Opinion
Docket No. 4152.
1946-03-11
HAROLD F. JONES AND RITA C. JONES, HUSBAND AND WIFE, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
William E. Sims, Esq., and Ewing Everett, Esq., for the petitioners. J. R. Riggles, Esq., for the respondent.
1. Taxpayer in 1935 set up a trust with broad powers of management and control in himself as trustee. Such part of the income and principal as the trustee might in his discretion deem necessary or proper for her comfort, support, or happiness was payable to grantor's wife, and after her death to their 2 children until they reached the age of 45 years. All income from 1935 to 1939, inclusive, less trust expenses, was accumulated and added to principal. Held, the trust income is includible in taxpayer's gross income for 1937, 1938, and 1939.
2. A trust was set up by a Mexican corporation, a holding company, holding all stock of the corporation employing petitioner. Petitioner, a bona fide nonresident citizen of the United States, rendered no services as an employee and received no compensation from the company which set up the trust. The trust held shares of stock of the company employing petitioner in trust for the benefit of petitioner and other key employees of the company, the stock having been conveyed to the trust in consideration of services earlier rendered by the beneficiaries. Petitioner and each of the beneficiaries received an assignable certificate (running to him, his assignees, and estate) evidencing his trust interest, that interest being to receive a pro rata part of the dividend from the trust stock for 20 years after which the stock was to be delivered to the certificate holders. The plan under which the trust was set up contemplated reduction of salaries, to be offset by distribution of the profits of the trust, and they were reduced. Held, that petitioner's income from the trust was not compensation for services rendered outside the United States, excludible under section 116(a) and section 25(a)(4)(A), I.R.C., but was income taxable under section 22(a). William E. Sims, Esq., and Ewing Everett, Esq., for the petitioners. J. R. Riggles, Esq., for the respondent.
The Commissioner determined deficiencies in income taxes of $2,291.50, $759.07, and $835.83 for the respective years 1937, 1938, and 1939. The questions involved are (1) whether the income of a trust created by Harold F. Jones for the benefit of his wife and children is includible in his gross income in the taxable years, and (2) whether the distributions from the so-called Los Mochis trust to Harold F. Jones, as beneficiary thereof, in the taxable years, constitute compensation for services rendered and, as such, are excludible from gross income under the provisions of section 116(a) of the Internal Revenue Code and corresponding provisions of the Revenue Acts of 1936 and 1938.
FINDINGS OF FACT.
Harold F. Jones, hereinafter referred to as the petitioner, and Rita C. Jones are, and during all of the taxable years 1937, 1938, and 1939 were, husband and wife and citizens of the United States, and during all of the taxable years they were bona fide nonresidents of the United States.
During the taxable years they were continuously domiciled and resided in Los Mochis, State of Sinaloa, Republic of Mexico. They filed joint Federal income tax returns on the cash receipts and disbursement basis for the taxable years in Baltimore, Maryland.
(1) On August 21, 1935, petitioner at Boston, Massachusetts, executed an instrument in which he declared that he held as trustee securities of a value of $58,916 and cash of $10,000 for the purposes: (1) To pay to or for his wife such part of the income, also such amounts from principal, as the trustee may, in his discretion, deem necessary or proper for the comfort, support and/or happiness of the donor's wife during her life. (2) Upon the death of the donor's wife to divide the fund then remaining into two equal parts as nearly as may be and hold one part thereof for the benefit of the donor's son Frederic, born in July 1922, who is to receive such part of the income and also such part of the principal as the trustee may in his discretion deem necessary for the comfort, support, education, and/or happiness of Frederic until he reaches the age of 45 years, at which time the part held for him shall be turned over to him free of all trusts. In the event of his death before reaching 45 years or before the death of donor's wife, the part which otherwise would be held for him shall be held for his issue in equal shares, with right of survivorship, on the same terms and with the same discretion as to payment of income and principal as set forth for Frederic. If there be no issue him surviving, one-half of the fund which would otherwise be held for such issue shall be held for the wife of Frederic, she to receive such part of the income and principal as the trustee may see fit until she reaches the age of 50 years, at which time the fund then held shall be paid to her, free of all trusts. If Frederic leaves no wife him surviving, or his wife dies before reaching the age of 50 years, then the fund which otherwise would be held for her shall be held as if it had been originally part of the fund held for the donor's daughter, Elinor, born in September 1925. The other half of the fund which would have been held for Frederic's issue shall be held as if it had originally been part of the fund held for Elinor. (3) The other half of the fund held for the donor's wife shall be held for donor's daughter and her issue and/or her husband on the same terms and with the same discretion as to payment of principal and income as above set forth for Frederic and his issue and/or wife, and if the principal shall not vest in any of them the fund shall be held as if it had originally been held for Frederic. In the event there shall be no one alive who would be entitled to receive the trust income or principal, the fund then held shall be turned over to those who would be entitled to take the estate of petitioner had he died at that time intestate, a resident of Massachusetts, free of all trusts. The instrument further provided that if payments of income or principal were due to be made to a person who in the opinion of the trustee was not competent or able carefully and properly to handle the same, then the trustee could in his discretion make such payments in whole or in part for one or more of the following purposes: (a) To the legal guardian or conservator of such persons; (b) to expend the same for the comfort, support, education, and/or happiness of such person or pay the same to some person or persons to be so expended; (c) to accumulate the same for his or her benefit, but not for a longer period than the lives of the donor's wife and children now living and 21 years thereafter for distribution at such time or times as the trustee may deem expedient; and (d) to reimburse any persons who may have expended money for the comfort, support, education, and/or happiness of any beneficiary, the same to be wholly within the discretion of the trustee and his decision as to whether money was so spent to be final. The instrument also provided that the interest of any beneficiary, either as to income or principal, could not be anticipated, alienated, or in any other manner assigned by such beneficiary or subject to any legal process, bankruptcy proceedings, or interference or control of creditors or others; that, in the event of the death or resignation of the donor as trustee, the State Street Trust Co. of Boston and William V. Hayden of Newton, Massachusetts, should be trustees, unless donor should have by a writing filed with an original of the trust instrument named a successor trustee or trustees, which right be reserved; and that unless sooner terminated the trust was to end 21 years from and after the death of the last survivor of the donor, his then living wife and issue, and that thereupon the trustee should pay over the principal of the trust free of all trusts to the persons entitled to share the net income of the trust in the same proportions in which they are entitled to share such income. The powers of the trustees stated in the instrument are s follows:
The Trustee, in addition to, and not in limitation of, all common law and statutory authority, shall have power with regard to both real and personal property in the trust fund and any part thereof, to mortgage, to lease with or without option to purchase, to sell in whole or in part at public or at private sale without approval of any court and without liability upon any person dealing with the Trustee to see to the application of any money or other property delivered to him; to hold or retain any of the property coming into his hands hereunder in the same form of investment as that in which he receives it; to exchange property for other property; to invest and reinvest in securities or properties although of a kind or in an amount which ordinarily would not be considered suitable for a trust investment; to loan money or property to any person, trust or corporation on such terms as he may see fit; to keep any or all securities or other property in the name of some other person or corporation with a power of attorney for their transfer attached, or in his own name without disclosing his fiduciary capacity; to determine what shall be charged or credited to income and what to principal, notwithstanding any determination by the courts; to determine who are the distributees hereunder and the proportions in which they shall take; to make payments of principal or income direct to and otherwise to deal with minors hereunder as though they were of full age; to make distributions or divisions of principal hereunder in property in kind at values determined by him; to decide whether or not to make deductions from income for depreciation, obsolescence, amortization or waste, and, if so, in what amount; to pay, compromise or contest any claim or other matter directly or indirectly affecting this fund; to employ counsel for any of the above or other purposes and to determine whether or not to act upon his advice, and generally to do all things in relation to the trust fund which the donor could do if this trust had not been executed. All such divisions and decisions made by the Trustee in good faith shall be conclusive on all parties at interest.
In the event of the death, resignation or inability to act of the Trustee first named herein, the successor Trustee or Trustees shall have all the powers hereinabove set forth for the Trustee first named herein, except the right to invest in securities which ordinarily would not be considered suitable for a trust investment; it being the intent of the donor that such Trustee shall consider safety of principal rather than amount of income, but nothing contained in this paragraph shall prevent such Trustee from holding the property as he finds it, and no Trustee shall be liable for any property not actually received by him.
The petitioner acted as trustee of the above trust from the time of its creation until on or about September 10, 1943, at which time he resigned and the State Street Trust Co. of Boston became trustee. During the first years of the trust the securities belonging to the trust were held by Brown Brothers, Harriman & Co., stockbrokers, of Boston and later by State Street Trust Co. of Boston, which collected the income and deposited it to the account of H. F. Jones, trustee. All purchases and sales of securities made from 1935 to 1943 were made by petitioner with the advice of investment counsel on the New York Stock Exchange through the above named stockbrokerage firm. The petitioner individually never purchased or sold any securities from or to the trust. He never borrowed funds from the trust. In February 1943 he personally loaned the trust the amount of $1,750 for the purpose of carrying out a purchase of securities, which amount, without interest, was repaid to the petitioner August 17, 1943.
In addition, the petitioner made direct gifts in cash to his wife and two children, which he held and invested along with and in the same manner as the trust funds as follows:
+-------------------------------------------------------+ ¦ ¦For his wife¦For his son¦For his daughter¦ +-------------+------------+-----------+----------------¦ ¦Dec. 1, 1936 ¦$4,500 ¦$5,000 ¦$5,000 ¦ +-------------+------------+-----------+----------------¦ ¦Dec. 31, 1937¦4,956 ¦4,956 ¦4,956 ¦ +-------------+------------+-----------+----------------¦ ¦May 15, 1938 ¦5,000 ¦5,000 ¦5,000 ¦ +-------------+------------+-----------+----------------¦ ¦Dec. 28, 1939¦4,000 ¦4,000 ¦4,000 ¦ +-------------+------------+-----------+----------------¦ ¦Dec. 31, 1940¦500 ¦ ¦ ¦ +-------------+------------+-----------+----------------¦ ¦Total ¦18,956 ¦18,956 ¦18,956 ¦ +-------------------------------------------------------+
The income of the trust and of the above funds to September 10, 1943, amounted to $44,898.57, of which $43,223.19 was transferred to the principal account and the balance of $1,675.38 was used for the payment of expenses of the trust. The expenses of the trust for 1937, 1938, and 1939 were $54.87, $69.78, and $99.68, respectively. The net income of the trust for 1937, 1938, and 1939 of $5,188.36, $2,422.19 ($3,700.99-$1,278.80 long term capital loss) and $3,107.09 ($4,695.17-$1,588.08 long term capital loss) respectively, was included by the Commissioner in petitioner's taxable income in computing the deficiencies herein.
Prior to the time of his resignation as trustee, the petitioner transferred and delivered to his wife and two children the funds last above referred to which he held for their account, together with the accumulated income thereon of $3,132, in securities and cash as follows:
+-----------------------------------------------------------------------------+ ¦ ¦To his wife¦To his son¦To his ¦ ¦ ¦ ¦ ¦daughter ¦ +---------------------------------------+-----------+----------+--------------¦ ¦3,344 shares British Investing Co. Ltd ¦$12,709.34 ¦$12,709.33¦$12,709.33 ¦ +---------------------------------------+-----------+----------+--------------¦ ¦Note of Bico Corporation 6 1/2s, 12/31/¦6,720.00 ¦ ¦ ¦ ¦50 ¦ ¦ ¦ ¦ +---------------------------------------+-----------+----------+--------------¦ ¦Cash ¦570.66 ¦7,290.67 ¦7,290.67 ¦ +---------------------------------------+-----------+----------+--------------¦ ¦Total ¦20,000.00 ¦20,000.00 ¦20,000.00 ¦ +-----------------------------------------------------------------------------+
The income, if any, from the above funds during the taxable years was not included by the Commissioner in the taxable income of petitioner in determining the deficiencies involved herein. On September 10, 1943, petitioner turned over to the successor trustee the trust res of the trust created by him on August 21, 1935, consisting of shares, ranging in number from 10 to 200, of 26 insurance, oil, utility, and industrial corporations, and a $1,000 American Telephone & Telegraph common debenture, of a total stated amount of $93,929.05, and cash of $2,322.40.
Petitioner filed Federal fiduciary income tax returns in which he reported the income of the trust for the years 1937, 1938, and 1939 and the tax as shown by such returns was paid.
No trust funds were used for the education, maintenance, or support of petitioner's two minor children during the taxable years. Petitioner from his separate funds paid for their education, maintenance, and support.
(2) United Sugar Companies, S. A. (hereinafter called United Sugar), a corporation organized under the laws of the State of Sinaloa, Mexico, was incorporated in 1917 and has continuously since that time conducted at Los Mochis, Sinaloa, Mexico, where its principal office is located, the business of the manufacture of cane sugar and byproducts and the sale thereof in Mexico. Benjamin F. Johnston, who died in March 1937, was the founder and president and active head of United Sugar and of its predecessor companies. He also was president and owned all the shares; except qualifying shares, of Compania Mexicana de Inversiones, S. A. (Mexican Investment Co.) (hereinafter called Compania Mexicana) a Mexican corporation, whose assets consisted principally of the shares of United Sugar. It was primarily a holding company. Petitioner was an officer thereof.
United Sugar during the taxable years was the largest producer of sugar and industrial alcohol in Mexico. About 25,000 acres of sugar cane were under cultivation, from which up to 40,000 tons of refined sugar were produced. I addition to its principal business, United Sugar operated a wholly owned subsidiary, Los Mochis Electric Co., which supplied electric light and power, water, telephone service, and ice to the city of Los Mochis, which had a population of about ten to twelve thousand. It owned and operated a railroad called the Kansas City, Mexico & Orient Railroad, which ran from the town of Presidio, Texas, to Topolobampo, Sinaloa, Mexico, except for an unconstructed section in the mountains. It was also associated with an investment company, called British Investing Co., which handled some $2,000,000 of common and preferred stocks traded over the New York Stock Exchange. The company also engaged in other minor activities, such as the operation of ranches and hotels. The petitioner was chief executive of and managed United Sugar and its subsidiaries, through managers and department heads, during the taxable years, but received no compensation except from United Sugar.
On June 1, 1931, the capital stock of United Sugar consisted of 62,500 shares of preferred stock of the par value of $50 each and 175,000 shares of common stock of the par value of $50 each. In or about 1934 the preferred stock was retired and the capitalization of the company since that time has consisted of 175,000 shares of common stock of the par value of $15 each.
The petitioner has been continually employed by United Sugar and its predecessor companies at its plant in Los Mochis since 1913, and he was paid for his services rendered by him in various capacities a monthly salary as follows:
+---------------------------------------------------------+ ¦ ¦ ¦ ¦Mexican ¦ +---------+------------------------+-------------+--------¦ ¦Years ¦Capacity ¦U.S. currency¦currency¦ +---------+------------------------+-------------+--------¦ ¦1913-1921¦Office assistant ¦$75 to $200 ¦ ¦ +---------+------------------------+-------------+--------¦ ¦1922 ¦Assitant manager ¦450.00 ¦ ¦ +---------+------------------------+-------------+--------¦ ¦1923-1924¦Junior vice president ¦833.33 ¦ ¦ +---------+------------------------+-------------+--------¦ ¦1925-1931¦Senior vice president ¦1,250.00 ¦ ¦ +---------+------------------------+-------------+--------¦ ¦1932-1933¦Senior vice president ¦687.50 ¦ ¦ +---------+------------------------+-------------+--------¦ ¦1934-1936¦Executive vice president¦1 763.88 ¦2,750.00¦ +---------+------------------------+-------------+--------¦ ¦ ¦ ¦2 (458.33 ¦2,750.00¦ +---------+------------------------+-------------+--------¦ ¦1937-1939¦Chief executive ¦(to 763.88 ¦ ¦ +---------------------------------------------------------+
FN 1 Based on the then current exchange rate of 3.60 pesos per dollar.FN 2 Based on the then current exchange rates, varying from 3.60 to 6.00 pesos per dollar
In 1924 Johnston inaugurated a plan under which certain officers and employees of United Sugar could acquire an interest in the company through stock ownership. Pursuant thereto, on October 28, 1924, petitioner and United Sugar entered into an agreement in which the following declarations were made:
The Company declares that with the intention of stimulating and properly compensating its loyal and devoted employees, it has decided to grant them a certain participation in the future profits of the Company in accordance with a plan which the said employees have considered satisfactory.
For this purpose, at the Stockholders' Meeting on the 30th day of July 1924, it was resolved to capitalize up to $750,000 U.S. Currency out of the profits realized by the said Company during the Fiscal year 1923-1924, issuing in the representation of such capitalization 15,000 shares of common stock all fully paid-up of a par value of $50.00 U.S. Currency each share.
On the basis of the foregoing, and as Mr. H. F. Jones is one of the employees whom the Company desires to interest in its business, * * *
it was agreed, inter alia, that 4,000 shares of the above 15,000 shares should be reserved for petitioner, that certain profits on such shares should be credited to the ‘Account of shares of Mr. H. F. Jones‘ as received on June 30 of each fiscal year, which credit was to be solely and exclusively for the purchase and payment of such shares, that the shares as paid for in full each year should become the property of petitioner, but without the right of withdrawal, alienation or pledge, except (1) in case of voluntary withdrawal or separation from the company's service, in which event the company reserved the option to reacquire the shares fully paid for at their par value, the shares remaining unpurchased to remain the property of the company, and (2) except that the entire lot of shares may be withdrawn at any time before separation from the company if fully paid for at par prior to such separation. All the key men and some lesser employees, about 25 in number, entered into agreements with the company in the same form except as to the number of allotted shares.
Johnston originally thought that under the plan the employees would acquire the shares allotted to them within a period of 10 years. However, the plan did not work out as expected. In June 1931 about 10 percent of the shares allotted to the employees under the 1924 agreement had been fully paid for. Johnston in the early part of 1931 told petitioner that he was contemplating retiring from the active management of United Sugar, and asked petitioner whether in that event he could depend upon petitioner to remain with the company in Mexico for the rest of petitioner's working days, to which petitioner replied that such was his intention. Johnston thereupon discussed with petitioner the details of a new plan he had conceived. Before the plan was initiated, however, all the other key employees who were to benefit under the new plan were called in for similar discussions in the presence of petitioner. Each employee interrogated indicated his intention of continuing with United Sugar during the period of the trust or until he retired or died. The plan contemplated and did reduce salaries, which reduction was to be offset by the distribution of profits through a trust to be created. Thereupon Johnston caused Compania Mexicana to execute on June 1, 1931, a declaration of trust, in which the six trustees named therein joined, under which the so-called Los Mochis trust was created. The trust instrument is in part as follows:
KNOW ALL MEN BY THESE PRESENTS, that the grantor COMPANIA MEXICANA DE INVERSIONES, S. A. a Mexican corporation, having its principal office at Los Mochis, Sinaloa, Mexico, for an (sic) in consideration of One Dollar ($1.00) in hand paid, and of faithful and loyal services heretofore rendered by the beneficiaries hereinafter named, has conveyed, set-over, assigned and delivered, and does herewith convey, set-over, assign and deliver the property hereinafter described as the ‘Res‘, to the persons hereinafter named as Trustees, for the use and benefit of the persons hereinafter named, described or provided for, as beneficiaries, in the manner and form as hereinafter provided, that is to say:
THE RES.
The properties hereby conveyed, set-over, assigned and delivered consist of thirty-three thousand four hundred twenty-six (33,426) shares of the common capital stock of the United Sugar Companies, S. A., a corporation organized and existing under the laws of Mexico, of the total par value of One million six hundred seventy one thousand three hundred dollars ($1,671,300.), United States Currency.
The legal title to the said stock shall be and remain in the Trustees hereinafter named, and in their successors in trust, for the period of twenty (20) years from the date hereof, but for the use and benefit of the beneficiaries, as hereinafter named and provided for.
The certificates of stock shall be deposited, for twenty (20) years in some responsible bank or trust company in the United States, subject to the joint order of the Trustees and their successors. The depositary may be changed from time to time by the trustees.
The Trustees shall make, execute and deliver to each beneficiary above named a certificate or certificates, under their hands and seals, certifying that such beneficiary, his heirs, executors, administrators and/or assigns will be entitled to the shares above specified, as well as to the income from the same, in the manner and form and at the times provided for in this conveyance and Declaration of Trust.
Said stock and the Trustees' certificates therefor, shall be in lieu of participating contracts, trusts and stock whereby said beneficiaries became entitled, under the Employes Trust Arrangement of 1924, and the Trustees hereunder shall deliver these new certificates only upon the surrender, cancellation or release of said former contract.
DUTIES OF TRUSTEES.
It shall be the duty of the Trustees to notify the United Sugar Companies, S. A. of their holdings, to the end that they, the Trustees may vote the stock at all Stockholders' meeting, (sic) and may receive all dividends declared on said stock.
The Trustees shall collect and receive all dividends declared on said stock, and keep a just and regular account of the same, and forthwith and within a reasonable and short time shall pay them out to the beneficiaries entitled to the same, keeping on hand only such sums as they may deem necessary or proper to meet ordinary existing expenses until the next dividend.
To the holders of trust certificates, they shall pay the dividends collected from the corresponding shares of stock, and after paying necessary expenses and reserving a reasonable amount to meet anticipated expenses from the unallocated income, they shall distribute the remainder of dividends on the stock not represented by trust certificates, to such Directors, Officers and/or loyal employes or their families, in case of their death, as to the Trustees, or a majority of them, shall deem proper, giving due consideration to their merits, length of service and needs. Such distribution of income shall continue for a period of twenty (20) years from the date hereof.
At any time during the life of this trust, the Trustees may at their discretion assign or allot any or all of the undistributed shares, to Directors, Officers or other employees of the United Sugar Companies delivering to the beneficiaries the corresponding trust certificates.
At the end of twenty (20) years from the date hereof, the Trustees shall distribute, assign and deliver to the holders of the Trustees' certificates, the shares represented by the same.
At the same time, they shall also allot and deliver any undistributed shares and/or income from the same to such Directors, Officers or other employee s of the United Sugar Companies, S. A. as they, in their discretion, may decide upon, with due regard to the merits, length of service and needs, and in case of the death of such Director, Officer or other employe, allotments may be made to their families.
Whereupon, this Trust shall cease and determine.
GENERAL PROVISIONS.
This is a trust and not a partnership. Neither the Trustees nor beneficiaries are partners, nor do they incur any personal obligation beyond the extent of the trust funds or properties in their hands.
Under the agreement the shares were conveyed to 7 trustees, the petitioner being named as one of them. Eight employees, all key men of United Sugar, were named as beneficiaries of the trust and 23,426 shares were allocated in various amounts to each ‘and his assigns,‘ including the petitioner, to whom ‘and his assigns‘ 6,595 shares were allocated. Out of the remainder of the 33,426 shares 2,400 shares were to be set aside by the trustees to carry out the terms of agreements made under the 1924 plan with 9 employees other than the above named, the trustees being authorized in their discretion, upon surrender of such agreements, to issue in exchange certificates for corresponding numbers of shares in substantially the same form as designated for the first above named 8 beneficiaries under the Los Mochis trust.
Upon the execution of the above trust instrument Compania Mexicana transferred to the 7 trustees named therein 33,426 shares of United Sugar. Petitioner's 1924 agreement was cancelled and pursuant to its terms he received 405 shares, which were in addition to the 6,595 shares allocated to him under the Los Mochis trust. Subsequently, but prior to January 1, 1937, the trustees allocated to petitioner 2,000 additional shares. The 33,426 shares transferred to the trustees included the 15,000 shares made available for purchase to certain employees under the 1924 plan, with the exception of approximately 1,500 shares which were distributed under the 1924 plan, including the 405 shares issued to petitioner.
The trustees issued to petitioner trustees' certificates for 6,595 shares and subsequently issued to him trustees' certificate for 2,000 shares. Upon the face of the trustees' certificates provisions were printed as follows:
The beneficiary shall be entitled to receive from the Trustees the dividends on said stock as and when paid to and received by the Trustees, and shall be entitled to receive the stock itself at the time of the termination of the Trust, in 1951, under the terms and conditions of said Trust Agreement, but shall not be entitled to hold, possess or vote said stock in the meantime.
The interest represented by this certificate is transferable only by the holder in person or by his attorney-in-fact, on the books of the Trustees, in accordance with said Trust Agreement, upon surrender of this certificate properly endorsed.
Neither petitioner nor any of the other beneficiaries of the Los Mochis trust ever rendered any services to Compania Mexicana as employees thereof. They were all employees of United Sugar and received compensation from it only. None of the beneficiaries were in 1931 large shareholders of United Sugar. Petitioner owned about 1,400 shares, another held about 1,000 shares, two others each owned 95 shares, and some owned lesser amounts. Petitioner was not related to Benjamin F. Johnston by blood or marriage.
All distributions made by the trustees during 1937, 1938, and 1939 were made only to employees of United Sugar who were beneficiaries of the trust, except that after the death of two of the beneficiaries in 1939 distributions to which they were entitled were paid to their respective estates. No transfers of trustees' certificates have been made by any of the beneficiaries. Certificates of deceased beneficiaries were transferred to their respective estates.
Because of the bad money exchange situation in Mexico, a so-called management fund was established about 1934 by United Sugar at the suggestion of Johnston, which fund was to be used to adjust and stabilize salaries to meet the exchange situation. This fund was used in 1934 and again in 1938 or 1939 ‘to equalize or readjust salaries to a predetermined minimum amount.‘
In 1934 United Sugar paid no dividends. The trustees received from United Sugar, on the 33,426 shares held by them in trust, dividends of $1.28 per share in 1937 and 75 cents per share in each of the years 1938 and 1939. The dividends on the 8,595 shares of United Sugar allocated to petitioner were paid to him by the trustees and amounted to $11,001.60 for 1937, $6,446.25 for 1938, and $6,446.25 for 1939. The petitioner did not report any of the foregoing amounts received from the trustees of Los Mochis trust as gross income in his income tax returns for the taxable years. The Commissioner included such amounts in the income of petitioner in computing the deficiencies herein.
OPINION.
DISNEY, Judge:
(1) The Commissioner determined that the income of the trust created by petitioner on August 21, 1935, for the years 1937, 1938, and 1939, was taxable to him under the provisions of section 22(a) of the Internal Revenue Code and the corresponding provisions of the Revenue Acts of 1936 and 1938, and respondent relies on that section, as construed in Helvering v. Clifford, 309 U.S. 331, and related cases, such as Richardson v. Commissioner (C.C.A., 2d Cir.), 121 Fed.(2d) 1; certiorari denied, 314 U.S. 684; rehearing denied, 314 U.S. 711; Commissioner v. Barbour (C.C.A., 2d Cir.), 122 Fed. (2d) 165; certiorari denied, 314 U.S. 691; Commissioner v. Woolley (C.C.A., 2d Cir.), 122 Fed.(2d) 167; certiorari denied, 314 U.S. 693. Louis Stockstrom, 3 T.C. 255; affd. (C.C.A., 8th Cir.), 148 Fed.(2d) 491; certiorari denied, 326 U.S. 719; Ben F. Hopkins, 5 T.C. 803.
The petitioner contends that the income of the trust is taxable to the trust under section 161(a)(1) and that it is not taxable to the petitioner under the Clifford and other cases, supra, following it, relying in particular upon Hall v. Commissioner (C.C.A., 10th Cir.), 150 Fed.(2d) 304; Donald S. Black, 5 T.C. 759; Herbert T. Cherry, 3 T.C. 1171; David Small, 3 T.C. 1142; Estate of Benjamin Lowenstein, 3 T.C. 1133; and Frederick Ayer, 45 B.T.A. 146.
For the determination of the question involved herein, as stated in Miller v. Commissioner (C.C.A., 6th Cir.), 147 Fed.(2d) 189, ‘there are no precise standards or guides, either in the Act, regulations or decisions of the courts * * * . Each case must rest upon its own peculiar facts and circumstances.‘ To similar effect see Herbert Cherry, 3 T.C. 1171, 1177. In Helvering v. Elias (C.C.A., 2d Cir.), 112 Fed.(2d) 171, it is stated:
* * * the court must look to the whole nexus of relations between the settlor, the trustee, and the beneficiary, and if it concludes that, in spite of their changed legal relations, the three continue in fact to act and feel toward each other as they did before, the income remains the settlor's * * * .
Under the trust created by the petitioner such part of the income thereof ‘as the Trustee may in his discretion deem necessary or proper for * * * (her) comfort, support and/or happiness‘ and also such amounts from the principal ‘as the Trustee may in his discretion deem necessary for * * * (her) comfort, support and/or happiness‘ was payable to petitioner's wife during her life. Upon the wife's death the fund remaining was to be divided into two equal parts, petitioner's son to receive ‘such income (of one part) and also such part of the principal (of one part) as the Trustee may in his discretion deem necessary for the comfort, support, education and/or happiness‘ until he reaches the age of 45 years, at which time the part held for him was to be turned over to him free of all trusts. If the son died before reaching the age of 45 years leaving issue him surviving, his share was to be held for his issue in equal shares, with right of survivorship, ‘on the same terms and with the same discretion as to payment of income and principal‘ as provided for the son. If the son died before reaching the age of 45 years without issue, then one-half his share was to be held for the son's wife, she to receive ‘such part of the income and such part of the principal as the trustee may see fit until she reaches the age of 50 years, at which time she shall receive the fund then held for her free of all trusts.‘ The other part was to be held in trust for petitioner's daughter. If no wife or issue survived the son, then his entire share was to be held for the daughter and her issue, and/or husband, for whom one-half of the trust estate at the death of the wife was to be held on the same terms and with the same discretion in the trustee as to payment of income and principal as provided for the son, his issue, and/or wife. The trust instrument also contained a spendthrift clause. The powers of the trustee as contained in the trust instrument are set forth in our findings of fact and need not be here repeated, except to point out that the trustee, among other things, was empowered ‘to loan money or property to any person, trust or corporation on such terms as he may see fit; to keep any or all securities or other property in the name of some other person or corporation with a power of attorney for their transfer attached, or in his own name without disclosing his fiduciary capacity; to determine what shall be charged or credited to income and what to principal, notwithstanding any determination by the courts; to determine who are the distributees * * * and the proportions in which they shall take; * * * and generally to do all things in relation to the trust fund which the donor could do if this trust had not been executed. It also provided that ‘All such divisions and decisions made by the Trustee in good faith shall be conclusive on all parties at interest.‘ Under the trust instrument petitioner lodged in himself as trustee, ‘a dominion over the trust property far in excess of nominal fiduciary powers under traditional chancery concepts.‘ Stockstrom v. Commissioner, supra.
The petitioner's principal argument is that under the trust instrument neither discretion nor powers were granted to or vested in the petitioner as an individual, but, on the contrary, the powers of management and the discretionary powers to accumulate or distribute income or corpus were vested in and granted to him in his fiduciary capacity as trustee, and that if petitioner had distributed more income than necessary or proper or more corpus than necessary to the life beneficiary he would have been subject to legal action by the remainderman. ‘Equity courts will go no further than to protect the beneficiaries in the enjoyment of the rights actually granted to them by the terms of the trust agreement.‘ Gordon M. Mather, 5 T.C. 1001. The decision of a trustee in the exercise of his discretion can not be overridden by the courts unless the trustee decides arbitrarily, capriciously or in bad faith. Holmes v. Welch, 49 N.E.(2d)(Mass.) 461, 465; Sears v. Childs, 35 N.E. (2d)(Mass.) 663, 669; Berry v. Kyes, 22 N.E.(2d)(Mass.) 622, 625; and Dumaine v. Dumaine, 16 N.E.(2d)(Mass.) 625. In the latter case the Supreme Judicial Court of Massachusetts, referring to a discretionary power granted to the trustee to determine whether property or money earned by him was principal or income, stated:
* * * The discretion conferred is not an empty one. It confers an important responsibility to make a determination which, if honestly exercised, calls for no revision by the court. Am. Law Inst. Restatement: Trusts, Sections 187, 233.
The question involved was whether the trustee had the right thereunder to distribute to himself as life tenant a profit derived during the year 1938 as the result of selling certain shares of stock, a part of the trust property, at a price over and above cost. Although the trustee was one of two life beneficiaries, to each of whom so much of the net income as the trustee in his absolute and uncontrolled discretion should determine was payable, and the balance, if any, in any year was to become a part of capital, and although the trust estate was to be transferred upon the death of the survivor of the two life beneficiaries to another trust, and although the local rule of allocation was well settled to the contrary, the court held that the trustee had the power to classify the gain as income and distribute it to himself as beneficiary. Thus, the trust herein being governed by Massachusetts law, the petitioner as trustee had a very wide latitude indeed in the exercise of his fiduciary discretion.
The powers of management and control given to the trustee under the trust instrument herein are equally as broad and inclusive as those conferred upon the trustee in Miller v. Commissioner (C.C.A., 6th Cir.), 147 Fed.(2d) 189; Stockstrom v. Commissioner (C.C.A., 8th Cir.), 148 Fed.(2d) 491; Funsten v. Commissioner (C.C.A., 8th Cir.), 148 Fed.(2d) 805; Edison v. Commissioner (C.C.A., 8th Cir.), 148 Fed.(2d) 810; Anna Morgan, 5 T.C. 1089. In all such cases the grantors were named as trustees. In all such cases the income of the trust was held to be taxable to the grantor-trustee.
In Donald S. Black, supra, cited by petitioner, the Commissioner contended that the income of the trust was taxable to the taxpayer-trustee because under the trust instrument the trustee was given full and plenary powers of investment such as he would possess if he were the absolute owner there in his individual capacity. As to this contention the Tax Court stated (5 T.C. 759):
* * * There is no such wording or phraseology as that the trustee was given full and plenary powers of investment such as he would possess if he were the absolute owner of the ‘trust estate in his private individual capacity.‘ Such language was contained in the trust instruments involved in the Stockstrom and Edison cases, supra, relied on by the respondent, and in Miller v. Commissioner, (C.C.A., 6th Cir.), 147 Fed.(2d) 189; and Funsten v. Commissioner (C.C.A., 8th Cir.), 148 Fed.(2d) 805.
Thus the Black case is not controlling herein, for the trust instrument herein does give the petitioner as trustee as full powers over the trust estate as he would have had if the trusts had not been executed. No such extensive powers were granted by the trust instrument to the grantor trustee in Herbert T. Cherry, supra, cited by petitioner.
It has been stated that income of a trust is not taxable to the grantor under section 22(a) merely because he has made himself trustee, with broad power in that capacity to manage the trust estate. Commissioner v. Branch, (C.C.A., 1st Cir.), 114 Fed.(2d) 985. However, in that case, it was pointed out that the grantor had ‘stripped himself of all command over the income for an indefinite period.‘ In that case the income of the trust was payable to the wife of the grantor-trustee during her lifetime for her separate use, ‘free whenever she shall be covert from all control and engagements of her husband. ‘ In White v. Higgins (C.C.A., 1st Cir.), 116 Fed.(2d) 312, it is stated:
* * * But on the other hand, taxation of the income to the grantor is not excluded by the mere fact that the grantor holds legal title to the corpus as trustee. His powers as trustee, in conjunction with other provisions of the trust instrument, may give him a dominion over the corpus substantially equivalent to ‘full ownership.‘ Helvering v. Clifford makes this clear.
In David Small, supra, cited by petitioner, the trust agreement provided that any income not used for or applied to the support, maintenance, education, and appropriate luxuries of the minor beneficiaries was to be accumulated and paid to the minor upon his or her attaining the age of 21 years. Herein it was in the discretion of petitioner as trustee to withhold all trust income from his wife during her entire life and, upon the death of his wife, from his two children until they each reached the age of 45 years. In Estate of Benjamin Lowenstein, supra, the income of the three trusts created by the decedent-grantor was payable to the respective life beneficiaries, who were the adult children of the grantor. It would serve no useful purpose to discuss all the cases cited by the parties.
The petitioner, in addition to his broad and extensive powers of management, including the right ‘generally to do all things in relation to the trust fund which the donor could do if this trust had not been executed,‘ retained absolute discretion over the control of the distribution of income and principal. He could distribute all the income or any portion of it, as well as principal, to the primary beneficiary if he thought it conducive to her comfort and happiness, or he could withhold all the income and principal from her and accumulate it for distribution to the remaindermen. He had the ‘right to 'spray’ the net income of the trust as between the primary beneficiary and the remaindermen within the thought of Commissioner v. Buck, 120 Fed.(2d) 775, and more particularly within the decision in Stockstrom v. Commissioner, 148 Fed.(2d) 491, affirming 3 T.C. 255.‘ Ben F. Hopkins, supra. See also Edison v. Commissioner, 148 Fed.(2d) 810; certiorari denied, 326 U.S. 721; Foerderer v. Commissioner, 141 Fed.(2d) 53.
In our opinion the absolute power of the petitioner over the distribution of the income and principal of the trust or accumulations thereof for the remaindermen, together with his other broad and extensive powers, gave him a dominion over the trust corpus substantially equivalent to full ownership, and the respondent did not err in taxing the income of the trust for the taxable years to the petitioner under the provision of section 22(a).
(2) The Commissioner, in computing the tax liability of the petitioner for the taxable years included in his taxable income distributions received by him from the Los Mochis trust. The explanation given by the Commissioner for such adjustment is as follows:
It is held that the income received by Mr. Jones from the Los Mochis trust does not represent compensation for services rendered outside the United States and is taxable, therefore, under the provisions of section 22(a) of the Internal Revenue Code and the corresponding provisions of the Revenue Acts of 1936 and 1938.
On brief he states the question to be whether the amounts received by petitioner ‘from an employee's trust represented additional compensation for services rendered by him to his employer or ordinary trust income.‘ He does not dispute the fact that the creation of the Los Mochis trust was for the purpose of awarding the ‘key‘ employees named therein as beneficiaries for their faithful and efficient services rendered to the corporation, but contends that each of such employees became possessed at the time the trust was created of a definite and fixed property interest, the value of which interest constituted his compensation when received, and that the income from such property interest thereafter can not be considered as compensation paid by the corporation, but, on the contrary, is ordinary trust income.
The petitioner contends that the Los Mochis trust falls in the category of an ‘employees' trust,‘ that it is a profit-sharing plan established for the purpose of providing additional incentive compensation for the employees of United Sugar, that the amounts received by the petitioner were earned income under section 25(a)(4)(A) of the Internal Revenue Code, and, therefore, petitioner, being a nonresident citizen of the United States, they were excludible from income under section 116(a) of the Internal Revenue Code (in effect in 1939) and corresponding sections of the Revenue Acts of 1936 and 1938. Those sections, so far as pertinent, are set forth in the margin.
SEC. 25. CREDITS OF INDIVIDUAL AGAINST NET INCOME.(a) Credits for Normal Tax Only.— There shall be allowed for the purpose of the normal tax, but not for the surtax, the following credits against the net income.(4) Earned income definitions.— For the purposes of this section—(A) ‘Earned income‘ means wages, salaries, professional fees, and other amounts received as compensation for personal services actually rendered, but does not include any amount not included in gross income, nor that part of the compensation derived by the taxpayer for personal services rendered by him to a corporation which represents a distribution of earnings or profits rather than a reasonable allowance as compensation for the personal services actually rendered. * * *SEC. 116. EXCLUSIONS FROM GROSS INCOME.In addition to the items specified in section 22(b), the following items shall not be included in gross income and shall be exempt from taxation under this chapter:(a) Earned Income from Sources Without United States.— In the case of an individual citizen of the United States, a bona fide nonresident of the United States for more than six months during the taxable year, amounts received from sources without the United States (except amounts paid by the United States or any agency thereof) if such amounts would constitute earned income as defined in section 25(a) if received from sources within the United States; but such individual shall not be allowed as a deduction from his gross income any deductions properly allocable to or chargeable against amounts excluded from gross income under this subsection.
The Los Mochis trust was created by Compania Mexicana, which company concededly was not the employer of petitioner or other beneficiaries of the trust. Most of the shares of United Sugar were contributed to the trust by Compania Mexicana. In substance, these shares were contributed by Johnston, who was the sole stockholder of Compania Mexicana. Neither was Johnston the employer of petitioner or other beneficiaries of the trust. United Sugar was the employer and it contributed nothing to the trust. It made certain payments to the trust, it is true. However, such payments were not made to the trust as compensation for services rendered to it by the beneficiaries of the trust, but as dividends on its shares held by the trust.
The consideration stated in the trust agreement for the transfer by Compania Mexicana of 33,426 shares of United Sugar to the trust is ‘One Dollar‘ and ‘faithful and loyal services heretofore rendered by the beneficiaries hereinafter named.‘ Each beneficiary belonging to the first group named, including the petitioner, was to receive a trust certificate covering the shares set aside for him, which certificate was to certify that ‘such beneficiary, his heirs, executors, administrators and/or assigns will be entitled to the shares above specified, as well as to the income from the same, in the manner and form and at the times provided for‘ in the declaration of trust. Under the declaration of the trust it was the duty of the trustees to distribute the dividends received by it from United Sugar to the beneficiaries, applicable to the number of shares as represented by the trust certificates held by each beneficiary. The necessary expenses and a reasonable amount for anticipated expense were to be paid and reserved from the unallocated income. Such distribution was to continue for 20 years, at the end of which period it was the duty of the trustees to distribute, assign, and deliver to the holders of the trust certificates the shares represented by the same. In so far as the first group of beneficiaries is concerned, the trust was merely the legal holder of the shares and the distributor of the dividends received from United Sugar for a term of 20 years. The trust certificates, representing an interest in the trust, were the property of the holders thereof with which they could deal as freely as they could with any other property owned by them. There were no limitations or restrictions as to their transfer in the trust agreement and neither the distributions by the trust of dividends when and as received nor the distributions of the shares of United Sugar as represented by the trust certificates at the end of 20 years were dependent upon the continued employment by United Sugar of the beneficiaries or the rendering of any services by them to the corporation during such 20 years. The certificate ran to the beneficiary, and his assigns, and upon the death of any beneficiary holding and possessed of his trust certificate the trust certificate became a part of his estate and the distributions of dividends received by the trust from United Sugar were payable to his estate. This was done in 1939 in the cas: of Hudson and Sherman Johnston. In the case of Ignacio Gastelum, who died in 1933, and in the -case of Hudson, who died in January 1939, their - certificates were transferred to their respective estates. This probably was also done in the case of Sherman Johnston, who died in August 1939, and Hassard, who died in 1942.
It is true that petitioner testified that he, as well as the other beneficiaries of the trust, assured Johnston, prior to the creation of the trust, that they intended to continue with United Sugar during the term of the trust or until death or retirement; that as a result of the establishment of the trust his monthly salary and the monthly salary of the other beneficiaries payable by United Sugar were reduced ‘in connection with the new plan, under which a large part of the compensation of the key men was to come from earnings of the company‘; that the key employees could have earned a substantially greater monthly salary if they had left the employment of United Sugar, and that, in fixing the monthly salaries at the time and after the establishment of the trust, the distribution which the employee would be entitled to receive from the trust would be taken into consideration as a factor in determining his compensation. This testimony, however, is not determinative in view of the clear and unambiguous language of the trust agreement, giving to the beneficiaries in the first group a vested interest in praesenti. The dividends issued by the trust were payable to the beneficiaries because of their rights as beneficiaries under the trust and not as employees of United Sugar. That United Sugar was not obligated to make payments to the trust of any specified amount as salary is evidenced by the fact that in 1934 no dividends were paid and in 1938 and 1939 the dividends were less than in 1937. Furthermore, United Sugar established a so-called management fund in about 1934 to provide funds to adjust and stabilize salaries when affected by the exchange situation in Mexico or otherwise.
Petitioner argues that the present issue was squarely presented in William J. R. Ginn, 47 B.T.A. 41. In that case the parties involved agreed that the fund under consideration was a pension trust within the meaning of section 165, which is not the situation herein. It was contended by the taxpayer that aliquot amounts of contributions of certain partners individually, bequests from two estates, and the amount undrawn by deceased employees were gifts to the fund, and that this gift characteristic followed through to the receipt of the pension by individual members of the fund and hence they were not taxable income to them. It was therein determined that the employee participants in the pension fund were taxable on amounts received in the taxable year in excess of their contributions to the fund and that the amounts so taxable, other than accretions attributable to the employees' contributions, were earned income for purposes of computing the earned income credit.
Joseph W. Frazer, 4 T.C. 1152 (on appeal, C.C.A., 6th Cir.), cited by the petitioner, is distinguishable on the facts and is also not applicable. In that case the employer corporation paid a percentage of its earnings to two trust funds in which selected officers and executives could participate by the purchase of shares of beneficial interest. The earnings were not paid as dividends, but to enable the trusts to purchase shares of the employer corporation. The contributions were held in effect to be payment of additional compensation and deductible as such by the corporation. Contributions to the fund by the corporation and profits from the sale of securities were to be credited to an account called surplus B. Such contributions were to be invested in common shares of the employer corporation and other temporary investments. The income therefrom was to be placed in an account called surplus A, from which distributions were to be made as the trustees should determine and, upon the death or resignation of any member upon the surrender of his certificates for shares of beneficial interest, he was to receive a distribution from the funds, the determination of the amount of which, and whether in cash or securities, was in the absolute discretion of the trustees. By the terms of the trust indentures the certificates for shares of beneficial interest were not assignable. All that the participating members could do with them to receive anything from the trusts was to surrender them to the trustees within one year from date of resignation. The taxpayer, a participating member of both funds, resigned from his position in 1939 and upon the surrender of his certificates he received a total of $60,553.77 from the two trusts. In 1939 he reported the receipts as a capital gain, only 50 percent of which was includible in gross income. It was stipulated that the taxpayer had recovered his entire investment in each fund through nontaxable distributions prior to 1939. The Commissioner determined that the entire amount was includible in taxpayer's gross income as compensation for services rendered. It was held that the entire amount received by taxpayer was includible in gross income except the small portion thereof consisting of certain income upon which the trust had been taxed, since income already taxed to a trust is not taxable when distributed to the beneficiary.
No doubt the Los Mochis trust was established to induce the beneficiaries particularly those included in the first group named, to remain in the employ of United Sugar and as an incentive to greater interest and endeavor on their part in behalf of the company, upon the theory that the amount of the earnings of the company would be dependent upon their continued efforts and services, and that they would benefit by a distribution of such earnings. However, under the plan as evolved and established, they received a distribution of such earnings not as employees in payment of compensation for services rendered in the year the distributions were received, but in substance and effect as shareholders in payment of dividends declared on shares of stock held by them. That the dividends on the shares allotted to each was routed through the trust is not important. Section 116(a) is therefore not applicable.
The determination of the respondent on this issue is approved.
Decision will be entered for the respondent.