UNITED STATES V. CARTWRIGHT
| Decision Date | 07 May 1973 |
| Court | U.S. Supreme Court |
CERTIORARI TO THE UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
Shares in mutual funds can be "sold" by the shareholder only back to the fund, and only at a set redemption price. Treas.Reg. § 20.2031-8(b), requiring that such shares be valued for federal estate tax purposes at the current public offering ("asked") price, which is determined by adding a load or sales charge to the net asset value, is clearly inconsistent with the Investment Company Act of 1940, and is therefore invalid. P P. 550-557.
457 F.2d 567, affirmed.
The Internal Revenue Code of 1954 requires that, for estate tax purposes, the "value" of all property held by a decedent at the time of death be included in the gross estate. 26 U.S.C. § 2031. By regulation, the Secretary of the Treasury has determined that shares in open-end investment companies, or mutual funds, are to be valued at their public offering price or "asked" price at the date
of death. Treas.Reg. on Estate Tax § 20.2031-8(b) (1963). The question this case presents is whether that determination is reasonable in the context of the market for mutual fund shares.
At the time of her death in 1964, Ethel B. Bennett owned approximately 8,700 shares of three mutual funds that are regulated by the Investment Company Act of 1940, 54 Stat. 789, as amended, 15 U.S.C. § 80a-1 et seq. [Footnote 1] The 1940 Act seeks generally to regulate publicly held companies that are engaged in investing in securities. Open-end investment companies, or mutual funds, "dominate" this industry. 1966 SEC Report 43. Unquestionably, the unique characteristic of mutual funds is that they are permitted, under the Act, to market their shares continuously to the public, but are required to be prepared to redeem outstanding shares at any time. § 80a-22(e). The redemption "bid" price that a shareholder may receive is set by the Act at approximately the fractional value per share of the fund's net assets at the time of redemption. § 80a2(a)(32). In contrast, the "asked" price, or the price at which the fund initially offers its shares to the public, includes not only the net asset value per share at the time of sale, but also a fixed sales charge or "sales load" assessed by the fund's principal underwriter who acts as an agent in marketing the fund's shares. § 80a-2(a)(35). [Footnote 2]
Sales loads vary within fixed limits from mutual fund to mutual fund, but all are paid to the fund's underwriters; the charges do not become part of the assets of the fund. [Footnote 3] The sales loads of the funds held by the decedent ranged from seven and eight percent to one percent of the fractional net asset value of the funds' shares.
Private trading in mutual fund shares is virtually nonexistent. [Footnote 4] Thus, at any given time, under the statutory scheme created by the Investment Company Act, shares of any open-end mutual fund with a sales load are being sold at two distinct prices. Initial purchases by the public are made from the fund, at the "asked" price, which includes the load. But shareholders "sell" their shares back to the fund at the statutorily defined redemption or bid price.
Respondent is the executor of the decedent's estate. On the federal estate tax return, he reported the value of the mutual fund shares held by the decedent at their redemption price, which amounted to about 4,400. The Commissioner assessed a deficiency based upon his valuation of the shares at their public offering or asked price, pursuant to Treas.Reg. § 20.2031-8(b). [Footnote 5] Valued
on that basis, the shares were worth approximately 3,300. Respondent paid the deficiency of about ,100, including interest, filed a timely claim for a refund, and, when that claim was denied, commenced a refund action in Federal District Court on the ground that the valuation based on § 20.2031-8(b) was unreasonable. The District Court agreed with respondent, and held the Regulation invalid. 323 F.Supp. 769. The Court of Appeals affirmed. 457 F.2d 567. We granted the Government's petition for certiorari, 409 U.S. 840, because of the conflict among the circuits. [Footnote 6]
We recognize that this Court is not in the business of administering the tax laws of the Nation. Congress has delegated that task to the Secretary of the Treasury, 26 U.S.C. § 7805(a), and regulations promulgated under his authority, if found to "implement the congressional mandate in some reasonable manner," must be upheld. United States v. Correll, 389 U. S. 299, 307 (1967). See Bingler v. Johnson, 394 U. S. 741, 749-751 (1969); Commissioner v. South Texas Lumber Co., 333 U. S. 496, 501 (1948). But that principle is to set the framework for judicial analysis; it does not displace it. We find that the contested regulation is unrealistic and unreasonable, and therefore affirm the judgment of the Court of Appeals.
In implementing 26 U.S.C. § 2031, the general principle of the Treasury Regulations is that the value of
property is to be determined by its fair market value at the time of the decedent's death.
"The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts."
Treas.Reg. § 20.2031-1(b). The willing buyer-willing seller test of fair market value is nearly as old as the federal income, estate, and gifts taxes themselves, and is not challenged here. [Footnote 7] Under this test, it is clear that, if the decedent had owned ordinary corporate stock listed on an exchange, its "value" for estate tax purposes would be the price the estate could have obtained if it had sold the stock on the valuation date, that price being, under Treas.Reg. § 20.2031-2(b), the mean between the highest and lowest quoted selling prices on that day. Respondent urges that similar treatment be given mutual fund shares, and that, accordingly, their value be measured by the redemption price at the date of death, the only price that the estate could hope to obtain if the shares had been sold.
Respondent's argument has the clear ring of common sense to it, but the United States maintains that the redemption price does not reflect the price that a willing buyer would pay, inasmuch as the mutual fund is under a statutory obligation to redeem outstanding shares whenever they are offered. According to the Government, the only market for mutual fund shares that has both willing buyers and willing sellers is the public offering market. Therefore, the price in that market, the asked
price, is an appropriate basis for valuation. The central difficulty with this argument is that it unrealistically bifurcates the statutory scheme for the trading in mutual fund shares. To be sure, the fund is under an obligation to redeem its shares at the stated price. 15 U.S.C. § 80a-22(e). But, at the time of the original purchases, both the fund and the purchasers are aware of that duty, and both willingly enter into the sale transactions nonetheless. As Judge Winner correctly observed in Hicks v. United States, 335 F.Supp. 474, 481 (Colo.1971):
In the context of the Investment Company Act, the redemption price may thus be properly viewed only as the final step in a voluntary transaction between a willing buyer and a willing seller. As a matter of statutory law, holders of mutual fund shares cannot obtain the "asked" price from the fund. That price is never paid by the fund; it is used by the fund when selling its shares to the public -- and even then the fund receives merely the net asset value per share from the sale, with the sales load being paid directly to the underwriter. In short, the only price that a shareholder may realize and that the fund -- the only buyer -- will pay is the redemption
price. In the teeth of this fact, Regulation § 20.20318(b) purports to assign a value to mutual fund shares that the estate could not hope to obtain, and that the fund could not offer.
In support of the Regulation, the Government stresses that many types of property are taxed at values above those which could be realized during an actual sale. For example, ordinary corporate stock is valued at its fair market price without taking into account the brokerage commission that a seller must generally pay in order to sell the stock. Respondent does not contend that that approach is inappropriate, or that, for example, the value of ordinary stock in an estate should be the market price at the time less anticipated brokerage fees. But § 20.2031-8(b) operates in an entirely different fashion. The regulation includes as an element of value the commission cost incurred in the hypothetical purchase of the mutual fund shares already held in the decedent's estate. If that principle were carried over to the ordinary stock situation,...
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