Freedman v. Tax Review Bd. of City of Philadelphia

• Decision Date: 13 June 1968
• Citation: 212 Pa.Super. 442,243 A.2d 130
• Parties: Herman M. FREEDMAN and Abraham E. Freedman, Executors of the Estate of Harry J. Freedman, Deceased, Appellants, v. TAX REVIEW BOARD OF the CITY OF PHILADELPHIA.
• Court: Pennsylvania Superior Court

Page 130

243 A.2d 130

212 Pa.Super. 442

Herman M. FREEDMAN and Abraham E. Freedman, Executors of the Estate of Harry J. Freedman, Deceased, Appellants, v. TAX REVIEW BOARD OF the CITY OF PHILADELPHIA.

Superior Court of Pennsylvania.

June 13, 1968.

Petition for Allowance of Appeal Granted Sept. 24, 1968.

Marvin J. Levin, Freedman, Borowsky & Lorry, Philadelphia, for appellants.

Levy Anderson, Asst. City Sol. (1st Deputy), Allan Gordon, Asst. City Sol., Edward G. Bauer, City Sol., Philadelphia, for appellee.

Before WRIGHT, P.J., and WATKINS, MONTGOMERY, JACOBS, HOFFMAN, SPAULDING and HANNUM, JJ.

HOFFMAN, Judge.

The sole issue in this case is whether a taxpayer's income, earned as a limited partner, is subject to the Philadelphia Net Profits Tax. Philadelphia General Code of Ordinances § 19--501 et seq.

By agreement dated July 15, 1952, a partnership known as Flandel Enterprises was formed for the purpose of owning and operating interests in realty and personalty. The partnership agreement provided for the formation of a limited partnership under § 2 of the Limited Partnership Act, Act of April 12, 1917, P.L. 55, 59 P.S. § 171 et seq., with its principal office in Philadelphia. Pertinent provisions of the agreement provided that profits and losses would be divided among the partners in the proportions set forth; that the general partners would have complete control of the funds and of the management and conduct of the partnership business; that the liability of the limited partners would not exceed their contribution to the partnership capital; that no additional limited partners would be admitted nor would any limited partner have the right to assign his interest; and that the death of a limited partner would not terminate the partnership, but that his estate would have the right to receive his share of the profits and distributions.

The partnership consisted of twenty-five partners--four general, two limited and general, and nineteen limited partners. Decedent taxpayer was entitled to a 5.405% Interest in the partnership.

The decedent taxpayer was at all times a resident of Philadelphia. Until his death in 1964 he did not file a return nor did he pay net profits tax on the profits of the partnership.

In 1966, the City of Philadelphia made an assessment for net profits taxes for the years 1953 through 1964. The Tax Review Board denied the estate's petition contesting the assessment, and the lower court affirmed. From this affirmance, the executors have now appealed.

Section 19--1502(1)(c) of the net profits tax ordinance imposes a tax 'on the net profits earned in business, professions or other activities conducted by residents * * *.'

It further provides under subsection (3): 'The tax levied under § 19--1502(1) (c) and (d) shall relate to and be imposed on the net profits of any business, profession or enterprise carried on by any person as owner or proprietor, either individually or in association with some other person or persons.'

Section 19--1501(7) defines a resident as: 'An individual co-partnership, association, corporation, or any other entity domiciled in the City.'

Flandel Enterprises was engaged in the ownership and operation of office buildings. As such, its activities were clearly 'business' within the meaning of the ordinance. Cf. Tax Review Board of City of Philadelphia v. Brine Corporation, 414 Pa. 488, 200 A.2d 883 (1964); Kungsgaten Inc. v. Philadelphia, 422 Pa. 209, 220 A.2d 803 (1966); Block v. Philadelphia Tax Review Board, 209 Pa.Super. 727, 226 A.2d 229 (1967); Philadelphia Tax Review Board v. Weiner, 211 Pa.Super. 229, 235 A.2d 184 (1967). The Tax Review Board and the lower court held, therefore, that the distributive share of the limited partner was taxable, because it was a profit distribution of business income.

The appellants contend, however, that the limited partner's share of income is merely 'investment' or 'passive' income and is not subject to the Philadelphia Net Profits Tax.

It is fundamental that the Net Profits Tax is imposed only on 'earned' income and ordinarily does not apply to 'investment' or 'passive' income such as bank deposits or shareholdings. Philadelphia Tax Review Board v. Weiner, supra; Breitinger v. City of Philadelphia, 363 Pa. 512, 70 A.2d 640 (1950); Murray v. City of Philadelphia, 363 Pa. 524, 70 A.2d 647 (1950).

To distinguish between 'earned' and 'passive' income is often a matter of great difficulty. The test which has emerged was set forth in Tax Review Board of City of Philadelphia v. Brine Corporation, supra:

'* * * we conclude that simply because a certain type of receipt may be derived as rent from real estate, dividends or interest from securities or gain from the sale of property (i.e., receipts generally referred to as 'unearned') is not itself sufficient reason for holding that such receipts are not derived from the conduct of a business. It is as possible to conduct a business which generates only 'unearned' receipts as it is to conduct an enterprise producing only 'earned' receipts. The test is neither the characterization of the receipt nor the size of the business; rather, it is the nature of the activity producing the receipt.' (Emphasis added.)

Thus, in Brine, the Supreme Court pointed out that 'a person may purchase one piece of real estate and actively engage in renting and managing it. He certainly would be liable for mercantile tax. Another person may inherit ten pieces of rent producing real estate with regard to which he does nothing but collect rents. He would not be liable for mercantile license tax.'

Similarly, in Philadelphia Tax Review Board v. Weiner, supra, Judge Spaulding, writing for our Court stated, 'The conclusion would then be that any quantum of such action, such as deliberate acquisition and the provision of even minimal services, would qualify the activity in question as a business activity * * *' (211 Pa.Super. at 238, 235 A.2d at 188).

With this understanding of the 'activity' concept, we turn to an appraisal of the limited partner's interest and activity. A limited partnership in Pennsylvania is an entity in which one or more persons, with unlimited liability, manage the partnership, while one or more other persons only contribute capital; these latter partners have no right to participate in the management and operation of the business and assume no liability beyond the capital contributed. The Limited Partnership Act specifically provides in § 7 that: 'A limited partner shall not become liable as a general partner unless, in addition to the exercise of his rights and powers as a limited partner he takes part in the control of the business.'

The limited partnership agreement in this case was in complete conformance with the Act in that it vested complete control over the management and conduct conducting the partnership business. ¹ He partners. The limited partners could not control the business, nor did they have the right to elect and remove from office those persons who were conducting the limited partnership business. Indeed, even upon death, a limited partner's money could not be removed from the partnership. The City does not suggest or argue that decedent taxpayer did, in fact, exercise any other powers other than those permitted a limited partner or that he was involved in a series of limited partnerships. In short, the limited partner in this case had but the right to invest his money and await a return, if any.

In light of these facts, it is clear that the decedent taxpayer's income was not 'earned'; it was passive, unearned, investment income in the fullest sense of the word. His investment differed little from that of the depositor in a savings and loan...