Respondent determined deficiencies in Federal income tax as follows:
Taxable Docket No. Petitioner year Deficiency
5530-72 Phillip G. Larson_ 1968 $6,744
5266-73 American Precision Metals- 1969 3,703
1970 1,810
5267-73 Phillip G. Larson_ 1966 1,409
1969 5,943
1970 6,389
Other issues having been disposed of by mutual agreement of the parties, the sole issue remaining for decision is whether the limited partnerships involved in this proceeding constitute associations taxable as corporations within the meaning of section 7701(a)(3).2
An opinion was filed in this case on October 21, 1975. On November 5, 1975, petitioners filed a “Motion for Reconsideration by the Full Court” which was denied. The motion was referred to the trial judge as a motion for reconsideration of the opinion. The trial judge granted this motion and the Court’s opinion was withdrawn on November 7,1975.
FINDINGS OF FACT
Some of the facts have been stipulated by the parties. Such facts and the exhibits attached thereto are incorporated herein by this reference.
Phillip G. Larson, petitioner in docket Nos. 5530-72 and 5267-73 (hereinafter petitioner), was a legal resident of Burlingame, Calif., at the time he filed his petitions herein. Petitioner filed Federal individual income tax returns for the calendar years 1968 to 1970, inclusive, with the Internal Revenue Service Center at Ogden, Utah. During the taxable years 1968, 1969, and 1970, petitioner was a limited partner in Mai-Kai Apartments (hereinafter Mai-Kai), a limited partnership formed under the laws of the State of California. During the taxable year 1970, petitioner was also a limited partner in Somis Orchards (hereinafter Somis), a limited partnership formed under the laws of the State of California.3
American Precision Metals, petitioner in docket No. 5266-73 (hereinafter referred to as American), was a corporation with its principal office in Burlingame, Calif., at the time it filed its petition herein. American filed its Federal corporation income tax returns for the calendar years 1969 and 1970 with the District Director of Internal Revenue at San Francisco, Calif. American was a limited partner in Somis during 1969 and 1970.
Grubin, Horth & Lawless, Inc. (hereinafter GHL), a California corporation, the sole general partner of both Mai-Kai and Somis, was formed April 2, 1968, primarily to organize so-called “real estate syndications” as limited partnerships under the laws of the State of California. GHL kept its books on the basis of a fiscal year ending March 31. GHL had a paid-in capital of $21,300. From its incorporation to March 31,1974, its capital and surplus ranged between a maximum of $49,593 at the close of the fiscal year 1970 to a minimum of $18,764 as of the close of the fiscal year 1974. Cash on hand was generally negligible. GHL organized both Mai-Kai and Somis and managed and administered the partnership properties. The assets and liabilities of GHL, as shown by its tax returns, may be summarized as follows:
Assets1 1969 Cash_ $8,756 Accounts receivable: Partnerships_ 11,435 Partners_ 12,400 FYEMar. 31— 1970 1971 0 0 1972 0 Other _ Other current assets_ Loans to stockholders-Other investments_ Depreciable assets-Accumulated depreciation _ Intangible assets_ Accumulated amortization 153 926 913 (54) 376 (75) $12,661 50,000 $48,780 $32,779 66,769 100 2,901 200 2,500 4,924 9,908 9,908 (851) (2,112) (3,690) 376 376 376 (150) (225) (300) Total assets_ 34,828 136,331 59,627 39,273 Liabilities Accounts payable_ 1,058 Mortgages and notes payable- 10,176 Other current liabilities_ 237 Loans from stockholders_ 1,577 Total liabilities_ 13,048 Capital stock_ 21,300 Retained earnings_ 480 44,500 42,238 39,383 14,619 86,738 39,383 14,619 21,300 28,293 21,300 (1,056) 21,300 3,353 Total equity_ 21,780 49,593 20,244 24,653
Mai-Kai was formed on or about November 26, 1968, under the limited partnership provisions of California Corporations Code sections 15501-15531, for the purpose of owning and operating a student apartment complex in Areata, Calif., known as the Mai-Kai Apartments. Upon the formation of Mai-Kai, GHL transferred to Mai-Kai, as a contribution to its capital, the right to acquire the Mai-Kai Apartments under a contract negotiated by Legrand Capital Corp., GHL’s predecessor in interest. The apartments were located across the street from Humboldt State College in Areata. The apartments were designed as a student residence catering to Humboldt State students. The apartments consisted of 55 units, each accommodating four students, and a three-bedroom house which was customarily leased to six students.
GHL was not required to make any further capital contributions to Mai-Kai. The limited partnership interests in Mai-Kai were divided into 10 “units” of $9,500 per “unit.” All of the “units” were sold to a total of eight limited partners. The total capital contribution to Mai-Kai by the limited partners was $95,000 in cash. GHL’s total capital contribution to Mai-Kai was reflected and carried at zero ($0) on Mai-Kai’s books and records.
GHL and the limited partners in the Mai-Kai venture subscribed to an agreement of limited partnership which defined their respective rights and obligations. Concurrently with the execution of the agreement of limited partnership, the Mai-Kai partners also executed a certificate of limited partnership which was filed and recorded in accordance with California law.
After its formation, Mai-Kai purchased the Mai-Kai Apartments from Century Land Co., a California corporation, for a purchase price of $450,000. The purchase price was paid by the execution of a promissory note dated November 17,1968, in the amount of $450,000 in favor of Century Land Co. The promissory note was secured by a deed of trust upon the Mai-Kai Apartments dated November 17, 1968, which was given to Century Land Co. by Mai-Kai to secure payment of the purchase price. Pursuant to section 580b of the California Code of Civil Procedure, in the event of default by Mai-Kai under the promissory note no money judgment would lie against Mai-Kai, and Century Land Co.’s remedy would be limited to requiring the sale of the Mai-Kai Apartments pursuant to the deed of trust, with the proceeds to be applied to the promissory note.
The Mai-Kai partnership agreement and certificate provided, in pertinent part:
AGREEMENT OF LIMITED PARTNERSHIP
3. Term.
The partnership shall commence as of December 1, 1968 and shall continue for a period of thirty three (33) years * * * unless sooner terminated as hereinafter provided for, or unless extended for such longer term as may be determined by the election of the Limited Partners entitled to sixty per cent (60%) or more of the profits of the partnership allocable to the Limited Partners.
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5. Capital Contributions.
(a) GRUBIN, HORTH & LAWLESS, INC. shall transfer and contribute to the partnership its right to acquire the [apartments] * * *.
The General Partner shall not be required to make any capital contribution other than its right to acquire the real property * * *.
(b) * * * The total capital contribution of the Limited Partners shall be Ninety Five Thousand Dollars * * *.
6. Rights, Duties and Obligations of the General Partner.
(a) The partnership business shall be managed by the General Partner. In addition to those powers granted to the General Partner by law the General Partner shall have the power to execute leases, incur obligations on behalf of the partnership in connection with the business, and execute on behalf of the partnership any and all instruments necessary to carry out the intentions and purposes of the partnership, including the power to dispose of the real property or other assets of the partnership for full and adequate consideration. The General Partner shall devote such time to the business of the partnership as shall be necessary to accomplish the purposes set forth herein.
(b) Management and Brokerage Fees. In addition to its share of the profits and cash flow distributions, * * * the General Partner shall receive and be entitled to the following fees:
(1) A monthly management fee equal to five per cent (5%) of the gross receipts of the partnership business during each month. * * *
(2) The General Partner may obtain financing or refinancing for the partnership property on behalf of the partnership, and if successful, the General Partner shall be entitled to a mortgage loan fee not to exceed two per cent (2%) of the total amount of each loan.
(3) The General Partner shall also be entitled to reimbursement for all reasonable out-of-pocket expenses incurred by it in the management and operation of the partnership business.
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7. Withdrawal of Capital.
No Limited Partner may withdraw his capital contribution to the partnership without the consent of the General Partner. * * *
8. Rights, Duties, Obligations of the Limited Partners.
(a) Except as otherwise expressly provided herein, no Limited Partner shall participate in the management of the partnership business.
(b) A Limited Partner shall have the right to withdraw his capital account upon the termination of the partnership * * *.
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10. Profits, Losses and Distributions.
(a) Profits. The net profits of the partnership shall be equal to the taxable income of the partnership as shown in the partnership tax information tax return filed in accordance with the requirements of the Internal Revenue Code.
Except as provided in Paragraph 11 below, profits shall be divided as follows:
(1) Twenty Per Cent (20%) to the account of the General Partner.
(2) Eighty Per Cent (80%) to the accounts of the Limited Partners * * *.
(b) Losses. All losses of the partnership shall be allocated entirely to the Limited Partners in proportion to their capital contributions, subject however to the limitation of liability of each Limited Partner to the amount of his individual investment in the partnership. All losses of the partnership in excess of the total capital contributions of the Limited Partners shall be borne entirely by the General Partner.
(c) Distributions. Subject to the provisions of Paragraph 11 below, in the event of the sale of the real property, or the liquidation of the partnership, the net proceeds realized from such sale, * * * or the proceeds of any liquidation, as the case may be, and the cash flow of the partnership shall be distributed as follows:
(1) Twenty Per Cent (20%) to the General Partner.
(2) Eighty Per Cent (80%) to the Limited Partners * * *.
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(e) The General Partner shall distribute the cash flow of the partnership at convenient intervals, but not less frequently than quarterly.
11. Limitation on Allocations and Distributions to General Partner.
Notwithstanding Paragraph 10 above, it is agreed that the General Partner shall not participate in the cash flow or profits of the project until such time as a Limited Partner (assuming 50% tax bracket) has been returned his initial investment through a combination of cash flow and operating losses * * *. For the purpose of this computation, the total after-tax investment for the Limited Partners shall be considered to be $47,500. From said amount shall be deducted 100% of the cash distribution to the Limited Partners and 50% of operating losses * * *. Added thereto shall be 50% of profits. When the after-tax investment of $47,500 has thus been reduced to zero, it will be considered that the Limited Partners have been returned their after-tax investment and thereafter the General Partner will participate in all future cash flow and profits
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15. Assignment of Partners’Interests.
(a) General Partner. The General Partner shall not assign, mortgage, encumber or sell its interest as General Partner in the partnership or enter into any agreement as a result of which any firm, person or corporation shall become interested with it in the partnership * * *.
(b) Limited Partners Right to Receive Income. The right of a Limited Partner to receive any income from the partnership shall not be transferred, sold or assigned without the prior written consent of the General Partner. The General Partner shall not unreasonably withhold such consent.
(c) Transfer of Capital Interest — Limited Partner. The capital interest of a Limited Partner may not be transferred, sold or assigned by such Limited Partner except in accordance with the following provisions:
A Limited Partner who desires to sell or transfer his capital interest in the partnership shall serve written notice on the General Partner * * *. If the General Partner, within ten (10) days following receipt of such notice, in good faith determines that the purchase price offered by the proposed transferee is less than the then fair market value of the interest to be transferred, the General Partner shall have the option to notify the proposed transferor within said ten day period, that the transferor cannot effect a transfer of the interest unless he first offers the interest to the remaining Limited Partners. * * *
In the event that (i) the General Partner does not exercise its option or (ii) the remaining Limited Partners do not elect to purchase the entire interest of the proposed transferor, the transferor may effect the transfer of his interest to the proposed transferee except that as a condition precedent to the admission of the proposed transferee, such person shall execute and acknowledge such instruments as the General Partner shall deem necessary or desirable to effect such admission and to confirm the agreement of the person being admitted to be bound by all of the terms and provisions of this agreement as the same have been amended. The transferee shall pay all reasonable expenses in connection with his admission as a substituted limited partner.
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17. Termination.
Notwithstanding anything to the contrary contained herein, the partnership shall terminate upon any of the following events:
(a) A disposition of [sic] the partnership of its entire interest in the real property.
(b) The adjudication of bankruptcy of the General Partner or otherwise as provided by the Uniform Limited Partnership Act, unless the business is continued by a General Partner elected in place thereof.
(c) A determination by the election of Limited Partners entitled to sixty per cent (60%) or more of the profits of the partnership allocable to the Limited Partners that the partnership shall terminate.
(d) The removal of the General Partner by the vote of Limited Partners entitled to sixty per cent (60%) or more of the profits of the partnership allocable to the Limited Partners. In such event, there shall be a distribution of assets * * * unless the Limited Partners, by an affirmative vote of Limited Partners owning 100% of the profits in the partnership allocable to the Limited Partners, elect to form a new partnership to continue the partnership business. * * *
CERTIFICATE OF LIMITED PARTNERSHIP
The undersigned, desiring to form a Limited Partnership under the Uniform Limited Partnership Act * * *, hereby make the following certificate:
1. The name of the partnership shall be MAI-KAI.
2. The character of the business shall be the ownership and operation of real property.
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5. The partnership shall continue for a term of approximately thirty-three (33) years.
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8. Limited Partners entitled to 60% or more of the profits of the limited partnership allocable to the Limited Partners may by a vote remove the General Partner. In the event of such removal the partnership shall terminate except that by the vote of 100% of the Limited Partners a new partnership may be formed to continue the partnership business.
In the case of Mai-Kai, GHL thus had a 20-percent “subordinated” participation interest in operating profits, cash flow, and net proceeds upon the sale of partnership assets. GHL’s participation interest in Mai-Kai became unsubordinated after December 31, 1972. The amount by which GHL’s participation interest was subordinated prior to December 31, 1972 — i.e., the amount remaining in the partners’ investment accounts (which amount was to be recovered by the limited partners before GHL was entitled to participate) — was as follows:
End of year Subordinated amount
1968_ $46,707
1969_ 27,692
1970_ 14,947
1971_ 1,431
During 1973 Mai-Kai did not generate a profit or cash flow to be distributed to either the limited partners or to the general partner.
For each of the taxable years 1968 to 1973, inclusive, Mai-Kai reported losses on its U.S. Partnership Income Tax Returns as follows:
Year Loss Year Loss
1968 _ $91,595 1971_ $11,169
1969 _ 38,030 1972 _ 8,378
1970 _ 23,491 1973 _ 12,520
On his individual U.S. income tax returns, the petitioner deducted his distributive shares of the losses reported by Mai-Kai. Respondent disallowed said deductions on the ground that Mai-Kai was an association taxable as a corporation within the meaning of section 7701(a)(3).
Somis Orchards was formed on or about November 1, 1969, under the limited partnership provisions of California Corporations Code sections 15501-15531 for the purpose of acquiring, holding, operating, improving, leasing, selling, and otherwise managing approximately 265 acres of citrus groves and related assets in Ventura County, Calif.
The citrus groves were purchased from Kaiser Aetna in 1969 for a total purchase price of $3,620,000. The purchase price was paid by $102,750 in cash and the execution of three installment notes dated December 30,1969, in favor of Kaiser Aetna totaling $3,709,630. The first installment note was in the amount of $3,398,500. The first and second installment notes totaling $3,434,500 were nonrecourse liabilities each being secured by a deed of trust dated December 30, 1969. The third installment note was paid in full by Somis in March 1970.4
The citrus groves were part of a 10,000 acre property owned by Kaiser Aetna known as Rancho Las Posas. At the time of their acquisition by Somis Orchards the citrus groves were planted with lemons, grapefruit, and oranges. The property was suitable, however, for possible future residential or commercial use. Kaiser Aetna, the seller of the property, had begun the formulation of an overall master plan for the development and marketing of the entire Rancho Las Posas property. A part of the consideration paid by Somis Orchards to Kaiser Aetna for the citrus groves related to Kaiser Aetna’s agreement to enhance the value of the citrus groves through Kaiser Aetna’s development of the comprehensive master plan and commencement of sales and marketing activities. Somis contracted with Kaiser Aetna to have the citrus groves remain in Kaiser Aetna’s master plan and for the citrus groves to be managed by Kaiser Aetna in the interim.
GHL’s capital contributions to Somis consisted of the transfer to the partnership of GHL’s rights to acquire the citrus groves under the purchase contract negotiated by GHL. In addition, GHL assigned to Somis the management contract negotiated by GHL for management of the citrus groves by Kaiser Aetna.
A total of 44 limited partners contributed $420,000 in cash to Somis.5 Each limited partner also executed a series of promissory notes reflecting annual contributions to be made by the limited partners during the 8 years following the formation of Somis. Of the total 44 limited partners in Somis, 26 joined the partnership in 1969, making capital contributions totaling $265,000. The remaining 18 limited partners joined the limited partnership in 1970.
At the time Somis was formed, it was contemplated that a total of $560,000 would be raised. However, in 1970, Somis sold one-fourth of the citrus groves to L. T. Anderson Construction Co. and L. T. Anderson, who executed and delivered to Kaiser Aetna their promissory notes for that portion of the citrus groves acquired from Somis. Somis’ obligation to Kaiser Aetna under the first and second installment notes was thereafter reduced by 25 percent to a total of $2,575,875.
The partnership agreement and certificate signed by GHL and the Somis limited partners were generally similar to those of Mai-Kai, with the following material differences:
(1) The initial 15-year term could be extended by a 51-percent vote of limited partners.
(2) The general partner could not sell or pledge more than 45 percent of the partnership’s assets or refinance the property without the approval of 51 percent of the limited partnership interests.
(3) The general partner was allowed additional compensation for organizational services, and an “incentive” fee equal to a percentage of cash flow in excess of a stated amount.
(4) Profits, proceeds from sales of assets, and liquidation proceeds were allocated, 15 percent to the general partner and 85 percent to the limited partners. The general partner had no interest in cash flow.
(5) Fifty-one percent of the limited partnership interests could elect to terminate the partnership. The same percentage could vote to remove the general partner, in which event the partnership would terminate unless 51 percent of the limited partnership interests elected to form a new partnership to continue the business. On removal, the general partner would be paid the value of its interest, as determined by arbitration.
(6) The limited partners acknowledged the general partner’s receipt of a real estate broker’s commission in connection with the acquisition of the real property.
(7) The rights of the parties were contingent on approval by the State department of corporations of the sale of the limited partnership interests.
(8) The agreement could be amended by a 51-percent vote of limited partners.
On two separate occasions individual limited partnership interests in Somis were transferred from the individual limited partner to a joint tenancy between the limited partner and his wife. In both instances, the individual limited partner wrote to GHL to request that such transfer be accomplished. GHL provided partnership agreements and certificates to be signed by the wives and thereafter filed amended certificates of limited partnership reflecting the transfer of ownership from sole ownership to joint tenancy without invoking any restrictions with respect to transferability.
In the case of Somis, GHL had a 15-percent “subordinated” participation interest in operating profits and net proceeds upon the sale of partnership assets. GHL did not have a participation interest in Somis’ cash flow. The amount by which GHL’s participation interest in the net profit was subordinated — i.e., the amount remaining in the limited partners’ investment accounts (which amount was to be recovered by the limited partners before GHL was entitled to participate) — was as follows:
Subordinated amount End of year (including 6-percent interest)
1969_ $271,992
1970_ 252,714
1971_ 277,074
1972_ 281,232
1973_ 300,342
During the taxable years 1969 to 1973 inclusive, Somis operated at a loss. The following schedule sets forth the annual losses as reported by Somis on its U.S. Partnership Income Tax Returns:
Year Loss
1969_ $185,820
1970_ 595,853
1971_ 373,220
1972_ 267,335
1973_ 229,621
On their respective individual and corporate U.S. income tax returns, the petitioners deducted their distributive shares of the losses reported by Somis. Respondent disallowed said deductions on the ground that Somis was an association taxable as a corporation within the meaning of section 7701(a)(3).
For its taxable years ending March 31, GHL reported gross receipts on its Federal income tax returns of the types and in the amounts shown below:
1969 1970 1971 1972 1973 1974 Grossreceipts $109,692.11 $342,145.02 $287,051.78 $65,839.04 $58,580.07 $37,961.00 Interest - 1,477.96 3,082.86 965.81 Partnership participation — — 118.00 Other - - -- -- 17,24 -- Total 109,692.11 343,622.98 290,252.64 66,804.85 58,597.31 37,961.00
GHL received $118 in 1971 as a distribution of cash flow from a limited partnership known as El Camino. An additional $1,470 was distributed by El Camino as the general partner’s share of cash flow, but pursuant to agreement was paid to an entity related to GHL. From 1971 to 1973 the general partner’s share of cash flow in El Camino amounted to $3,190.60, of which all but the above amounts was inadvertently distributed to the limited partners.
No limited partner in Somis or Mai-Kai was a stockholder of GHL, with the exception of Harris E. Lawless, who at all pertinent times held a 1.905-percent limited partnership interest in Somis and owned 23.125 percent of the stock of GHL. Neither Somis nor Mai-Kai issued certificates to the limited partners representing shares in the partnerships. During the period 1968 to 1973, no meetings of the limited partners in Mai-Kai were held, nor were any decisions with respect to either Mai-Kai or Somis referred to the limited partners for their vote or approval. Meetings of the Somis partners were held in December of 1972 and 1973 to allow Kaiser Aetna to inform them of progress in obtaining master plan approval for the planned city development covering the land owned by Somis.
Pursuant to the provisions of the California Corporate Securities Law (Cal. Corp. Code secs. 25000 et seq.), and prior to the formation of Somis, GHL applied for and secured from the California Corporations Commissioner a permit authorizing it to offer for sale, negotiate for the sale of, and sell security interests (or subscriptions therefor) in Somis.
Offering circulars, prepared by GHL, were distributed by GHL to prospective limited partners in Somis and Mai-Kai. The circulars advertised the limited partnership interests as “tax-sheltered real estate investments,” and contained extensive descriptions of the underlying real property, the investment terms, and the anticipated return on the proposed investments.
Of the 42 limited partnership “units” sold in Somis, 17 were sold by two employees of GHL, Robert L. Horth and Alan J. Parisse, without commission. Horth and Parisse held restricted brokers’ licenses issued by the National Association of Security Dealers (hereinafter NASD), which authorized them to sell mutual funds, limited partnership interests, and similar investments but not to sell stocks, bonds, or other corporate securities. Eleven and one-half of the Somis limited partnership “units” were sold by Robert Schmidt (a shareholder and director of GHL but not an employee), who was paid a commission on his sales by GHL. Schmidt also held a restricted NASD broker’s license. The remaining 13V2 Somis limited partnership “units” were sold by a total of nine financial planners holding restricted NASD brokers’ licenses, all of whom were paid a commission by GHL.
All of the Mai-Kai limited partnership “units” were sold to investors by Robert L. Horth and Alan J. Parisse (as GHL employees) under their restricted NASD brokers’ licenses. No commissions were paid to Horth or Parisse on said sales.
OPINION
Petitioners owned limited partnership interests in Mai-Kai and Somis, two real estate ventures organized under the California Uniform Limited Partnership Act, Cal. Corp. Code secs. 15501 et seq. (West Supp. 1976) (hereinafter referred to as CULPA). The partnerships incurred losses during the years in issue, and petitioners deducted their distributive shares of such losses on their individual tax returns. Respondent disallowed those deductions on the ground that the partnerships were associations taxable as corporations, as defined in section 7701(a)(3),6 and not partnerships as defined in section 7701(a)(2).7 Petitioners allege that the partnerships fail all of the tests of corporate resemblance established by respondent’s regulations (sec. 301.7701-2, Proced. & Admin. Regs.); respondent contends that all those tests are satisfied. Both sides agree that the regulations apply and are controlling, and our opinion and decision are consequently framed in that context; the validity of respondent’s regulations is not before us.8 In our previous (now withdrawn) opinion dated October 21, 1975, we concluded that respondent should prevail. Upon reconsideration, we have come to the opposite conclusion and hold for petitioners.
The starting point of the regulations’ definition of an “association” is the principle applied in Morrissey v. Commissioner, 296 U.S. 344 (1935), that the term includes entities which resemble corporations although they are not formally organized as such. Morrissey identified several characteristics of the corporate form which the regulations adopt as a test of corporate resemblance. For the purpose of comparing corporations with partnerships, the significant characteristics are: continuity of life; centralization of management; limited liability; and free transferability of interests. Other corporate or noncorporate characteristics may also be considered if appropriate in a particular case. An organization will be taxed as a corporation if, taking all relevant characteristics into account, it more nearly resembles a corporation than some other entity. Sec. 301.7701-2(a)(l), Proced. & Admin. Regs.; see and compare Bush 0, 48 T.C. 218, 227-228 (1967), and Giant Auto Parts, Ltd., 13 T.C. 307 (1949). This will be true only if it possesses more corporate than noncorporate characteristics.
The regulations discuss each major corporate characteristic separately, and each apparently bears equal weight in the final balancing. See pp. 185-186 infra. This apparently mechanical approach may perhaps be explained as an attempt to impart a degree of certainty to a subject otherwise fraught with imponderables. In most instances, the regulations also make separate provision for the classification of limited partnerships. Petitioners rely heavily on those provisions, while respondent seeks to distinguish them or to minimize their importance.
1. Continuity of Life
Pertinent provisions of the regulation concerning this characteristic are set forth below.9 A corporation possesses a greater degree of continuity of life than a partnership, since its existence is not dependent upon events personally affecting its separate members. Because of their more intimate legal and financial ties, partners are given a continuing right to choose their associates which is denied to corporate shareholders. A material alteration in the makeup of the partnership, as through the death or incapacity of a partner, either dissolves the partnership relation by operation of law or permits dissolution by order of court. Uniform Partnership Act, secs. 31 and 32 (hereinafter referred to as UPA). Partners are then free to withdraw their shares from the business, though they may agree to form a new partnership to continue it. A partner is also given the right to dissolve the partnership and withdraw his capital (either specific property or the value of his interest) at will at any time (UPA sec. 31(2)), although he may be unable to cause the winding up of the business and may be answerable in damages to other partners if his act breaches an agreement among them (UPA secs. 37 and 38(2)). The significant difference between a corporation and a partnership as regards continuity of life, then, is that a partner can always opt out of continued participation in and exposure to the risks of the enterprise. A corporate shareholder’s investment is locked in unless liquidation is voted or he can find a purchaser to buy him out.
In a partnership subject to the Uniform Limited Partnership Act (hereinafter referred to as ULPA), this right of withdrawal is modified. A limited partner can withdraw his interest on dissolution (ULPA sec. 16), buU he can neither dissolve the partnership at will (ULPA sec. 10) nor force dissolution at the retirement, death, or insanity of a general partner if the remaining general partners agree to continue the business in accordance with a right granted in the partnership certificate (ULPA sec. 20). CULPA section 1552010 further provides that a new general partner can be elected to continue the business without causing dissolution, if the certificate permits.
The sole general partner in the limited partnerships involved herein was a corporation, whose business was the promotion and management of real estate ventures. As a practical matter, it is unlikely that either Mai-Kai or Somis would have been dissolved midstream and the partners afforded an opportunity to withdraw their investments. Petitioners argue that the partnerships nevertheless lacked continuity of life because they could be dissolved either at will by, or on the bankruptcy of, the general partner. We turn first to the effect of bankruptcy of GHL.
California Uniform Partnership Act section 15031(5) (West Supp. 1976) (hereinafter referred to as CUPA) provides that a partnership is dissolved on the bankruptcy of a partner. CUPA section 15006(2) makes that act applicable to limited partnerships unless inconsistent with statutes relating to them. CULPA nowhere provides for dissolution or nondissolution in the event of bankruptcy. Section 15520, which merely covers dissolution and countervailing action by the remaining partners under certain circumstances, does not provide for such event. See n. 10 supra. CUPA section 15031(5) therefore applies. Since the bankruptcy of GHL would bring about dissolution by operation of law, each limited partner would be entitled to demand the return of his contribution (CULPA sec. 15516). Somis and Mai-Kai simply do not satisfy the regulations’ test of continuity, which requires that the “bankruptcy * * * of any member will not cause a dissolution of the organization.” (Emphasis supplied.)11
The fact that under the agreements involved herein a new general partner might be chosen to continue the business does not affect this conclusion. Respondent seizes upon this aspect of the agreements to argue that the limited partners could anticipate the bankruptcy of GHL12 and elect a new general partner. But this element does not detract from the hard fact that if GHL became bankrupt while it was the general partner of Somis and Mai-Kai, there would at best be a hiatus between the event of bankruptcy and the entry of a new general partner so that, from a legal point of view, the old partnerships would have been dissolved. Moreover, at least in the case of Mai-Kai, a vote of 100 percent of the limited partners was required to elect a new general partner. Glensder Textile Co., 46 B.T.A. 176 (1942), held that such contingent continuity of life did not resemble that of a corporation. Respondent’s regulations (see n 9 supra) incorporate this conclusion.
We hold that the partnerships involved herein do not satisfy the “continuity of life” test as set forth in respondent’s regulations. We recognize that our application of respondent’s existing regulations to the event of bankruptcy results in a situation where it is unlikely that a limited partnership will ever satisfy the “continuity of life” requirement of those regulations. But the fact that the regulations are so clearly keyed to “dissolution” (a term encompassing the legal relationships between the partners) rather than “termination of the business” (a phrase capable of more pragmatic interpretation encompassing the life of the business enterprise) leaves us with no viable alternative.13 In this connection, we note that respondent is not without power to alter the impact of our application of his existing regulations. See Morrissey v. Commissioner, n. 8 supra.
In view of our conclusion as to the effect of GHL’s bankruptcy, we find it unnnecessary to deal with the contentions of the parties as to whether, under California law, GHL had the legal power to dissolve both Mai-Kai and Somis so as to counteract the “continuity of life” elements contained in the rights of the limited partners under the partnership agreements and certificates, or whether, in respect of this characteristic, CULPA corresponded to the Uniform Limited Partnership Act. See sec. 301.7701-2(b)(2) and (3), Proced. & Admin. Regs., n. 9, supra. Indeed, since the California law, as we interpret it, does not permit the partners in Mai-Kai and Somis to contract against dissolution in the event of bankruptcy of GHL, the rights and duties created by the agreements and certificates cannot alter our conclusion on the “continuity of life” issue; this is a quite different situation from that which exists when other corporate characteristics such as centralized management (see pp. 178-179 infra) and free transferability of interest (see pp. 182-184 infra) are considered.
2. Centralized Management
In the corporate form, management is centralized in the officers and directors; the involvement of shareholders as such in ordinary operations is limited to choosing these representatives. In a general partnership, authority is decentralized and any partner has the power to make binding decisions in the ordinary course (UPA sec. 9). In a limited partnership, however, this authority exists only in the general partners (ULPA secs. 9 and 10), and a limited partner who takes part in the control of the business loses his limited liability status (ULPA sec. 7). From a practical standpoint, it is clear that the management of both Mai-Kai and Somis was centralized in GHL. The sole general partner was empowered by law as well as by the partnership agreements to administer the partnership affairs. However, respondent’s regulations specify that—
In addition, limited partnerships subject to a statute corresponding to the Uniform Limited Partnership Act, generally do not have centralized management, but centralized management ordinarily does exist in such a limited partnership if substantially all the interests in the partnership are owned by the limited partners. [Sec. 301.7701-2(c)(4), Proced. & Admin. Regs.]
In other words, even though there may be centralized administration by a general partner, the “centralization of management” test will not be met if the general partner has a meaningful proprietary interest. See Zuckman v. United States, 524 F.2d 729 (Ct. Cl. 1975). In specifying this additional condition, respondent has adopted the theory of Glensder Textile Co., supra, that managing partners with such interests in the business are not “analogous to directors of a corporation” because they act in their own interests “and not merely in a representative capacity for a body of persons having a limited investment and a limited liability.” (46 B.T.A. at 185; emphasis added.) It is thus necessary to look to the proprietary interest of GHL in order to determine whether the additional condition imposed by respondent’s regulations has been met.14
Unlike the taxpayers in Zuckman v. United States, supra, petitioners herein have failed to show that the limited partners did not own all or substantially all the interests in the partnerships involved herein within the meaning of the regulations. GHL’s interests in Mai-Kai and Somis were subordinated to those of the limited partners. Petitioners have not attempted to demonstrate that GHL’s capital interests had any present value during the years in issue, and it is clear that, because of the subordination provisions, it had no present right to income during those years. Petitioners would have us look to the anticipated return on the partnership properties in future years to determine that GHL had a substantial proprietary stake in the business independent of its management role. They have not, however, proved by competent evidence that such a return could in fact be expected, relying instead on unsupported projections;15 nor have they shown that any such future profit would be reflected in the present value of GHL’s interest. Although there was testimony that GHL expected profits from the subordinated interests when the limited partnerships were liquidated, we are not convinced that the possibility of such income at an indefinite future date had value during the years at issue. GHL reported gross income of $906,930.89 from fiscal 1969 to fiscal 1974, out of which only $118 represented a partnership distribution (from a partnership not involved herein).16
Furthermore, the limited partners in Somis and Mai-Kai possessed the right to remove GHL as the general partner. Thus, GHL’s right to participate in future growth and profits was wholly contingent on satisfactory performance of its management role,17 and not at all analogous to the independent proprietary interest of a typical general partner. In Glensder Textile Co., supra, our conclusion that centralization of management was lacking rested not only on the fact that management retained a proprietary interest but also on the fact that the limited partners could not “remove the general partners and control them as agents, as stockholders may control directors.” 46 B.T.A. at 185.
Petitioners argue that such power of removal and control could be given to limited partners under ULPA,18 that CULPA (which makes specific reference to such power) is a statute corresponding to ULPA, and that accordingly respondent’s regulation requires a decision in their favor on this issue. In our opinion, the regulation was not intended to provide a blanket exemption from association status for ULPA limited partnerships, regardless of the extent to which the partners by agreement deviate from the statutory scheme. It states only that a limited partnership in an ULPA jurisdiction generally will lack centralized management. See p. 176 supra. We have repeatedly held that an organization is to be classified by reference to the rights and duties created by agreement as well as those existing under State law. Bush #1,48 T.C. at 228; Western Construction Co., 14 T.C. 453, 467 (1950), affd. per curiam 191 F. 2d 401 (9th Cir. 1951); Glensder Textile Co., 46 B.T.A. at 183. The effect of such organic laws as ULPA (and CULPA) is to provide a rule which governs in the absence of contrary agreement. Where the theme is obscured by the variations, it is the latter which set the tone of the composition. Neither ULPA nor CULPA requires that the limited partners be given the right to remove the general partner; in fact, ULPA does not even mention such a possibility. By reserving that right, the limited partners in Mai-Kai and Somis took themselves out of the basic framework of ULPA and hence out of the shelter of the regulation, which is based on Glensder.
We conclude that Somis and Mai-Kai had centralized management within the meaning of respondent’s regulations.
3. Limited Liability
Unless some member is personally liable for debts of, and claims against, an entity, section 301.7701-2(d)(l), Proced. & Admin. Regs., states that the entity possesses the corporate characteristic of limited liability. The regulation provides that “in the case of a limited partnership subject to a statute corresponding to the Uniform Limited Partnership Act, personal liability exists with respect to each general partner, except as provided in subparagraph (2) of this paragraph.” The first sentence of subparagraph (2)19 establishes a conjunctive test, under which a general partner is considered not to have personal liability only “when he has no substantial assets (other than his interest in the partnership) which could be reached by a creditor of the organization and when he is merely a ‘dummy’ acting as the agent of the limited partners.” (Emphasis added.) In other words, personal liability exists if the general partner either has substantial assets or is not a dummy for the limited partners. We do not agree with respondent’s assertion, made for the first time in connection with the motion for reconsideration, that the regulation should be read disjunctively. Although the purpose of subparagraph (2) was ostensibly to delineate the conditions under which personal liability of a general partner does not exist, practically all the remaining material in the subparagraph outlines the conditions under which such personal liability does exist. In several examples, personal liability is said to exist, either because the general partner has substantial assets or because he is not a dummy for the limited partners. See Zuckman v. United States, supra. In no instance is there a suggestion that both conditions established by the first sentence of subparagraph (2) need not be satisfied.
In so concluding, we are mindful that in Glensder Textile Co., supra, the apparent source of the language in the regulations, the term “dummy” was arguably considered applicable to any general partner without substantial assets risked in the business. The opinion in Glensder states (46 B.T.A. at 183):
If, for instance, the general partners were not men with substantial assets risked in the business but were mere dummies without real means acting as the agents of the limited partners, whose investments made possible the business, there would be something approaching the corporate form of stockholders and directors. * * * [Emphasis added.]
Thus, lack of substantial assets seems to be considered the equivalent of being a dummy — an equivalence which respondent apparently sought to avoid by using the word “and” in his existing regulations.20
While it may be doubtful that GHL could be considered to have had substantial assets during the years in issue, we find it unnecessary to resolve this question since it is clear that GHL was not a dummy for the limited partners of Somis and Mai-Kai. Respondent contends that GHL fell within the “dummy” concept because it was subject to removal by the limited partners, and thus was subject to their ultimate control. While it is true that a mere “dummy” would be totally under the control of the limited partners, it does not follow that the presence of some control by virtue of the power to remove necessarily makes the general partner a “dummy.” It seems clear that the limited partners’ rights to remove the general partner were designed to give the limited partners a measure of control over their investment without involving them in the “control of the business”; the rights were not designed to render GHL a mere dummy or to empower the limited partners “to direct the business actively through the general partners.” Glensder Textile Co., 46 B.T.A. at 183. Moreover, the record indicates that the limited partners did not use GHL as a screen to conceal their own active involvement in the conduct of the business; far from being a rubber stamp, GHL was the moving force in these enterprises. With a minor exception, the persons controlling GHL were independent of and unrelated to the limited partners.
In view of the foregoing, we conclude that personal liability existed with respect to GHL, and the partnerships lack the corporate characteristic of limited liability.
4. Transferability of Interests
A stockholder’s rights and interest in a corporate venture are, absent consensual restrictions, freely transferable by the owner without reference to the wishes of other members. A partner, on the other hand, can unilaterally transfer only his interest in partnership “profits and surplus,” and cannot confer on the assignee the other attributes of membership without the consent of all partners (UPA secs. 18(g), 26, and 27). Respondent’s regulations recognize and rely upon this distinction.21
The regulations state that if substantially all interests are freely transferable, the corporate characteristic of free transferability of interests is present. Since we have concluded, for the purposes of this case, that the limited partners should be considered as owning substantially all the interests in Mai-Kai and Somis (see pp. 177-179 supra), we turn our attention to the question whether their interests were so transferable.
A transferee of a limited partnership interest may become a substituted limited partner with the consent of all members or under a right given in the certificate. CULPA sec. 15519. The partnership certificates of Mai-Kai and Somis are silent in this regard. However, when the provisions of the agreements relating to transferability and the power of an assignee to obtain a judicial amendment of the partnership certificate (see CULPA secs. 15502(1 )(a)X and 15525) are taken into account, it would appear that the agreements rather than the certificates should be considered the controlling documents herein. Indeed, petitioners do not seek to draw any solace from the certificates, positing their arguments as to lack of transferability on the agreements themselves.
Both partnership agreements permit the assignment of a limited partner’s income interest with the consent of the general partner, which may not unreasonably be withheld. Petitioners have not suggested any ground on which consent could be withheld. The requirement of consent, circumscribed by a standard of reasonableness, is not such a restriction on transfer as is typical of partnership agreements; nor is it the sort referred to by the regulations. In our opinion, the limited partners’ income rights were freely transferable. See Outlaw v. United States, 494 F. 2d 1376, 1384 (Ct. Cl. 1974).
Petitioners also argue that transferability is limited by the requirement that, in the event of a proposed assignment, a limited partner’s capital interest first be offered to other members under certain circumstances. While an assignment for less than fair market value could be prevented in this manner, there was no requirement that such an offer be made if an interest was to be sold to a third party at fair market value. Thus, there was no “effort on the part of the parties to select their business associates,” as is characteristic of the usual partnership arrangement. J. A. Riggs Tractor Co., 6 T.C. 889,898 (1946). We think that these interests possessed considerably more than the “modified” form of free transferability referred to in subpara-graph (2) of the regulation.
In sum, an assignee for fair consideration of a limited partner’s interest in Somis or Mai-Kai could acquire all of the rights of a substituted limited partner within the framework of the agreement and governing State law, without discretionary consent of any other member. Any restrictions or conditions on such a transfer were procedural rather than substantive. The right of assignment more closely resembles that attending corporate shares than that typically associated with partnership interests. Mai-Kai and Somis therefore possessed the corporate characteristic of free transferability of interests. See also n. 23 infra.
5. Other Characteristics
Both parties have identified other characteristics of Mai-Kai and Somis which they allege are relevant to the determination whether those entities more closely resemble partnerships or corporations. Some of these are within the ambit of the major characteristics already discussed. Petitioners point to the fact that, unlike a corporate board of directors, GHL as manager lacked the discretionary right to retain or distribute profits according to the needs of the business. This argument is in reality directed to the issue of centralized management. The same is true of respondent’s analogy between the limited partners’ voting rights and those of corporate shareholders. To be sure the partnership interests were not represented by certificates but this factor conceivably is more properly subsumed in the transferability issue. See Morrissey v. Commissioner, 296 U.S. at 360. Moreover, those interests were divided into units or shares and were promoted and marketed in a manner similar to corporate securities — an additional “characteristic” which we have not ignored, (see Outlaw v. United States, supra), but which we do not deem of critical significance under the circumstances herein. Similarly, we do not assign any particular additional importance to the facts that the partnerships have not observed corporate formalities and procedures (Morrissey v. Commissioner, supra; Giant Auto Parts, Ltd., 13 T.C. 307 (1949)) or that, unlike general partners, limited partners were not required personally to sign the partnership certificates. Finally, respondent argues that the limited partnerships resemble corporations because they provide a means of pooling investments while limiting the liability of the participants. Cf. Helvering v. Combs, 296 U.S. 365 (1935). As it relates to the facts of this case, this point is subsumed in our earlier discussion. To the extent that it presages an attempt to classify all limited partnerships as corporations, it is in irreconcilable conflict with respondent s own regulations.
6. Conclusion
The regulations provide that an entity will be taxed as a corporation if it more closely resembles a corporation than any other form of organization. They further state that such a resemblance does not exist unless the entity possesses more corporate than noncorporate characteristics. If every characteristic bears equal weight, then Mai-Kai and Somis are partnerships for tax purposes. We have found that they possess only two of the four major corporate characteristics and that none of the other characteristics cited by the parties upsets the balance.22 On the other hand, if the overall corporate resemblance test, espoused by Morrissey and adhered to by the regulations, permits us to weigh each factor according to the degree of corporate similarity it provides, we would be inclined to find that these entities were taxable as corporations. Each possessed a degree of centralized management indistinguishable from that of a pure corporation; the other major factors lie somewhere on the continuum between corporate and partnership resemblance. Were not the regulations’ thumb upon the scales, it appears to us that the practical continuity and limited liability of both entities would decisively tip the balance in respondent’s favor. However, we can find no warrant for such refined balancing in the regulations or in cases which have considered them. See Zuckman v. United States, 524 F.2d 729 (Ct. Cl. 1975); Outlaw v. United States, supra; Kurzner v. United States, 413 F. 2d 97, 105 (5th Cir. 1969) (“four equally weighted procrustean criteria”); secs. 301.7701-2(a)(3) and 301.7701-3(b)(2), Proced. & Admin. Regs., example (2). Cf. Estate of Smith v. Commissioner, 313 F. 2d 724, 736 (8th Cir. 1963) (“substantially greater noncorporate characteristics both in number and in importance”) (emphasis added). Only in connection with free transferability of interests do the regulations recognize a modified and less significant form of a particular characteristic.23
Our task herein is to apply the provisions of respondent’s regulations as we find them and not as we think they might or ought to have been written.24 See and compare David F. Bolger, 59 T.C. 760, 771 (1973). On this basis, petitioners must prevail.
Decisions will be entered under Rule 155.
Reviewed by the Court.
Fay and Hall, JJ., did not participate in the consideration and disposition of this case.All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.
The parties agreed by stipulation that the use of the terms “partner” or “partnership,” alone or in conjunction with the words “limited” or “general,” refers to the descriptive designations of the entities and their members under the law of the State of California, and is not intended to characterize their status for purposes of the Federal income tax.
Small errors in the stipulated column totals have not been explained.
Pursuant to sec. 580b of the California Code of Civil Procedure, in the event of default by Somis Orchards under the installment notes, no money judgment would lie against Somis Orchards with respect to the first and second installment notes and with respect to the third installment note to the extent of $82,750, and Kaiser Aetna’s remedy to that extent would be limited to requiring the sale of the citrus groves pursuant to the deeds of trust; however, the balance of the third installment note, $192,380, was not given as part of the purchase price of the citrus groves, and accordingly, Somis Orchards was liable therefor.
Interests in Somis were sold in “units” of $10,000. Some limited partners acquired half units or more than one unit.
That section reads as follows:
Sec. 7701(a)(3). Corporation — The term “corporation” includes associations, joint-stock companies, and insurance companies.
That section reads as follows:
Sec. 7701(a)(2). Partnership and partner — The term “partnership” includes a syndicate, group, pool, joint venture, or other unincorporated organization, through or by means of which any business, financial operation, or venture is carried on, and which is not, within the meaning of this title, a trust or estate or a corporation; and the term “partner” includes a member in such a syndicate, group, pool, joint venture, or organization.
In this connection, we note the following passage from the Supreme Court opinion in Morrissey v. Commissioner, 296 U.S. 344, 354-355 (1935):
“As the statute merely provided that the term ‘corporation’ should include ‘associations,’ without further definition, the Treasury Department was authorized to supply rules for the enforcement of the Act within the permissible bounds of administrative construction. Nor can this authority be deemed to be so restricted that the regulations, once issued, could not later be clarified or enlarged so as to meet administrative exigencies or conform to judicial decision.”
Sec. 301.7701-2(b), Proced. & Admin. Regs., provides:
(b) Continuity of life. (1) * * * if the death, insanity, bankruptcy, retirement, resignation, or expulsion of any member will cause a dissolution of the organization, continuity of life does not exist. If the retirement, death, or insanity of a general partner of a limited partnership causes a dissolution of the partnership, unless the remaining general partners agree to continue the partnership or unless all remaining members agree to continue the partnership, continuity of life does not exist. See Glensder Textile Company (1942) 46 B.T.A. 176 (A., C.B. 1942-1,8).
(2) For purposes of this paragraph, dissolution of an organization means an alteration of the identity of an organization by reason of a change in the relationship between its members as determined under local law. * * * An agreement by which an organization is established may provide that the business will be continued by the remaining members in the event of the death or withdrawal of any member, but such agreement does not establish continuity of life if under local law the death or withdrawal of any member causes a dissolution of the organization. Thus, there may be dissolution of the organization and no continuity of life although the business is continued by the remaining members.
(3) An agreement establishing an organization may provide that the organization is to continue for a stated period or until the completion of a stated undertaking or such agreement may provide for the termination of the organization at will or otherwise. In determining whether any member has the power of dissolution, it will be necessary to examine the agreement and to ascertain the effect of such agreement under local law. * * * if, notwithstanding such agreement, any member has the power under local law to dissolve the organization, the organization lacks continuity of life. Accordingly, a general partnership subject to a statute corresponding to the Uniform Partnership Act and a limited partnership subject to a statute corresponding to the Uniform Limited Partnership Act both lack continuity of life.
That section provided during the years in issue:
The retirement, death, insanity, removal or failure of reelection of a general partner dissolves the partnership, unless the business is continued by the remaining general partners and/or the general partner or general partners elected in place thereof
(a) Under a right so to do stated in the certificate, or
(b) With the consent of all members * * * (Cal. Stats. 1963, c. 870, sec. 5 at 2112.1
In light of our conclusion, infra at pp. 177-179, that GHL has not been shown to have had a substantial interest in the partnerships, it may be argued that it was not a “member” for the purpose of the regulations. Such an argument, however, we find to be structurally incompatible with the regulations, which consider the substantiality of a partner’s interest in the partnership only in connection with centralization of management and transferability of interests. Cf. sec. 301.7701-2(d)(2), Proced. & Admin. Regs., n. 19 infra (fourth sentence).
An assumption which, given the startling instances of unexpected bankruptcies in the current business world and the absence of involvement of the limited partners in the operations of GHL, is questionable.
It should be noted that under sec. 5(i) of the Bankruptcy Act, 11 U.S.C. sec. 23(i) (1970), bankruptcy of all general partners requires that the partnership itself be adjudicated bankrupt.
We need not determine what the consequences would be if the respondent’s regulations did not contain this additional condition. Cf. John Provence ‡1 Well, 37 T.C. 376 (1961), affd. 321 F. 2d 840 (3d Cir. 1963).
For example, petitioners blithely assume a 3-percent annual increase in the value of the real estate, which they characterize as “conservative,” and, in effect, ask us to take judicial notice that their assumption is valid.
The parties have stipulated that $1,588 was distributed as GHL’s share of cash flow but that all but $118 was distributed directly to a related entity. It is also stipulated that an additional $1,602.60 should have been distributed to GHL but was inadvertently distributed to the limited partners.
On removal, GHL would have been entitled to receive the cash value of its interest, both by statute (CUPA sec. 15038(1)) and, in the case of Somis, by agreement. To the extent of that value, GHL would have a vested present proprietary interest to protect. The petitioners had the burden of showing that such value existed and that it was substantial; they have done neither. GHL did not list any partnership interests as assets on its tax returns and apparently did not report any income either on the receipt of a partnership interest or on the lapse of a subordination clause. See secs. 1.61-2(d)(5) and 1.421-6(d)(2), Income Tax Regs.; Sol Diamond, 56 T.C. 530 (1971), affd. 492 F.2d 286 (7th Cir. 1974). Cf. sec. 83. It did, however, report as ordinary income $118 of cash flow received from another partnership. See n. 16 supra.
Cf. UPA sec. 31.
The full text of sec. 301.7701-2(d), Proced. & Admin. Regs., is as follows:
(d) Limited liability. (1) An organization has the corporate characteristic of limited liability if under local law there is no member who is personally liable for the debts of or claims against the organization. Personal liability means that a creditor of an organization may seek personal satisfaction from a member of the organization to the extent that the assets of such organization are insufficient to satisfy the creditor’s claim. A member of the organization who is personally liable for the obligations of the organization may make an agreement under which another person, whether or not a member of the organization, assumes such liability or agrees to indemnify such member for any such liability. However, if under local law the member remains liable to such creditors notwithstanding such agreement, there exists personal liability with respect to such member. In the case of a general partnership subject to a statute corresponding to the Uniform Partnership Act, personal liability exists with respect to each general partner. Similarly, in the case of a limited partnership subject to a statute corresponding to the Uniform Limited Partnership Act, personal liability exists with respect to each general partner, except as provided in subparagraph (2) of this paragraph.
(2) In the case of an organization formed as a limited partnership, personal liability does not exist, for purposes of this paragraph, with respect to a general partner when he has no substantial assets (other than his interest in the partnership) which could be reached by a creditor of the organization and when he is merely a “dummy” acting as the agent of the limited partners. Notwithstanding the formation of the organization as a limited partnership, when the limited partners act as the principals of such general partner, personal liability will exist with respect to such limited partners. Also, if a corporation is a general partner, personal liability exists with respect to such general partner when the corporation has substantial assets (other than its interests in the partnership) which could be reached by a creditor of the limited partnership. A general partner may contribute his services, but no capital, to the organization, but if such general partner has substantial assets (other than his interest in the partnership), there exists personal liability. Furthermore, if the organization is engaged in financial transactions which involve large sums of money, and if the general partners have substantial assets (other than their interests in the partnership), there exists personal liability although the assets of such general partners would be insufficient to satisfy any substantial portion of the obligations of the organization. In addition, although the general partner has no substantial assets (other than his interest in the partnership), personal liability exists with respect to such general partner when he is not merely a “dummy” acting as the agent of the limited partners.
In this connection, it is of interest to note that the proposed regulations were cast solely in economic terms, i.e., relied entirely on substantiality of assets, without any reference whatsoever to a “dummy” situation. See 24 Fed. Reg. 10,450,10,452 (1959), which reads as follows:
(d) Limited liability. (1) An organization has the corporate characteristic of limited liability if there is no member who is personally liable for the debts of or the claims against the organization. Personal liability means that a creditor of an organization may seek personal satisfaction from a member of the organization to the extent that the assets of such organization are insufficient to satisfy the creditor’s claim.
(2) For purposes of this paragraph, personal liability does not exist when the only members who are personally liable for the debts of the organization have no substantial assets which could be reached by a creditor of the organization. A member may contribute his services, but no capital, to the organization, but if such member is personally liable for the debts of the organization and has substantial assets, there exists personal liability. Furthermore, if the organization is engaged in financial transactions which involve large sums of money, and if the members who are personally liable have substantial assets, there exists personal liability although the assets of such members would be insufficient to satisfy any substantial portion of the obligations of the organization. However, personal liability does not exist when the members who are personally liable have risked no substantial assets.
Sec. 301.7701-2(e), Proced. & Admin. Regs., provides:
(e) Free transferability of interests. (1) An organization has the corporate characteristic of free transferability of interests if each of its members or those members owning substantially all of the interests in the organization have the power, without the consent of other members, to substitute for themselves in the same organization a person who is not a member of the organization. In order for this power of substitution to exist in the corporate sense, the member must be able, without the consent of other members, to confer upon his substitute all the attributes of his interest in the organization. Thus, the characteristic of free transferability of interests does not exist in a case in which each member can, without the consent of other members, assign only his right to share in profits but cannot so assign his rights to participate in the management of the organization. Furthermore, although the agreement provides for the transfer of a member’s interest, there is no power of substitution and no free transferability of interest if under local law a transfer of a member’s interest results in the dissolution of the old organization and the formation of a new organization.
(2) If each member of an organization can transfer his interest to a person who is not a member of the organization only after having offered such interest to the other members at its fair market value, it will be recognized that a modified form of free transferability of interests exists. In determining the classification of an organization, the presence of this modified corporate characteristic will be accorded less significance than if such characteristic were present in an unmodified form.
Indeed, considering the importance of predictability in applying respondent’s regulations, we would not be inclined to give such lesser characteristics controlling weight unless their materiality was unmistakable, a situation which does not obtain in this case.
Even if we had found that the interests of the limited partners in Somis and Mai-Kai possessed only such modified form of free transferability, petitioners would still prevail, since the balance would be two characteristics favoring partnership status and something less than two characteristics favoring corporate status.
As to respondent’s future possibilities, see Morrissey v. Commissioner, n. 8 supra.