*2187 Held, that petitioners constituted an "association" taxable as a corporation under the Revenue Acts of 1921 and 1924.
*1056 This is a proceeding for the redetermination of deficiencies in income tax as follows:
| Period | Deficiency in tax | 25 per cent penalty |
| Period Sept. 30 to Dec. 31, 1922 | $76.83 | $19.21 |
| 1923 | 866.93 | 216.73 |
| 1924 | 945.75 | 236.44 |
| 1925 | 727.48 | 181.87 |
| Total | 2,616.99 | 654.25 |
*1057 The sole issue raised by the pleadings is whether the Hillsboro Court Syndicate is a trust, taxable only as such, or whether it is an association, taxable a corporation.
FINDINGS OF FACT.
The petitioners are trustees for the Hillsboro Court Syndicate, with their principal office at Nashville, Tenn. The Hillsboro Court Syndicate was organized pursuant to the following agreement:
HILLSBORO COURT SYNDICATE AGREEMENT
(1) J. W. Pritchett, Geo. G. Thomas, and John A. Pritchett, partners under the style and firm name of Pritchett-Thomas Company, Stahlman Building, Nashville, Tennessee, *2188 are the owners in fee of a certain tract or parcel of land in Davidson County, Tennessee, particularly described as follows:
(Technical description of land by metes and bounds omitted.)
(2) Said Pritchett-Thomas Company agree to organize a Syndicate, to be known as "HILLSBORO COURT SYNDICATE," capitalized at $260,000.00, divided into 1300 shares, par value $100.00 per share, to be known as Preferred Certificates, and 1300 shares, par value $100.00 per share, to be known as Common Certificates more particularly hereinafter described, and to be disposed of as hereinafter set forth, provided however, that said Common Certificates shall not be issued, except as Preferred Certificates are issued, and then not to a greater extent or in a greater amount than the face value of the issued and outstanding Preferred Certificates.
(3) The objects and purposes of those becoming members of, or interested in, said Syndicate, are to acquire interests, according to their respective investments, in said above described lot and the buildings and improvements to be erected thereon, title to all of which shall be vested in trust, in J. W. Pritchett, Geo. G. Thomas, and John A. Pritchett, styled*2189 Syndicate Trustees, and their successors and assigns. The improvements to be erected on said lot will consist of a modern residential apartment house and garage in connection therewith, according to the plans and specifications of Asmus & Clark, Architects, Stahlman Building, Nashville, Tennessee, to be built by some reliable contractor or contractors, to be bonded in some reliable Bonding Company, to insure the faithful performance of all the requirements of the contract for the erection of said building and in accordance with the plans and specifications of said Architects, and under supervision of said Architects.
(4) Said Syndicate Trustees shall give active attention to the making of all contracts for the erection and equipment of said buildings or improvements on said lot, and shall use due diligence in requiring and securing full and faithful performance of all obligations on the part of any and all contractors in connection with said work. Said Trustees are expressly authorized and empowered to make any changes in plans and specifications of said Architects, which, in their judgment, is for the best interest of the syndicate. And upon the completion of said improvements*2190 they shall have full control of the operation and management of said property, including the renting and leasing of all apartments in said building and collecting the rents therefor. For securing tenants, collecting rents, and giving active supervision to the management and control of said property, said Syndicate Trustees shall receive the usual commission of 5% charged for such services by Real Estate Agents in Nashville.
*1058 All contracts, obligations, and other written instruments, including lease contracts executed by said Trustees, for and on behalf of said Syndicate shall be in the name of Hillsboro Court Syndicate, by said Syndicate Trustees. Said Syndicate Trustees are authorized and empowered to employ and discharge all agents and employees that may be necessary in the operation and management of said property, and fix their compensation or wages, and to employ and compensate legal counsel whenever in the opinion of said Trustees, such is necessary for their guidance or the protection of the property and interests under their management and control.
(5) Said preferred certificates shall be signed by the Syndicate Trustees, and shall be dated on the day of*2191 issuance, and be due and payable on or before November 1, 1932. Said certificates shall bear interest at the rate of 4% per annum from date of issuance until the first day of November, 1922, and from and after that date until the date of maturity, or prior retirement of same, shall bear interest at the rate of 8% per annum, payable semi-annually, and first semi-annual payment of interest to be due and payable May 1, 1923, and thereafter, at periods of six months, until the maturity or retirement of same.
Said preferred certificates may be called in and paid by said Trustees at any time; after one year, from date of same, whenever in the judgment of said Trustees, a sufficient amount has accumulated in the sinking fund, to justify such retirement, and in event any certificate is so called and retired, the holder of same shall receive therefor $105.00 for every $100.00 par value of same, provided, however, that said Syndicate Trustees, may at any time when in their judgment said sinking fund so justifies, retire any such preferred certificate, on application of the holder of same, at not more than face value.
(6) Said preferred certificates shall constitute a first charge against*2192 said lot and all improvements thereon, and on the total net income arising therefrom, and in event said apartment house and improvements are built and equipped from the proceeds derived from the sale of said preferred certificates, so that no loan is necessary to complete same, then, and in such event, said Syndicate Trustees will execute and record, in the Register's Office of Davidson County, Tennessee, a conveyance, or instrument in writing, which shall declare and make said preferred certificates a first lien upon said lot and improvements.
(7) In event, however, the proceeds arising from the sale of said preferred certificates are not sufficient to complete and equip said building and improvements on said lot, then said Trustees are fully authorized and empowered to make a building loan upon said property and improvements, for such length of time as said Trustees may deem desirable, but the amount of money so borrowed shall not exceed, or be greater than, the difference between the aggregate face value of said preferred certificates, issued and outstanding, and the sum of $130,000.00, and said Syndicate Trustees are further fully authorized and empowered to make execute and*2193 deliver to the person loaning said money, the notes or other obligations of said Syndicate signed by said Syndicate Trustees, bearing interest at a rate not greater than 8% per annum, and to secure same by deed of trust, mortgage, or other instrument required by the person or persons so advancing or loaning said money.
(8) Said Common Certificates in an amount equal to the par or face value of the preferred certificates sold and disposed of, shall be issued by said Syndicate Trustees to Pritchett-Thomas Company as compensation (in addition to the 5% hereinafter provided for) for services rendered and to be rendered by said Pritchett-Thomas Company in the promotion, organization, erection and *1059 equipment of said apartment building and improvements on said lot, and said Certificates shall not bear interest and shall not participate in the profits or earnings of said Syndicate until after all of said preferred certificates have been paid off in full and cancelled, after which they shall be entitled to all the net earnings and profits of said building and improvements, but the holders of said common certificates shall at all times have equal voting power with the holders*2194 of said preferred certificates.
(9) Said Pritchett-Thomas Company will give to the holders of preferred certificates, a common certificate, or certificates equal in face value to one-half the face value of such preferred certificate, or certificates, so held.
(10) At all meetings of those holding Syndicate Certificates, each certificate holder, whether of preferred or common certificates, shall have one vote for every $100.00 represented in the certificate or certificates, so held by him, which vote may be cast either in person or by written proxy, and a bare majority of the votes given at any such meeting upon any measure or question shall be sufficient to pass or defeat the same.
(11) The entire rents or income arising from the operation of said apartment house and improvements upon said lot, after the payment of all fixed charges, including insurance, repairs, taxes, and assessments, interest and payments on any loan or loans, and operating expenses, shall be applied to the payment of interest accruing upon said preferred certificates and the balance remaining shall be placed in a sinking fund to be held by the Syndicate Trustees, and used solely for the purpose of retiring*2195 said preferred certificates at maturity or prior thereto, as hereinbefore provided.
(12) Said Pritchett-Thomas Company (and the individuals composing same) will, when the preferred certificates to the aggregate face value of $40,000.00 have been sold, convey said lot hereinbefore described to J. W. Pritchett, Geo. G. Thomas, and John A. Pritchett, Syndicate Trustees, to have and to hold the same in trust, subject to the terms, provisions and conditions of this Syndicate Agreement, and said conveyors will accept in full payment therefor, preferred certificates in the aggregate amount, or face value of $17,500.00.
(13) It is agreed and understood that said Pritchett-Thomas Company are fully authorized and empowered to employ agents or brokers to assist them in selling or disposing or said Preferred Certificates and in raising any loan or loans that may be necessary for the erection and completion of said buildings, and they are authorized to deduct as brokerage or compensation therefor, not more than 5% of the total actual cost of said building and improvements on said lot.
(14) In the event, at any time after two years from the date hereof, the holders of the majority in interest*2196 of certificates, both preferred and common, may so desire and determine, they may, - and they are hereby fully authorized and empowered so to do, - organize or convert the Syndicate into a corporation, under the laws of the State of Tennessee with an authorized capital, in such sum as the majority of said certificate holders may determine, to be divided into shares common stock, par value of $100.00 per share, to which corporation all of the property and assets of the Syndicate shall be conveyed by the Syndicate Trustees, who are hereby authorized so to do, and all certificate holders hereby agree and bind themselves, their heirs, representatives and assigns, to accept and receive from the corporation its corporate stock, securities or obligations, in proportion to their then holding; provided, that holders of preferred certificates shall receive bonds, or other obligations of said corporation equal in face value to said certificates, bearing interest at the rate of 8% per annum, if such rate of interest then be lawful, if not then the lawful *1060 rate, secured by a lien upon said lot and improvements thereon, but subject to prior liens if any, and said holders of common*2197 certificates shall receive all of the common stock of said corporation which it may issue in exchange for, or on account of, the property and assets conveyed to said corporation.
(15) The Syndicate Trustees may, on their own motion, or on the written request of the holders of not less than one-third of the outstanding certificates, preferred and common, call a meeting of the certificate holders, both preferred and common, upon giving not less than two days written notice mailed to the given post office address of each certificate holder, and the action of a majority in interest, of both preferred and common certificate holders, represented at such meeting, shall be conclusive and binding.
(16) The American National Bank of Nashville, Tennessee, or some other Bank or Trust Company in Nashville, to be chosen by said Syndicate Trustees, shall be depository for all funds of the Syndicate, which can be drawn out or expanded on the joint check of not less than two of said Syndicate Trustees.
(17) Said Syndicate Trustees shall give bond in the sum of $25,000.00 for the faithful performance of their duties and obligations as Syndicate Trustees under the terms of this Syndicate Agreement, *2198 and all funds of the Syndicate, until otherwise ordered, shall be subject to the control and disbursement of said Syndicate Trustees.
(18) This agreement and the trust hereby created shall terminate on the first day of November, 1932, unless before that date, the agreement and trust may have been terminated by the organization of the Syndicate into a corporation, or by other proper action taken by the holders of said preferred and common certificates at a meeting called for such purpose. If, however, the agreement and trust has not been terminated before the first of November, 1932, then, and in such event, the Syndicate Trustees are authorized and empowered to sell said property at public or private sale upon such terms as they may deem best, with full power and authority to make, execute and deliver a deed to the purchaser, and apply the proceeds arising from said sale, First, to the payment of any expenses necessary to such sale, Second, to the retirement of any and all outstanding preferred certificates, at not more than par value, and third, to the holders of common certificates in proportion to their holdings.
(19) As soon as Preferred Certificates of the aggregate*2199 face value of $40,000.00 have been issued, contract will be let for said building. Said Syndicate Trustees shall also have power to enforce this agreement either by suit in their names as Syndicate Trustees, against each of the subscribers, or preferred certificate holders, or by forfeiture as liquidated damages, of all payments made by the subscriber, or certificate holder, in default, and may deprive the same of any right to participate in the benefits of this agreement.
In event preferred certificates to the aggregate face value of $40,000.00 shall not be sold or disposed of on or before the day of , 1922, then said Syndicate Trustees shall return to said preferred certificate holders the full amount paid by them on or for said preferred certificates.
(20) In event a vacancy should occur in the office of any of said Syndicate Trustees by death or resignation, or in event any of said Syndicate Trustees should otherwise become incapable of acting, then the majority in interest of all outstanding certificates, both preferred and common, may elect a successor to such trustee, or Trustees.
The land referred to in the foregoing instrument was conveyed to to the petitioners herein*2200 by deed dated May 8, 1922. Said deed contained, among other things, the following provisions:
*1061 TO HAVE AND TO HOLD said tract or parcel of land, with the appurtenances, estate, title and interest thereto belonging, to the said J. W. Pritchett, George G. Thomas and John A. Pritchett, Trustees, their successors in trust, and assigns, forever, with full authority and power hereby expressly granted to and vested in said Trustees, to manage and control said property according to the terms and provisions of a paper writing entitled "HILLSBORO COURT SYNDICATE AGREEMENT," entered into between Pritchett-Thomas Company, (a partnership composed of J. W. Pritchett, George G. Thomas, and John A. Pritchett), and other persons signing the said agreement and becoming interested in said Syndicate.
Reference is here made to said HILLSBORO COURT SYNDICATE AGREEMENT, a copy of which is herewith delivered to said Trustees for their control and guidance, and in pursuance of which said agreement, this conveyance in trust is made to said Trustees.
The petitioners held said land as trustees for a large number of beneficiaries. The trustees held no regular meetings, and did not keep any*2201 minutes of their proceedings. They hold no official position with respect to said syndicate, but are of equal rank. The trustees do not exercise or undertake to exercise any function or power other than as granted by the said agreement. The beneficiaries have never held a meeting since the organization of said syndicate, and do not exercise any control over or advise or participate in the management of the apartment house. The trustees rent the apartments, fix the amount of rent and pass upon the desirability of tenants. The certificate holders have nothing to do with the building, or the management or renting of the apartments. The trustees have never consulted the beneficiaries in regard to these matters. The certificate holders do not associate together and generally do not know who all the certificate holders are. The trustees have never made any report to the beneficiaries or certificate holders, and the latter have never, directly or indirectly, had any voice in the affairs of said syndicate. The Hillsboro Court Syndicate has no connection with any other syndicate. It is a complete entity, owning and operating through the trustees one apartment house known as the Hillsboro*2202 Court Apartments.
The individual beneficiaries personally paid income tax on the income received by them from said syndicate.
OPINION.
TRAMMELL: The Revenue Acts of 1921 and 1924, in section 230, impose a tax at specified rates "upon the net income of every corporation" and in section (2) provide that the term "corporation" includes "associations, joint-stock companies, and insurance companies." Said Acts also provide, in section 219, for an entirely different method of taxing the net income of trusts, the tax in some instances *1062 being payable by the fiduciaries and in others by the beneficiaries upon the amount of the net income distributable to each.
The respondent determined that the Hillsboro Court Syndicate was an "association" subject to tax as a corporation. The deficiencies involved were computed accordingly, and 25 per cent penalties added thereto for failure to file returns. The correctness of the respondent's computations is not questioned. However, the petitioners assert that the syndicate is not an "association" within the meaning of the statutes, but is a trust (of which they were the trustees), and that it is taxable only as such.
It is not*2203 contended that said syndicate is either a "joint-stock company" or an "insurance company," and therefore it can be taxed at the rates applicable to corporations only if the facts are such that it must be held, for income-tax purposes, to be an "association." If it is not an "association," it is not taxable as a corporation. What, then, is an "association" within the purview of the statute, and what is a "trust"? What is the material and fundamental distinction between them?
The form of organization involved in this proceeding is what is commonly known as a Massachusetts trust, and it is at once apparent that in many respects it bears a close resemblance to common law trusteeships, and in others, it possesses the attributes of an unincorporated joint-stock association.
So-called Massachusetts trusts may be divided into two classes. The first class consists of those where the trustees merely invest and collect dividends or interest or rental (from a single lease) and distribute such income among the shareholders. These are held to be common law trusteeships, as where a trustee under a will collects income and distributes it among the beneficiaries.
The second class is composed*2204 of business trusts, the trustees of which carry on active business enterprises for profit. These are simply unincorporated joint-stock associations. Cook on Corporations, vol. III, 8th ed., 2251, et seq., where it is further stated:
These two lines of decisions probably mark the true line of distinction. Certainly those who carry on an active business for profit, through others, are principals and not merely beneficiaries, irrespective of how much or how little power of management and control they exercise, actually or by the terms of the original agreement. A silent participant in the profits of a business concern is liable for its debts, even though he take no part in its management.
The theory that these trusts should be divided according to whether the shareholders exercise great or little powers of control is only confusing. The trust instrument may be drawn either way. * * * The real test is whether the shareholders or trustees or both combined carry on business; if so, they are a business trust, with liability for debts and taxes.
To sustain their contention, the petitioners herein rely upon and cite us to the decision of the Supreme Court of the United States*2205 in *1063 . The respondent relies mainly upon the decision of the same court in .
In , taxes were assessed against the plaintiffs as a joint-stock association within the meaning of the Income Tax Act of October 3, 1913, and were levied in respect of dividends received from a corporation that itself was taxable upon its net income. The plaintiffs were trustees of the Wachusett Realty Trust, which was organized under the following circumstances: A Maine paper-manufacturing corporation, with eight stockholders, had its mills on the Nashua River in Massachusetts, and owned outlying land to protect the river from polution. In 1912 a corporation was formed in Massachusetts. The Maine corporation conveyed to it seven mills and let to it an eighth that was in process of construction, together with the outlying lands and tenaments, on a long lease, receiving the stock of the Massachusetts corporation in return. The Maine corporation then transferred to the plaintiffs as trustees the fee of the property subject to lease, left the Massachusetts*2206 stock in their hands, and was dissolved.
In brief, the trustees received the property in trust to convert the same into money and distribute the net proceeds to the persons holding the trustees' receipt certificates. The trust was created because of the determination of the Maine corporation to dissolve without waiting for the final cash sale of its real estate, and was declared to be for the benefit of its eight stockholders. The purpose of the trust was not to engage in a business enterprise for profit, but to convert the property into money and distribute the net proceeds, including current net income, to the beneficiaries. It was on this broad principal that the court held that it was not taxable as an association. In its opinion, the court said:
The function of the trustees is not to manage the mills but simply to collect the rents and income of such property as may be in their hands, with a large discretion in the application of it, but with a recognition that the receipt holders are entitled to it subject to the exercise of the powers confided to the trustees. In fact, the whole income, less taxes and similar expenses, has been paid over in due proportion to the holders*2207 of the receipts.
In the later case of , which arose under the Revenue Acts of 1916 and 1918, the court referred to its opinion in Crocker v. Malley, and said:
This opinion * * * is to be read in the light of the trust agreement there involved, under which the trustees were, in substance, merely holding property for the collection of the income and its distribution among the beneficiaries, and were not engaged, either by themselves or in connection with the beneficiaries, in the carrying on of any business.
It is significant to note that the Wachusett Realty Trust, which the court in Crocker v. Malley held was not taxable as an association, was *1064 again before the court in Hecht v. Malley under the name of The Crocker, Burbank & Company Association, and it appearing that the original trust agreement had been modified, with the assent of the certificate holders, so that the trustees were authorized to acquire the entire property of the corporation and to carry on the business theretofore conducted by it, the court held it was no longer a nontaxable trust, but was taxable as an association.
*2208 Owning and renting an office building constitutes the carrying on of a business for profit. ; .
The Hillsboro Court Syndicate, through the petitioners as trustees, was engaged in the business of owning and operating an apartment house for profit. Certainly the functions of the trustees far exceeded the mere collection of the income from property in their hands and its distribution among the beneficiaries. They were, we think, actively engaged in carrying on a business venture for profit through the instrumentality of an organization of quasi-corporate form. Except only in the lack of control of the trustees by the certificate holders, the functions of the trustees were not, in any material respect, vastly different from those usually exercised by the directors of a corporation. While the matter of control or lack of control may be an element which should be taken into consideration (), we have held that the absence of control of the trustees by the shareholders would not convert into a trust*2209 what would otherwise be an association. .
In our opinion, the agreement set out in our findings of fact created an "association" within the meaning of the Revenue Acts of 1921 and 1924, which is taxable as a corporation. ; ; ; ; ;.
The determination of the respondent is approved.
Judgment will be entered for the respondent.