Sherman v. Commissioner of Internal Revenue

• Court: U.S. Court of Appeals — Sixth Circuit
• Writing for the Court: ALLEN, MARTIN, and McALLISTER, Circuit
• Citation: Sherman v. Commissioner of Internal Revenue, 146 F.2d 219 (6th Cir. 1944)
• Decision Date: 14 December 1944
• Docket Number: No. 9714.,9714.
• Parties: SHERMAN v. COMMISSIONER OF INTERNAL REVENUE (two cases). CENTRAL NAT. BANK OF CLEVELAND v. SAME.

146 F.2d 219 (1944)

SHERMAN v. COMMISSIONER OF INTERNAL REVENUE (two cases). CENTRAL NAT. BANK OF CLEVELAND v. SAME.

No. 9714.

Circuit Court of Appeals, Sixth Circuit.

December 14, 1944.

L. C. Wykoff and Ashley M. Van Duzer, both of Cleveland, Ohio (Ashley M. Van Duzer and Arthur E. Griffith, both of Cleveland, Ohio, on the brief) for petitioners.

Leonard Sarner, of Washington, D. C. (Samuel O. Clark, Jr., Sewall Key, Robert N. Anderson, and S. Dee Hanson, all of Washington, D. C., on the brief), for respondent.

Before ALLEN, MARTIN, and McALLISTER, Circuit Judges.

MARTIN, Circuit Judge.

These three cases involving identical issues, were consolidated for hearing in the United States Tax Court and also in this court on review, sought by the petitioning taxpayers. To avoid unnecessary restatement, we have set forth in a footnote the Tax Court's complete findings of fact, which have been accepted both by the petitioners and by the respondent Commissioner of Internal Revenue.¹ The deficiencies determined by the Commissioner of Internal Revenue and upheld by the Tax Court were in income taxes for 1939.

Two questions of law are presented: (1) Was the trust created by the declaratory indenture of March 16, 1931, between the bank, as trustee, and the parties of the second part as beneficiaries an "association" taxable as a "corporation" within the scope and meaning of Section 3797 of the Internal Revenue Code, 26 U.S.C.A.Int.Rev. Code, § 3797? (2) Did the petitioning taxpayers realize capital gains upon the termination and final liquidation of the trust in 1939 within the meaning and coverage of Section 115(c) of the Internal Revenue Code, 26 U.S.C.A.Int.Rev.Code, § 115(c)?

The Tax Court held that the Commissioner of Internal Revenue had properly characterized the trust of March 16, 1931, as an "association" taxable as a "corporation" under Section 3797; and sustained the Commissioner's affirmative answer to the second question. It is insisted by the petitioners that the tax court erred in both conclusions.

(1) The petitioners contend that the findings of fact demonstrate that the trust was not employed as a substitute for a corporation, but was created by members of a family for the purpose of eliminating the danger of sale for partition of the proceeds of jointly owned real property, not capable of partition in kind, by the conveyance of the legal title to a trustee empowered to collect and distribute rents in proportionate shares; that no operation or management of the property by the trustee was necessary; and that the trustee, in fact, transacted no business pertaining to the property conveyed. They say that, in no aspect, did the trusteeship arrangement constitute a business venture or the doing of business, or a subterfuge to obtain corporate advantages without paying corporate taxes, but was strictly a family affair to assure the consummation of their common desire that family property should remain family property. They point out that under Ohio law land trust certificates are interests in real estate, and are not personal property. Senior v. Braden, 295 U.S. 422, 55 S.Ct. 800, 79 L.Ed. 1520, 100 A.L.R. 794.

The trustee was granted exclusive power and control over the trust estate; was empowered to collect and receive all moneys accruing therefrom, and, in general, to give "such attention to the proper management of the trust estate as may be necessary." The trustee was directed to require the lessees to carry insurance and to pay taxes and assessments on the trust property, and upon forfeiture or termination of leases, to carry the insurance and receive reimbursements from the trust estate. The trust instrument instructed the trustee to "keep the premises in repair," unless the leases required the lessees to do so. In the event of forfeiture or termination of existing or future leases, the trustee was vested with discretion to make new leases. Leases for a term not to exceed ten years could be made without the consent of the certificate holders; existing leases could be modified with the consent of three-fourths in interest of the outstanding certificates; and the trustee was given authority "at any time," with the approval of such three-fourths interest, to lease all or any part of the trust estate for a period of ninety-nine years, "renewable forever, with or without purchase option," upon such terms and conditions and for such rents as it might deem advisable. The trustee was empowered to mortgage and encumber the trust property for the improvement, protection, or preservation thereof, and for the payment of taxes and assessments thereon. Money could be borrowed and the property mortgaged by the trustee for the repair or restoration of any building thereon, partially or totally destroyed during the existence of any lease; and upon the termination of any existing long-time lease, the trustee, at the request of three-fourths in interest of the certificate holders, was directed to demolish existing improvements on the trust property and to erect new buildings thereon. For such purposes, the trustee was authorized to encumber the trust property.

The trustee was required to keep true and complete records and accounts of "all business transacted by it;" to render to each certificate holder annually a complete statement of its receipts and disbursements and an inventory of all assets and property then belonging to the trust estate; and to pay from the rents and other income of the trust estate any and all expenses "incurred in the management of the trust estate, and any charges and expenses incurred by the trustee or for which it shall be liable in connection with its management of the trust estate." Italics supplied.

Subject to the provisions of the trust agreement, the trustee was directed to convert the lands received in trust into money, and to disburse the proceeds of sale to the persons owning beneficial interests as evidenced by certificates of interest issued by the trustee; and in its uncontrolled discretion, could postpone such conversion and distribution for any period not more than twenty years after the death of the last survivor of numerous persons named in the declaration of trust.

During the existence of the trust, in addition to collecting rents and distributing the proceeds therefrom to certificate holders after deduction of its fees, the trustee, upon the final decision of the beneficiaries, made with the lessee an adjustment of the rental payable under the fifty-year lease on the West Side property; and also adjusted the rent based upon a reappraisal of the Arcade property, negotiations for which had been carried on by two of the beneficiaries. During the depression, the trustee occasionally called upon the lessees for payment of delinquent rent. Upon appropriate demand and delivery, the trustee reissued one certificate of interest for 300 of the total 1200 parts transferred by Henry S. Sherman to his wife, Edith McBride Sherman. Records and books of account were kept by the trustee. The Commissioner of Internal Revenue contends that these actions of the trustee constituted "doing business" — one of the tests to be applied in determining whether the trust was truly an association within the intended scope of the pertinent internal revenue act.

Other provisions of the trust agreement, not heretofore mentioned, assimilate the motivation of the trust to purposes usually accomplished by the organization of a corporation. It was provided that certificate holders could be held to no personal liability by any contract or obligation of the trustee, and that such exemption must be expressed in all documents executed by the trustee. The trust was terminable upon the unanimous request in writing of the certificate holders, but death of any or all of the certificate holders would not terminate the trust. Beneficial interests in the trust consisted of 1200 parts, evidenced by "trustee's certificates of interest," which were transferable in writing. New certificates were to be issued to transferees and every transfer was required to be recorded upon a transfer book to be kept by the trustee. Lost certificates were to be reissued upon evidence satisfactory to the trustee and upon such reasonable terms as to indemnity as the trustee might prescribe.

The trustee was authorized to call meetings of the certificate holders for submission to them of "any question or policy in respect to the trust estate." The trustee was required to call a meeting upon request in writing of not less than twenty-five percent in interest of the outstanding certificates. Any such request must specify the matters or questions to be considered at the meeting. Ten days' notice, specifying the time, place and object of a meeting, was required to be sent by registered mail to each certificate holder. A certificate holder could appoint a proxy to represent him in a meeting. A majority in interest of the certificate holders was necessary to constitute a quorum. Subject to limitations elsewhere provided in respect of the powers of certificate holders, the majority in interest could act upon any question specified in the notice of meeting. In the agregate, these provisions of the trust instrument are most reminiscent of certain standardized sections of corporate by-laws.

Section 3797(a) (3) of the Internal Revenue Code distinctly defines the term "corporation" as inclusive of "associations."

Treasury Regulations 103, promulgated under the Internal Revenue Code (Section 19.3797-1), declare that for taxation purposes the Internal Revenue Code prescribes its own standard of classification; that local law is of no importance in this connection; that a trust may be classed as an association (and, therefore, as a corporation), "depending upon its nature or its activities;" and that the term "corporation" is not limited to the artificial entity usually known as such, but includes also both an association and "a trust...