CO. et al. v. HELVERING, Commissioner of Internal Revenue. HELVERING, Commissioner of Internal Revenue, v. FIDELITY-BANKERS TRUST CO. et al.
• Court: U.S. Court of Appeals — District of Columbia Circuit

113 F.2d 14 (1940)

FIDELITY-BANKERS TRUST CO. et al. v. HELVERING, Commissioner of Internal Revenue. HELVERING, Commissioner of Internal Revenue, v. FIDELITY-BANKERS TRUST CO. et al.

Nos. 7271, 7272.

United States Court of Appeals for the District of Columbia.

Decided March 4, 1940.

Writ of Certiorari Denied June 3, 1940.

Forrest Andrews, of Knoxville, Tenn., for Fidelity-Bankers Trust Co. and others.

Sewall Key, J. P. Wenchel, Paul E. Waring, and L. W. Post, all of Washington, D. C., for Commissioner of Internal Revenue.

Before GRONER, Chief Justice, and MILLER and RUTLEDGE, Associate Justices.

Writ of Certiorari Denied June 3, 1940. See 60 S.Ct. 1102, 84 L.Ed. ___.

RUTLEDGE, Associate Justice.

Fidelity-Bankers Trust Company (the Trust Company) appeals from a decision of the United States Board of Tax Appeals¹ holding it liable, as trustee for Fidelity Realty Company (the syndicate), to pay tax on $4,474.06 income for the year 1933. The Commissioner of Internal Revenue appeals from the Board's refusal in the same decision to hold the Trust Company liable to pay tax on $10,009.69 and $13,041.94, alleged to have been income of the syndicate during the years 1932 and 1933 respectively. The principal questions to be decided are: (1) Whether the syndicate is an association which is taxable as a corporation within the meaning of the taxing statute;² (2) whether, if so, money paid to the syndicate by the Trust Company pursuant to a guaranty is income taxable to the syndicate.

The Trust Company is a Tennessee corporation engaged in the general banking and trust business at Knoxville, Tennessee. Its chief business consists of lending money which is secured by first mortgages or trust deeds on real property in or near Knoxville, and selling its own interest-bearing bonds secured by these mortgages and trust deeds. In 1931, because of maturities on its bonds and a decline in its collections of principal and interest on real estate loans, the Trust Company faced serious financial embarrassment and probable receivership proceedings. To meet this situation arrangements were made whereby nineteen individuals and a company, substantially all of whom were stockholders or directors of the Trust Company, formed the syndicate, one purpose of which was to advance to the Trust Company up to $510,000 under the terms of a declaration of trust executed on October 20, 1931. By one provision the Trust Company guaranteed that the syndicate's annual profits would equal six per cent on the face value of outstanding syndicate certificates, and in exchange for this guaranty the Trust Company was to take all syndicate profits exceeding that sum. Pertinent portions of the declaration are set forth in the margin.³

The fundamental difference concerns the construction and legal effect of the instrument. The taxpayer says it is in substance nothing more than an arrangement for loans by the individual subscribers to the Trust Company and for securing them by provisions amounting to no more than a mortgage or deed of trust on the property. Implicit is the view that the syndicate is a mere name or mode of designating the individual subscribers, not an entity, association, corporation or business for purposes of the act. The Commissioner takes the contrary position, regarding the syndicate as a taxable entity distinct from the subscribers and the Trust Company, and as such engaged in a separate and distinct business of its own.

During the fiscal year ending October 31, 1932, operation of the syndicate properties resulted in a loss of $2,156.06, but for that ending October 31, 1933, a profit of $4,474.06 was realized. In those years the Trust Company, pursuant to its guaranty, paid $12,165.75 and $13,041.94, respectively, to the trustee, which enabled it to pay the syndicate subscribers their guaranteed six per cent. The Commissioner considered these payments as income to the syndicate and therefore deducted the operating loss for 1932 from the guaranty payment for that year and assessed taxes against the syndicate on the difference and the whole amount paid for 1933. The Board held that the guaranty payments were made "under an obligation running directly from the Trust Co. to the certificate owners," and therefore were not taxable to the syndicate, although its profits on operating the properties for 1933 were held taxable.

I. Was the syndicate a taxable association?

We are concerned here with a trust. Taxability as an association or corporation no longer turns on technical differences in organizational structure⁴ 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 nonbusiness¹⁰ 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 attributes¹³ 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 Associates¹⁵ 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...