Opinion
Docket Nos. 50203 50204 50205.
1955-10-19
WEBSTER CORPORATION, et AL.,1 PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Charles C. Parlin, Esq., and Margaret Smith, Esq., for the petitioners. Ellyne E. Strickland, Esq., and Emil Sebetic, Esq., for the respondent.
PERSONAL HOLDING COMPANY INCOME— RENTS— SEC. 502(g), I.R.C. 1939— Income derived from farms owned by the petitioners and managed by them through a supervising agent who engaged farmers to operate the properties under a crop-sharing arrangement was not ‘rent’ within the meaning of section 502(g) of the Internal Revenue Code of 1939, and the petitioners were not liable for personal holding company surtaxes for their fiscal years ended May 31 of 1945 through 1949. Charles C. Parlin, Esq., and Margaret Smith, Esq., for the petitioners. Ellyne E. Strickland, Esq., and Emil Sebetic, Esq., for the respondent.
The Commissioner determined deficiencies in personal holding company surtaxes, as follows:
+------------------------------------------------------------+ ¦Taxable year ended May 31¦Webster ¦Shelby ¦Essex ¦ +-------------------------+----------+-----------+-----------¦ ¦1946 ¦$12,995.31¦$27,741.70 ¦$23,951.08 ¦ +-------------------------+----------+-----------+-----------¦ ¦1947 ¦17,315.34 ¦41,852.48 ¦35,738.31 ¦ +-------------------------+----------+-----------+-----------¦ ¦1948 ¦15,780.64 ¦38,991.57 ¦32,474.71 ¦ +-------------------------+----------+-----------+-----------¦ ¦1949 ¦14,870.36 ¦34,185.36 ¦30,705.01 ¦ +-------------------------+----------+-----------+-----------¦ ¦Total ¦$60,961.65¦$142,771.11¦$122,869.11¦ +------------------------------------------------------------+
The only issue for decision is whether or not the income received by the petitioners from their Iowa farms was ‘rent’ within the meaning of section 502(g) of the Internal Revenue Code of 1939.
FINDINGS OF FACT
Each of the petitioners is a Delaware corporation which commenced operations on June 7, 1945. Personal holding company tax returns for the taxable years showing no tax due were filed by the petitioners on April 25, 1952, with the collector of internal revenue for the second district of New York.
Each petitioner owned farm lands in Iowa during the taxable periods involved herein. The location, approximate size, and the cost of the properties as shown on the petitioner's books at the time of acquisition were as follows:
+--------------------------------------------------------------+ ¦ ¦ ¦ ¦ ¦Depreciable¦ +-------------------+----------------+-----+-------+-----------¦ ¦ ¦Location ¦Acres¦Land ¦assets ¦ +-------------------+----------------+-----+-------+-----------¦ ¦Webster Corporation¦Calhoun County ¦320 ¦$41,500¦$8,302.93 ¦ +-------------------+----------------+-----+-------+-----------¦ ¦ ¦ ¦ ¦ ¦ ¦ +-------------------+----------------+-----+-------+-----------¦ ¦ ¦(Humboldt County¦400 ¦39,975 ¦18,556.50 ¦ +-------------------+----------------+-----+-------+-----------¦ ¦Shelby Corporation ¦(Greene County ¦317.5¦35,949 ¦7,890.57 ¦ +-------------------+----------------+-----+-------+-----------¦ ¦ ¦ ¦ ¦ ¦ ¦ +-------------------+----------------+-----+-------+-----------¦ ¦ ¦(Kossuth County ¦342 ¦31,375 ¦9,382.50 ¦ +-------------------+----------------+-----+-------+-----------¦ ¦Essex Corporation ¦(Hamilton County¦346 ¦37,590 ¦10,054.34 ¦ +--------------------------------------------------------------+
The gross income of each of the petitioners during the taxable years consisted solely of dividends and of income received from the farms in Iowa. The farm income of the petitioners ranged between 22 per cent and 35 per cent of their gross income.
More than 50 per cent in value of the outstanding stock of each of the petitioners throughout the period involved was owned directly or indirectly by or for not more than five individuals within the definition of section 501 of the Internal Revenue Code of 1939. Substantially all the interests of the petitioners were owned directly or indirectly by members of the family of C. Douglas Dillon.
Dillon, who was president of each of the corporations, had been interested in farm operations for over 20 years and had investments in that field. He had a financial adviser make analyses in 1945 for the years 1943 and 1944 of the operations of the five farms involved herein. The adviser concluded that the farms could be operated as a business venture from New York with the assistance of an agent in Iowa and the receipt of proper information from that agent.
The petitioners' objectives in acquiring the farms were to realize a fair return on their investments and to obtain an appreciation in the asset value of the farms by increasing the productivity of the soil and improving the buildings. The farms were in a run-down condition due to overcropping when acquired, and the petitioners' officers were convinced that they would have to exercise tight control over the crop plantings in order to avoid further depletion of the soil.
Each petitioner, during the years involved, had an agency agreement with Farmers National Company of Omaha, Nebraska, a farm management concern. The agreements were substantially similar. The agent, in consideration of a percentage of the proceeds from the operation of the farms, undertook to carry out the management of the farms in accordance with instructions from the petitioners, particularly as to the plantings and the programs for fertilization and rotation of crops. The agent supervised the farming operations which were carried on by an ‘operator,‘ approval. The agent carried out the instructions of the petitioners with respect to the the selling of crops and the collection and remission of all proceeds, attended to taxes and insurance, and rendered periodic crop reports.
The agent, on behalf of each petitioner, entered into contracts with farmers for the operation of the farms. Those agreements were all substantially similar, were for 1-year terms, and covered the operation of a specific farm which the farmer agreed to operate according to a program to be laid out by the use of a field map and explanatory notes at the beginning of the season, which program was to constitute a part of the agreement upon being initialed by the parties. The farmer was to furnish the machinery, tools, implements, automobiles or other vehicles draught animals, and supplies necessary to operate the farm properly and was to purchase the hay and grass at $8 per acre and to pay $8 per acre on feeding lots for building maintenance. The petitioners were to furnish materials and skilled labor for the repair and upkeep of farm improvements and were to provide one-half of all the commercial fertilizer used on the farm and all the grass seed, while the farmer was to furnish all the hybrid seed corn of a variety approved by the agent and to plant the acreage agreed on with the agent. The agreement could not be assigned and the farmer had no authority to permit the farm to be occupied by any other person for any reason. The farmer was obligated not to work on, manage, or operate any other farm during the term of the agreement, without the agent's consent. Various other provisions of the agreement pertained to the farmer's duties with respect to the maintenance and operation of the farm and to the conduct of planting and harvesting operations.
The agreement defined the status of the farmer as follows:
16. It is expressly understood and agreed that this agreement is an operating agreement for the operation of the Farm by the Farmer as an independent contractor, in return for the compensations herein specified and that this agreement does not render the parties hereto partners nor give the Farmer any estate, right of possession or right to occupy or enter upon the Farm, other than the license to enter upon and occupy the Farm for the purposes and during the time contemplated by this agreement.
The agreement further specified that in the event of the death of the farmer ‘the performance of this agreement may be completed by the family of the farmer with the written consent of the agent, or this agreement may be terminated forthwith by the agent, and the agent may employ another person or persons to render the services contemplated by this agreement * * *.’ In the event of such termination a fair and reasonable compensation for any services performed was to be paid to the estate of the farmer.
The compensation of the farmer for operating the farm was a stated percentage of the crops to be grown measured by a customary method acceptable to the agent, the use during the term of the agreement of the buildings on the farm, and the use of the same respective percentage of storage facilities as the percentage of crops to be paid to him.
Dillon and his financial adviser together with the supervisor from the Farmers National Company toured the farms in the latter part of 1945. They visited each farm and talked with each of the operators. A 5-year crop rotation plan for each of the farms was established afterwards in consultation with the agent who relayed Dillon's instructions to the farmers on how the fields were to be farmed and cropped, what crops were to be sown, what fertilizer was to be used, and when the crop was to be sold. A supervisor on the agent's staff visited each farm a number of times a month and a monthly report was sent to Dillon for examination by him and his advisers. The reports contained plats of the farms showing the crops planted in the various fields, the physical condition of the fields, fences, and structures, information on the weather condition and the progress of the growing crops, market conditions, and other detailed progress of the growing crops, market conditions, and other detailed information as to the operation of the farm. The monthly reports were often supplemented by special reports as situations warranted or in the event special information was requested by Dillon. Instructions from Dillon were sent to the agent by mail and frequently by telephone.
Detailed records were kept by the petitioners with respect to the operation and physical condition of each farm. Those records were designed to give the corporations' officers as complete a picture as possible of the condition of each farm at all times. One record book contained information for each farm on such matters as the number of acres planted to each crop, the size of the crop, the price received, the gross income and comparative and combined totals for the five farms for the period of ownership. A second record book contained detailed operating information on each of the farms so that the progress of each one could be followed. This book was divided into several sections devoted to the following matters:
Repairs— the amounts spent on each structure on each farm; the condition of each structure in relation to a long-term improvement program.
Land Maintenance— pictures of the farms; descriptions of the soil types and their locations.
Drainage— maps of tiling installed for the drainage of each field, amounts spent on improving each field after acquisition.
Fences— map of fencing and amounts spent and condition of each section of fence.
Buildings— maps of locations and pictures and descriptions of all buildings, amounts spent on improvements and repairs.
Crop Progress— detailed comments by supervisors as to progress of the growing crops in each year.
Crop Rotation— plats showing the crop plantings in each field and comments on the degree to which each farm was conforming to the long-term rotation plan and comments on the fertilizer used in each field and for each crop.
Cattle Inventory— inventory of cattle owned by each farmer.
Dillon tried to have the operator of each farm maintain sufficient cattle to consume the bulk, if not all, of the farmer's share of the crop, so that the depletion of the soil would be checked by a return to it of a portion of the crop as fertilizer.
The Commissioner determined deficiencies in petitioners' personal holding company surtax liabilities on the ground that the income derived from the farms was ‘rent’ within the meaning of section 502(g) of the Internal Revenue Code of 1939.
The stipulation of facts and exhibits annexed thereto are incorporated herein by this reference.
OPINION
MURDOCK, Judge:
The issue for decision is whether not the amounts received by the petitioners during the years involved from the five farms owned by them constituted ‘rent’ within the meaning of section 502(g) of the Internal Revenue Code of 1939. The parties have agreed that if these amounts were rent then all other conditions necessary to constitute petitioners personal holding companies during such years were met and the petitioners are liable for the personal holding company surtaxes in the respective amounts determined, but if the amounts are not rent then those surtaxes are not due. Section 502(g) defines ‘rent’ as ‘compensation, however designated, for the use of or right to use, property, * * *.’ See also Regs. 111, sec. 29.502-1 (10).
Each party has discussed local law in the hope of showing that it would support that party's contention, but it is conceded on behalf of each that there is no Iowa statute or case directly in point. However, this provision of the Internal Revenue Code should be construed to give a uniform application to a nationwide scheme of taxation if that is at all possible. Burnet v. Harmel, 287 U.S. 103; Western Transmission Corporation 18 T.C.818.
These petitioners were actively engaged in the operation of these farms, and, historically, efforts were made to exclude operating companies from the burden of the surtax of the personal holding company provisions. Those provisions were first enacted in the Revenue Act of 1934 to prevent tax avoidance by wealthy individuals who organized corporations to receive and hold some of their income and thus avoid the high rates on their individual income. H. Rept. No. 704, 73d Cong., 2d Sess. (1934), p. 11. Rent was then deliberately excluded from the definition of personal holding company income in the belief that corporations receiving rent were mostly operating companies and not mere holding companies. S.Rept. No. 558, 73d Cong., 2d Sess. (1934, p. 14; H.Rept. No. 1546, 75th Cong., 1st Sess. (1937), p. 6. A change was made in the Revenue Act of 1937 to prevent corporations which were not bona fide operating companies from escaping the surtax by investing just enough in rental property so that more than 20 per cent of their gross income would be from rent and consequently less than 80 per cent of the gross income would be personal holding company income. Rents were then included in personal holding company income unless they constituted 50 per cent or more of the gross income of the corporation. H. Rept. No. 1546, supra. It was also said in that report that ‘rents' was used in its broadest sense. Definitions of rent have included such phrases as consideration paid for use or occupancy of property; something which a tenant renders out of the profit of the land which he occupies and enjoys; a certain profit either in money, provisions, or labor in return for the use of land. Black's Law Dictionary, 4th ed. (1951); Logan Coal & Timber Association, 42 B.T.A. 529, 536, affd. 122 F.2d 848. Rent is usually payable periodically.
These petitioners were operating companies, and the record does not suggest that the ownership and operation of these farm lands was undertaken by them for the purpose of avoiding personal holding company surtaxes. An owner can receive rent in crops as well as in money, but where the owner who receives a percentage of the crop takes an active part in the operation by reserving and exercising the right of detailed supervision and direction of the operation of the farm, and the farmer is subject to all of the restrictions here present, the farmer appears to be in some category other than that of a tenant, and the money which the petitioners received appears to be more in the nature of income from their own use of their own land than rent received by them for permitting the farmer to use their land. Certainly some part of the amount which these petitioners received was received because of their activities in operating and supervising the farms. The share of the crop taken by the farmers in this case, whether they be considered employees, independent contractors, joint venturers, or something else, was in the nature of payment for their services in carrying out the instructions of the petitioners and their agent, the Farmers National Company, and the share retained by the petitioners was their return for their management and operation of the farms owned by them as well as for the use of their own land in the operations. The definition of rent under which this case must be decided is extremely broad, and it is not easy to fit the arrangements made by these petitioners into a fixed category from which the answer in this case will flow as a matter of course. Nevertheless, a conclusion has to be reached, and it is that the amounts received by the petitioners during the taxable years did not constitute rent within the meaning of section 502(g).
Reviewed by the Court.
Decisions will be entered by the petitioners.