1936 BTA LEXIS 595">*595 1. Income from securities transferred by an individual to separate safe-deposit accounts after the execution of instruments purporting to create trusts for his wife and son, held, taxable to him, since the ambiguous wording of the instruments and his handling of account funds indicate that the alleged trusts are without substance.
2. Securities redeemed or sold in 1927, 1928, and 1929 were derived, through several intermediate transactions, from an exchange in 1916 for shares which were acquired before March 1, 1913. Held, for the purpose of computing gain in 1927, 1928, and 1929, that the exchange in 1916 was in a transaction described as a reorganization in section 203(f), Revenue Act of 1926, and that the basis is value on March 1, 1913, which was higher than prior cost and higher than value in 1916.
3. Gain derived from the redemption of debentures and preferred shares owned for two years, held, taxable not as capital gain, but as ordinary income.
34 B.T.A. 1107">*1108 1936 BTA LEXIS 595">*596 The Commissioner determined the following deficiencies in petitioner's income taxes:
| 1927 | $65,566.99 |
| 1928 | 79,143.08 |
| 1929 | 22,564.06 |
| 1930 | 1,077.92 |
1. He included in petitioner's individual income dividends and profits on securities alleged to belong to two trusts for his wife and son. 2. He used the 1916 basis in computing gain from sales and redemptions of debenture notes and shares of stock, having their origin in property acquired before March 1, 1913. 3. By affirmative answer, the Commissioner seeks to tax the profit on the redemptions as ordinary income instead of as capital gain. Other issues are settled by stipulation.
FINDINGS OF FACT.
1. Petitioner, a resident of Detroit, Michigan, on October 17, 1923, executed two instruments, naming, respectively, his wife, Rose A. Rands, and his son, W. C. Rands, Jr. Each instrument is as follows:
DECLARATION OF TRUST
This Declaration of Trust, made this 17th day of October, 1923, by W. C. Rands, of Detroit, Michigan,
WHEREAS, the undersigned, W. C. Rands, is possessed among other things of (2500) twenty five hundred shares of the common stock of the Motor Products Corporation, and is desirous of1936 BTA LEXIS 595">*597 creating a trust thereof for the benefit of Rose A. Rands, [William C. Rands, Jr.] and is likewise desirous of having the details of said trust set forth in a definite form:
NOW, THEREFORE, THIS DECLARATION WITNESSETH:
First: That I am possessed of (2500) twenty five hundred shares of the common stock of the Motor Products Corporation, which I now hold and shall continue to hold except as herein stated, for the use and benefit of my wife, Rose A. Rands [William C. Rands, Jr.].
Second: That the entire beneficial interest to the dividends on said stock shall be from hence forth the sole and individual property of the said Rose A. Rands, [William C. Rands, Jr.] until the termination of this trust as later specified.
Third: That the title to said stock shall nominally remain in me individually, and it shall not appear that I am holding said stock as trustee for said beneficiary; I shall be possessed of all rights to vote said stock at the corporate meetings of the company, in any manner that I may see fit, but notwithstanding the fact that said stock shall remain in my name individually, the said stock shall be deemed to be trust property, and the said beneficiary1936 BTA LEXIS 595">*598 shall be entitled to all dividends that may be declared upon said stock up to the time of the termination of this trust as later specified.
Fourth: That I shall have the right to sell and dispose of said shares of stock which now form the body of this trust, provided that prior to the next dividend date after such sale, I have purchased a like number of shares of 34 B.T.A. 1107">*1109 stock in the company or other first class securities and placed same in said trust, to the end that the dividend payable to said beneficiary shall remain undisturbed and she [he] shall continue to receive the same income as if such sale had not been made by me.
Fifth: That the dividends upon said shares of stock shall be made payable to said beneficiary, through orders given to the Motor Products Corporation; or in the event that said orders are not specifically given, the dividends upon said shares of stock, when and as received by me, shall be delivered over to said beneficiary.
Sixth: That in the event of my death prior to the death of said beneficiary, said trust shall be continued by the representatives of my estate until the death of said beneficiary, in like manner as if I were alive. 1936 BTA LEXIS 595">*599 Upon the death of said beneficiary this trust shall come to an end and said trust property shall then become a part of my estate, and be disposed of according to my will.
Petitioner was over fifty years of age in 1923, and worth between two and three million dollars. His wife and son were without independent means, and he desired to protect them against his own possible financial reverses. Upon execution of the instruments he endorsed in blank the certificates for two blocks each of 2,500 shares of Motor Products Corporation stock, then on deposit in his account with the safekeeping department of the First National Bank of Detroit, and redeposited them, with the instruments attached, in separate accounts opened in the same department in the names, respectively, of "Rose A. Rands Trust" and "William C. Rands, Jr., Trust." The shares, then paying a $5 annual dividend, were not transferred to him as trustee on the corporate books. This was because he wanted to retain voting control and to facilitate transfer in case of a sale. The instruments have not been amended, and property is still kept in the names of the trusts in the same bank. A savings account was also opened in the1936 BTA LEXIS 595">*600 name of each, in which cash receipts were deposited. Separate books were set up for each account and audited at intervals. Rose A. Rands and William C. Rands, Jr., were advised of the arrangement and were permitted access to the books and audits, but statements of account were not rendered them. Petitioner has made no substantial gifts to his wife or son since the execution of the instruments. The books were kept by the accountant in petitioner's office who kept petitioner's personal records and those of Rands, Inc., his personal holding or investment corporation. When they were opened on January 1, 1924, the Motor Products Corporation securities of each trust, which in November 1923 had been exchanged for 2,500 common and 2,500 preferred shares and 250 $1,000 debenture notes of a new corporation of the same name, were entered at a value of $187,500, the same value at which the original shares had appeared on petitioner's books. This book value continued until January 1, 1927, when at the suggestion 34 B.T.A. 1107">*1110 of the auditor they were written up to about $390,000 to reflect the March 1, 1913, value of the original shares. The following are the book amounts of corpus at the1936 BTA LEXIS 595">*601 end of 1927 and succeeding years:
| 1927 | 1928 | 1929 | 1930 | |
| Rose A. Rands trust | $447,555.87 | $838,702.58 | $874,738.05 | $875,396.91 |
| W. C. Rands, Jr., trust | 390,180.84 | 766,994.93 | 766,818.85 | 773,634.91 |
Changes in the trust property have resulted from redemptions, and sales and purchases, sometimes executed through brokers. Cash proceeds from such transactions were deposited in the trusts' bank accounts and reinvested in other property deposited in their safekeeping accounts, and set up on the books as their property. The safekeeping department, on petitioner's order, would deliver or receive shares sold or bought, a check for the price and receipts simultaneously passing. The trusts' securities always bore endorsements in blank; those in the accounts of petitioner and Rands, Inc., did not. Petitioner alone was empowered to sign trust checks and withdraw trust securities, and never delegated this authority. Among the assets appearing on the balance sheet of the Rose A. Rands trust as of December 31, 1928, are lands, building, and furnishings described as "Algonac residence property", valued at $77,013.33. Some withdrawals from Rose A. Rands' account1936 BTA LEXIS 595">*602 with the trust from December 1927 are described as "Algonac Expenses."
Petitioner, in administering the trust, regarded the beneficiaries as entitled to interest and dividends received by the trusts but not to the profits resulting from a disposition of corpus. A part of such income was distributed to them as they required it. The distributions to the beneficiaries were as follows:
| Year | Rose A. Rands | W. C. Rands, Jr. |
| 1924 | $1,036.28 | $2,588.06 |
| 1925 | 2,546.62 | 4,555.86 |
| 1926 | 212.67 | 3,671.41 |
| 1927 | 20,420.12 | |
| 1928 | 13,564.54 | 44,358.49 |
| 1929 | 33,066.09 | 5,732.39 |
| 1930 | 17,606.71 | 2,760.15 |
The books do not make a segregation of income from corpus nor specify the aggregate income to which the beneficiaries were entitled during the several years, but do show profits and income received on the securities held, which, as corrected by the auditor, were as follows:
| ROSE A. RANDS TRUST | ||||
| 1927 | 1928 | 1929 | 1930 | |
| Profit on stock sales | $20,000.50 | $257,190.00 | $29,009.04 | |
| Profit on bond redemption | 92,289.49 | -1,222.45 | ||
| Dividends | 17,687.50 | 21,018.75 | 52,630.61 | $13,075.00 |
| Interest | 17,429.82 | 17,506.69 | 18,213.90 | 10,319.11 |
| Total | 147,407.31 | 294,492.99 | 99,853.55 | 23,394.11 |
| W. C. RANDS, JR., TRUST | ||||
| Profit on stock sales | 11,597.50 | 258,519.84 | 21,987.76 | -1,199.77 |
| Profit on bond redemption | 92,175.50 | |||
| Losses on real estate | -389.00 | -114.69 | -20,087.44 | |
| Dividends | 17,687.50 | 19,581.25 | 49,680.59 | 12,271.25 |
| Interest | 16,796.04 | 19,905.46 | 15,000.79 | 9,567.97 |
| Total | 137,867.54 | 297,891.86 | 66,581.70 | 20,639.45 |
1936 BTA LEXIS 595">*603 34 B.T.A. 1107">*1111 Funds were transferred to Rands, Inc., in 1929 and 1930 as loans on open account. No notes were given and no interest paid. The amounts of these loans, which were carried on the books as trust assets and have been repaid in part, were as follows:
| 1929 | 1930 | |
| Rose A. Rands trust | $354,338.97 | |
| W. C. Rands, Jr., trust | 127,446.39 | $457,767.71 |
No loans were made to petitioner from the trust accounts. Call loans were made from the trust accounts to brokers.
Income tax returns were filed by the petitioner for each alleged trust in 1927, 1928, 1929, and 1930.
In determining the petitioner's income taxes, the Commissioner included the following amounts of income and profits of the two trust accounts in petitioner's ordinary income and capital gains:
| Year | Ordinary income | Capital gains |
| 1927 | $88,267.53 | $295,985.00 |
| 1928 | 57,613.59 | 526,702.00 |
| 1929 | 97,860.11 | 80,688.84 |
| 1930 | 12,901.11 |
2. and 3. The 5,000 shares of Motor Products Corporation stock which petitioner transferred to the two trusts on October 17, 1923, were part of a total of 10,465 shares which he held and which were exchanged on November 1, 1923, for 10,4651936 BTA LEXIS 595">*604 shares of common and 10,465 shares of preferred stock and 1,203 debenture notes of a par 34 B.T.A. 1107">*1112 value of $1,000 each in a new corporation of the same name in the course of a nontaxable reorganization. In 1927 the debenture notes were redeemed at par, and petitioner received $313,000 for the 313 which he then held in his name and account; similarly there was received for each trust $250,000 for the 250 notes held in its account. After a 100 percent common stock dividend in 1927, petitioner sold 2,630 of the common shares in his account in 1928 for $497,148.55, and for each trust account sold 2,000 of the common shares in its account in 1928, the Rose A. Rands trust account receiving $272,865 and the W. C. Rands, Jr., trust account receiving $273,552.50 therefor. In 1929 the 2,500 preferred shares in each trust account were redeemed, each receiving $75,000 therefor.
Petitioner's ownership of the 10,465 shares in the earlier Motor Products Corporation resulted from various purchases and sales for cash and an original acquisition of 5,948 shares, which were received, together with cash, in exchange for his stock in the Rands Manufacturing Co. in the course of a consolidation1936 BTA LEXIS 595">*605 of the latter and four other corporations into the original Motor Products Corporation on June 3, 1916. The Rands Manufacturing Co., known until 1905 as the Wheeler Manufacturing Co., was a Michigan corporation with an authorized capital of $25,000, engaged in the manufacture of automobile parts and accessories. Petitioner's investment in it was not in excess of this amount. On March 1, 1913, the fair market value of his stockholdings in it was $1,669,597.97.
On June 3, 1916, the Rands Manufacturing Co. and four other corporations, engaged in the same business, consummated a plan of consolidation into the Motor Products Corporation. Pursuant thereto, one of the incorporators of the latter formally offered to procure the conveyance to it of the assets of the five consolidating corporations in consideration of the issuance of its stock to him. This offer was accepted, its stock was issued and immediately exchanged with shareholders of the five consolidating corporations for their stock, which was immediately transferred to the Motor Products Corporation. Thereupon the Motor Products Corporation formally took over all the assets of the consolidating corporations. Petitioner1936 BTA LEXIS 595">*606 was president of the corporation from 1916 to his retirement in 1923.
In exchange for his shares in the Rands Manufacturing Co., which were the same in amount as those held by him in 1913, petitioner received $738,093.60 in cash and 5,948 shares of Motor Products Corporation stock, having a value of $446,100, or a total of $1,184,193.60. He claimed no loss deduction on his 1916 income tax return because of this transaction, since the original cost of the shares exchanged was not in excess of $25,000.
The parties are agreed that the basis to petitioner of each $1,000 debenture note received upon the reorganization of 1923 and redeemed 34 B.T.A. 1107">*1113 in 1927 is $670.55851 if its basis should be related back to the March 1, 1913, value of Rands' shares in the Rands Manufacturing Co., or $408.03 if its basis should be related back to the value of the Motor Products Corporation shares received upon the consolidation of 1916.
The parties are agreed that the basis to petitioner of each common share of Motor Products Corporation sold in 1928 is $8.20624 if the basis should be related back to the March 1, 1913, value of petitioner's shares in the Rands Manufacturing Co., or $5,10051936 BTA LEXIS 595">*607 if its basis should be related back to the value of the Motor Products Corportion shares received upon the consolidation of 1916.
The parties are agreed that the basis to petitioner of each preferred share of Motor Products Corporation stock received upon the reorganization of 1923 and redeemed in 1929 is $28.52965 if its basis should be related back to the March 1, 1913, value of petitioner's shares in the Rands Manufacturing Co., or $18.306 if its basis should be related back to the value of the Motor Products Corporation shares received upon the consolidation of 1916.
In determining petitioner's income taxes for 1927, 1928, and 1929, the Commissioner included in capital gains profits arising from the sales or redemptions of the notes and shares in Motor Products Corporation.
OPINION.
STERNHAGEN: 1. The respondent has determined that for each of the four years in question the income which the petitioner has treated as income of the two trusts, one for his wife and one for his son, was in reality income of his own, taxable to him as an individual. In the notice of deficiency covering the years 1927, 1928, and 1929, the Commissioner held "that the beneficial title to1936 BTA LEXIS 595">*608 the corpus of the trusts created by you for your wife and son was never relinquished, and the income from same represents taxable income to you as grantor." This is assailed by the petitioner, who vigorously insists that by the two instruments of 1923 he established trusts consisting of 2,500 shares of Motor Products Corporation stock, or such other property as by exchange or reinvestment should be acquired in lieu thereof. The respondent argues that both from the language of the instruments themselves and from the method and circumstances of their administration, there were in truth no trusts; and that in any event, if trusts may be recognized, they must be limited to the income from the alleged funds after it is derived by the petitioner as owner of the securities. In the evidence can be found detailed facts which tend to support each side of the controversy, and the ultimate decision can only be reached after carefully weighing the entire record.
34 B.T.A. 1107">*1114 The instruments themselves give the impression of declarations of trust in behalf of the wife and son of 2,500 shares of Motor Products stock, with the right in the trustee to sell and reinvest the proceeds and also to1936 BTA LEXIS 595">*609 vote the shares. A closer examination, however, indicates that all that the so-called beneficiary was said to have was a right to receive the dividends from the original shares or an equivalent amount of periodical income from the successor securities during the life of the beneficiary. All of the substantial rights and incidents of ownership in the principal were retained by Rands as an individual, without let or hindrance from either the beneficiary or any other person. The only obligation which he purported to impose upon himself was the duty to distribute income "to the end that the dividend payable to said beneficiary shall remain undisturbed"; and this only so long as the beneficiary lived. Thereafter both the securities and the income therefrom were his own or his estate's.
If there were any doubt that the interest of the beneficiary was in each case limited to the dividends or equivalent income, this doubt would be dispelled by Rands' testimony as to the understanding and habitual practice with which he administered the trusts. He said that the beneficiary was in no event entitled to a distribution of gains or profits in the corpus, and the instrument itself indicates1936 BTA LEXIS 595">*610 that the income from such gains and profits was not distributable. Consistently with this practical oral construction by the trustee of his own duties under an ambiguous instrument, the evidence shows that no profit has been in fact distributed and less income than the amount of dividends on the original shares. Thus the effect of the arrangement has been that Rands has never parted nor undertaken to part with the so-called corpus, but has retained the right and has fully exercised the right to build up the corpus for himself and his estate, qualified only by the undertaking to distribute an amount equivalent to the dividends upon the original 2,500 shares. In practice, so much only has been actually distributed as "they required"; whether in the judgment of Rands or of the beneficiaries is not clear.
These is evidence to indicate that Rands conducted himself as the sole and unqualified owner of the funds and in a manner wholly inconsistent with a proper regard for fiduciary responsibility. Large amounts which were supposed to be in the trust funds were loaned to Rands, Inc., a corporation of which Rands held substantially all the shares and which was engaged in active speculative1936 BTA LEXIS 595">*611 trading in the stock market (see ). This loans were made without interest or security. Substantial amounts were also loaned to brokers on call. Whether in fact these uses of the funds proved to be profitable or otherwise is beside the point. Their significance is as an indication that no one regarded them as 34 B.T.A. 1107">*1115 trust funds in the custody of a fiduciary or that they were subject to any restrictions by virtue of the instruments of 1923.
Furthermore, although there was a showing on the books of account kept by Rands' bookkeeper of separate accounts attributed to the two trusts, this showing itself indicates that there was no nice regard for the existence of trust property and income and no segregation of distributable income, nondistributable profits or increment, or the sources of such distributions or withdrawals as were made. We think, therefore, that a full and careful consideration of all the evidence offers no escape from the view that the alleged trusts were wholly without substance and that the income which the taxpayer omitted from his own return upon the theory that it was separately taxable to each of the two trusts1936 BTA LEXIS 595">*612 is properly to be taxed as his own. .
This is not to say as a general rule that the income of a trust legally created and administered may be lightly attributed to the settlor and taxed to him. When, however, one attempts such a scheme, particularly by placing himself in the equivocal position of being both the settlor and the trustee, he must execute the plan with the most exact, even meticulous, adherence to it. The integrity of each detailed act must be established. If there is any shilly-shallying by him, he can not expect the Government to give recognition to a structure for which he himself has less than a high regard. While a tax-saving motive does not vitiate a plan otherwise legal, it may serve, when coupled with loose and inexact administration, to confirm a suspicion that the plan is one without substance or reality. This we think is the situation here.
As an alternative to the view that there were no trusts whatever, we think that at most the instruments established only an obligation upon Rands to hold the income in trust for these beneficiaries after it was derived by him from the securities, and that the securities1936 BTA LEXIS 595">*613 themselves were at all times his own. Thus the legal effect was only as an assignment of future income, and as such did not operate to exclude it from his taxable income. It is only when the income-producing property is itself transferred that the income therefrom is no longer attributable to the transferor. . Here it seems that at most Rands attempted to transfer the property itself to himself as trustee for himself and his estate as beneficiary, and the present ownership of the principal was still in him. Upon this view, if not upon the other, the petitioner has failed to establish that the income should, as a matter of law, be excluded from his return.
2. In determining the amount of gain derived from the redemption of the preferred shares and the debenture notes and from the sale of the common shares of the Motor Products Corporation, the 34 B.T.A. 1107">*1116 respondent used as the basis for computation the agreed value of the old Motor Products shares received in 1916 rather than the higher value of the Rands Manufacturing Co. shares on March 1, 1913. The petitioner claims to be entitled to the use of March 1, 1913, value1936 BTA LEXIS 595">*614 as the basis. This controversy is precisely the same as that presented in , and, as in that proceeding, the decision here is that the respondent's determination is in error. The March 1, 1913, value is the correct basis to be used.
3. The gain derived from the redemption of the Motor Products debentures and preferred shares was treated by the respondent in his determination of the deficiency as capital gain. He now, by affirmative pleading, claims that the capital gain provision does not apply to the proceeds of redemption because the redemption of shares or debentures is not a sale or exchange; and that such proceeds are therefore properly to be taxed as ordinary income. This question has been fully considered in , overruling , and followed in , and . We can see no distinction in principle, and the respondent's contention that the proceeds shall be treated as ordinary income is sustained.
Reviewed by the Board.
Judgment will be entered1936 BTA LEXIS 595">*615 under Rule 50.
SMITH and LEECH dissent from the holding that the alleged trusts are without substance.