Isidro Martin-Montis Trust v. Comm'r of Internal Revenue, Docket Nos. 5380-78
| Decision Date | 11 December 1980 |
| Docket Number | 7847-78,7932-78.,Docket Nos. 5380-78 |
| Citation | 75 T.C. 381 |
| Parties | ISIDRO MARTIN-MONTIS TRUST, F. B. HUBACHEK, JR., TRUSTEE, et al., 1 PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Held, interest income earned by a U.S. trust is not U.S. source income where the beneficiary is a nonresident alien. Frank T. Foster and Thomas E. Chomicz, for the petitioners.
Harmon Dow, for the respondent.
Judge: Respondent determined deficiencies in income tax as follows:
The sole issue for decision is whether interest on U.S. bank deposits, which interest is received by a nonresident alien beneficiary as distributions from a U.S. trust which is not a grantor trust, is U.S. source income within the meaning of section 861.2
This case was submitted fully stipulated.
The Isidro Martin-Montis Trust (Martin-Montis Trust), Soledad Portago Trust U/D 11/14/45 (Portago Trust-1945), and Soledad Portago Trust U/D 3/10/51 (Portago Trust-1951) are all trusts administered under the laws of the State of Illinois. The Martin-Montis Trust and the Portago Trust-1945 were established in 1945. The Portage Trust-1951 was established in 1951. These petitioners are hereinafter collectively referred to as the “trusts.”
The grantor of each of the trusts was Olga Martin-Montis, a citizen of the United States. The only beneficiary of the Martin-Montis Trust was Isidro Martin-Montis, a nonresident alien, who was a resident of Switzerland during the years in issue. The only beneficiary of the Portago Trust-1954 and the Portago Trust- 1951 was Soledad Portago, also a nonresident alien who was a resident of Switzerland during the years in issue.
At all times material to this case, F. B. Hubachek, Jr., a resident of Illinois, was the trustee of the three trusts. Under the trust instruments establishing the trusts, all control, management rights, and powers were vested in the trustee.
The trustee deposited funds belonging to each of the trusts into interest-bearing accounts with U.S. banks. These accounts generated interest income in the following amounts for the years stated:
+---------------------------------------------------+
¦Trust ¦1974 ¦1975 ¦1976 ¦
+-------------------+----------+----------+---------¦
¦ ¦ ¦ ¦ ¦
+-------------------+----------+----------+---------¦
¦Martin-Montis Trust¦$37,685.25¦$14,294.38¦$1,407.34¦
+-------------------+----------+----------+---------¦
¦Portago Trust—1945 ¦25,384.81 ¦16,541.84 ¦2,054.90 ¦
+-------------------+----------+----------+---------¦
¦Portago Trust—1951 ¦40,545.67 ¦21,299.99 ¦7,431.26 ¦
+---------------------------------------------------+
The above-stated amounts were distributed by the trustee to the trusts' respective beneficiaries in the years the trusts received them. All of this interest income was investment income not effectively connected with a trade or business within the United States.
Each of the trusts timely filed a U.S. Fiduciary Income Tax Return (Form 1041) for each of the years in issue. In addition, each of the trusts timely filed a U.S. Annual Return of Income Tax to be Paid at Source (Form 1042) together with a Form 1042S, Income Subject to Withholding under Chapter 3, Internal Revenue Code, for each of the years in issue. The interest income distributed to the beneficiaries in 1974, 1975, and 1976 was separately stated by the trusts on the Forms 1042S with the notation “Exempt Interest on Bank Deposits.” The trustee did not withhold any income tax under section 1441 with respect to the interest income distributed to the beneficiaries during the years in issue.
In his statutory notices, respondent determined that the interest earned on the U.S. bank deposits and distributed to the nonresident alien beneficiaries was income from sources within the United States and was subject to income tax and withholding of tax. Accordingly, respondent determined deficiencies representing the tax required to be withheld at source by the trustee for each of the years in issue.
Section 871(a)(1)(A) provides that a nonresident alien individual, not engaged in a trade or business in the United States, is subject to a 30-percent tax on interest received by him from sources within the United States.3 Section 1441 requires a trust fiduciary to withhold the tax on U.S. source interest income distributed to nonresident alien beneficiaries.
Section 861 specifically excludes from gross income from sources within the United States interest earned on U.S. bank deposits received by a nonresident alien.4 This exclusion originated in the Revenue Act of 1921, sec. 217(a)(1)(A), 42 Stat. 227, 243. The original purpose of the exclusion was to encourage bank deposits in the United States by nonresident aliens and generally to aid foreign and international trade. See Hearings Before the Senate Finance Committee on H.R. 8245, 76th Cong., 1st Sess. 65 (1921). The current statutory provision, section 861, was enacted in its present form by section 103(a) of the Foreign Investors Tax Act of 1966, Pub. L. 89-809, 80 Stat. 1539, 1547. Congress at that time was questioning the rationale of permitting U.S. source interest received by a nonresident alien to escape U.S. taxation. S. Rept. 1707, 89th Cong., 2d Sess. 10 (1966), 1966-2 C.B. 1095, 1066. As a result, Congress decided to repeal this statutory exclusion altogether, effective December 31, 1972. Foreign Investors Tax Act of 1966, sec. 102(a)(1), 80 stat. 1541. The reason for delaying the repeal was that it was feared that an immediate repeal would have a substantial adverse effect on our balance of payments. S. Rept. 1707, supra. Subsequently, Congress delayed the 1972 elimination of the exclusion, and in 1976 decided to make the exclusion permanent. Tax Reform Act of 1976, sec. 1041, 90 Stat. 1634.
In 1954 Congress enacted section 652(b), which provides that in the case of a simple trust which distributes income annually, the income received by the beneficiary of the trust retains the same character in the hands of the beneficiary as in the trust.5 This is sometimes called the conduit theory of trust taxation.
Petitioners contend that, under the conduit theory, the trust income distributed to the nonresident aliens, retained in their hands its same character as the income possessed in the hands of the trusts. Although respondent agrees with petitioners that the character of the income in the hands of the nonresident alien beneficiary was interest income, and that the source was U.S. banks, respondent contends that the statute, properly construed, requires, in addition, both control of the deposits by the beneficiaries and receipt of the interest directly by the beneficiaries before section 861 would apply at the beneficiary level.
Respondent relies primarily on Vondermuhll v. Commissioner, 29 B.T.A. 895 (1934), affd. 75 F.2d 656 (D.C. Cir. 1935). In Vondermuhll, the taxpayer was a Swiss citizen who transferred property to her two sons, both U.S. citizens, who in turn conveyed the property to themselves as trustees for the benefit of their mother. The trust funds were deposited with certain U.S. companies, assumed for the purposes of the opinion to be bankers, and these companies paid interest to the trustees, who distributed the interest to their Swiss mother. The mother, a nonresident alien, sought to come within section 217(a)(1)(A) of the Revenue Acts of 1924 and 1926 (which was similar to current section 861). Respondent, in that case, contended that what was paid to the taxpayer was not “interest,” but income from a trust; that the taxpayer had no deposits, but if the deposits were hers they were not “with persons carrying on the banking business”; and even if the persons were carrying on the banking business, they never “paid” the money to the taxpayer, but to certain trustees. To this, the taxpayer replied in part that the trustees were her agents and constituted merely a “conduit” through which interest due her was paid by the bankers. The Court found that the taxpayer had no ownership or control over the trust funds or how they should be invested. The Court concluded (29 B.T.A. at 899-900):
if we hold that the language of the statute is sufficient to include as bankers those who paid interest to the trustees herein, nevertheless our answer to other questions involved, about which we entertain no such doubt, must exclude the petitioner from the benefits of the exception to the statute upon which she relies. For, under the language of the statute, we hold that she was not a depositor with persons carrying on the banking business; that what she received was not interest, but income from the trust; that it was not paid by the bankers, if they were such, to her; and that the trustees were not agents of petitioner in their conduct of the trust.
The Court of Appeals for the District of Columbia affirmed. This case, according to respondent, established the requirement that the nonresident alien have investment control and receive the interest directly to come within the statutory exemption. Petitioners assert that the case turns primarily on the conclusion that the interest received by the beneficiary lost its identity as U.S. bank interest and was simply trust income to her, and that the embodiment in the statute of the conduit theory...
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