Flood v. United States

• Decision Date: 29 January 1943
• Docket Number: No. 3816.,3816.
• Parties: FLOOD et al. v. UNITED STATES.
• Court: U.S. Court of Appeals — First Circuit

133 F.2d 173 (1943)

FLOOD et al. v. UNITED STATES.

No. 3816.

Circuit Court of Appeals, First Circuit.

January 29, 1943.

Philip Nichols, of Boston, Mass. (J. A. Boyer and Nichols, Boyer & Morton, all of Boston, Mass., of counsel), for appellants.

Newton K. Fox, Sp. Asst. to Atty. Gen., (Samuel O. Clark, Jr., Asst. Atty. Gen., Sewall Key, A. F. Prescott, and Eugene E. Angevine, Sp. Assts. to Atty. Gen., and Edmund J. Brandon, U. S. Atty., and George F. Garrity, Asst. U. S. Atty., both of Boston, Mass., of counsel), for appellee.

Before MAGRUDER, MAHONEY, and WOODBURY, Circuit Judges.

MAGRUDER, Circuit Judge.

This consolidated appeal brings up three related cases which were tried and decided together by the court below. D. C., 44 F.Supp. 509. In one, plaintiff-appellant Flood sued to recover an alleged overpayment of income taxes for the year 1936 in the sum of $3,500. In another, he sought recovery of a similar alleged overpayment for the year 1937 in the sum of $3,110. In the third the executor of John Moir, deceased, sued to recover an overpayment of income taxes in the sum of $5,976.49 for the period January 1, 1938, to September 20, 1938, the date of decedent's death. Judgment was rendered in favor of the defendant in each case.

The basic questions to be decided are these: (1) Whether the income of a trust known as the Chase & Sanborn Pension Fund is taxable to the grantors in proportion to their respective contributions to the corpus, under the identical provisions of §§ 166 and 167 of the Revenue Acts of 1936 and 1938, 49 Stat. 1707, 1708, 52 Stat. 519, 26 U.S.C.A.Int.Rev. Code §§ 166, 167¹; (2) if the income is so taxable, whether, under § 23(a) of the said revenue acts, 49 Stat. 1658, 1659, 52 Stat. 460, 26 U.S.C.A. Int.Rev.Code § 23 (a) (1),² the grantors were entitled to take proportionate deductions in their individual returns for so much of the trust income as was paid in the taxable years to former employees of a dissolved partnership of which the grantors had been members.

The partnership of Chase & Sanborn was formed in 1878 and thereafter was continuously engaged until July 16, 1929 in the business of importing and jobbing tea and coffee. On the latter date the partners were John Moir, William T. Rich, Frederick A. Flood and five other individuals. For a considerable period prior to 1929 it had been the regular practice of the partnership through the voluntary action of the partners to provide pensions or allowances of extra compensation to employees who had served the firm long and faithfully and who for reasons of age or ill health had become partially or completely incapacitated. This had been done as a matter of moral, rather than legal, obligation. The firm had at that time between 400 and 500 employees.

On July 16, 1929 the business of the partnership was sold as a going concern to Standard Brands, Inc. The sale included all the assets of the partnership and the buyer assumed all its liabilities except a few minor obligations, which the partners took over. The partnership was not formally dissolved after the sale, but it did no further merchandising. It continued to exist only for the purpose of cleaning up expenses connected with the sale, e. g., attorneys' fees and transfer taxes, and of adjusting the obligations which Standard Brands, Inc., did not assume.

During negotiations leading up to the sale it was proposed that Standard Brands, Inc., should undertake to continue the policy of pensioning the old employees. Standard Brands, Inc. declined to undertake any such responsibility. In consequence, the partners agreed among themselves in advance of the sale that each should contribute a certain portion of his share of the purchase price to be paid by Standard Brands, Inc., to be held in trust for the purpose of paying pensions or allowances to former employees of Chase & Sanborn.

A trust agreement was executed by all the partners on July 16, 1929, creating the Chase & Sanborn Pension Fund. The corpus consisted of shares of first preferred stock in Standard Brands, Inc., of an approximate value of $800,000, contributed by the partners in proportion to their respective interests in the partnership. Moir, Rich and the Day Trust Company became the trustees, and remained as such during the periods now involved. Moir and Rich were the two partners owning the largest partnership interests, 36.63 per cent and 18.78 per cent, respectively.

The trustees were given broad powers of management and were directed to pay the income of the trust to numerous employee beneficiaries named in schedules attached, in monthly payments of varying amounts, ranging at first from $30 to $200 a month. The amounts were determined with reference mainly to the type of service which had been performed by the employee and the pay previously earned, the more valuable and higher salaried men receiving larger pensions. Names were added to the list in subsequent years, in some cases to provide for old employees of the partnership who had continued for a time in the employ of Standard Brands, Inc., and who were later retired, and in a few cases to provide payments to widows of deceased employees who had worked for the partnership. It was provided that upon the death of the last survivor of the beneficiaries named in the schedules the trustees should then pay to the contributors of the fund in proportion to their contributions, or to their legal representatives, the principal as it then should be, with any accrued income, the trust thereupon to terminate.

Most of the income of the trust in the years now in question was actually paid to the beneficiaries.

In their original returns for the taxable years each of the taxpayers included in his gross income so much of the income of the trust as was attributable to his proportionate contribution to the fund. The taxes were paid accordingly. Claims for refund were filed on the contention that the income of the Chase & Sanborn Pension Fund was not legally taxable to the grantors and, in the alternative, that if the grantors were required to include in their gross income the income of the trust, they were entitled to deduct as business expenses, on their individual returns, their respective portions of the income of the trust which was actually paid to the employee beneficiaries. The court below ruled against the taxpayers on both of these points.

For the purpose of considering the taxability of the grantors under §§ 166 and 167 it is not necessary to quote in detail the provisions of the trust instrument. It is conceded by the taxpayers that "the powers of amendment and modification and the degree of control of payments from income provided by this instrument and vested in the three trustees acting unanimously, when considered together, are the full equivalent of a power of revocation and of a power to hold income for, or distribute it to, the eight grantors." With respect to the taxpayer Flood, the point in dispute is whether Moir and Rich, who under the terms of the trust would have to concur in a revocation or in the accumulation of the income for future distribution to the grantors, were persons not having a "substantial adverse interest" within the meaning of §§ 166 and 167. With respect to the taxpayer Moir the question in dispute is whether Rich was a person not having a substantial adverse interest. The corporate trustee, though its concurrence also was necessary, had an interest which was neither substantial nor adverse. Treas. Regs. 94, Art. 167-1(b) (3).

It is urged by the taxpayers that the legal power which Moir and Rich held under the trust instrument, whereby they could compel the continued application of the income to the discharge of what they regarded as their moral obligation to the former employees of the partnership, constituted a substantial interest in the disposition of the corpus or income therefrom adverse to revocation. Significance is attached to a change in the phraseology of §§ 166 and 167 introduced by the Revenue Act of 1932, 26 U.S.C.A. Int.Rev.Code §§ 166, 167. Under the 1928 act, 45 Stat. 840, 26 U.S.C.A. Int.Rev.Acts, page 407, the income of a trust was taxable to the grantor if he had the described powers "either alone or in conjunction with any person not a beneficiary of the trust." In the 1932 act, 47 Stat. 221, and subsequent acts, in place of the words "beneficiary of the trust" there is substituted the phrase "person not having a substantial adverse interest in the disposition" of the corpus or income. Under this altered language the argument is that a grantor is saved from taxability on the income of a trust not only where the repository of the power is a beneficiary having a substantial property interest in the trust, but also where the power holder has any interest in the disposition of the corpus or income of a sort that should be recognized as giving him "a sufficient and compelling motivation against revocation"; that in any case where such an interest is present the grantor cannot be said to have so retained the substantial mastery over the property which he contributed to the trust as to justify the attribution of the income to him. We think the court below was right in concluding that in amending §§ 166 and 167 in 1932 Congress did not intend to liberalize those provisions in favor of grantors, but on the contrary sought to "tighten rather than loosen the reins." 44 F.Supp. 513. This is borne out by the report of the Senate Committee on Finance (Sen. Rep. No. 665, 72d Cong., 1st Sess., p. 34).³ It is there pointed out that taxpayers had sought to avoid the effect of § 166 in its earlier form by reserving to the grantor the power of revocation "in conjunction with a beneficiary having a very minor interest" or by "conferring the power to revest upon a person other than a beneficiary." The report makes clear that under the amendments the income is to be taxable to the grantor "in any of these cases," including the...