*2362 Held that a syndicate known as the Nutt-House-Bradley Syndicate was not an association taxable as a corporation under the revenue acts.
*584 This proceeding was brought to determine the liability of the petitioner as transferee of the assets of the Nutt-House-Bradley Syndicate for income taxes amounting to $614.45, $4,371.87, $4,913.84, $6,076.06, and $109,426.90, aggregating $125,403.12, for the years 1919, 1920, 1921, 1924, and 1925, respectively.
The respondent determined that the Nutt-House-Bradley Syndicate was an association taxable as a corporation. The petitioner asserts that the respondent erred in such determination and by stipulation the hearing was limited to that question, leaving for later decision, if necessary, the petitioner's liability as transferee or distributee of the assets of the Nutt-House-Bradley Syndicate.
FINDINGS OF FACT.
The petitioner is a corporation organized under the laws of the State of Delaware. It owns all of the capital stock of the Van Sweringen Co., a corporation organized in 1913 under the laws*2363 of the State of Ohio. The Van Sweringen Co. was engaged principally in the promotion of a large real estate enterprise known as the Village of Shaker Heights and located about six miles from the public square of Cleveland, Ohio. Shaker Heights is an attractive residential suburb and was projected as a development catering to the more wealthy and exclusive citizens of Celveland.
*585 In 1917 the Van Sweringen Co. found itself in financial difficulties. It had outstanding bond issues aggregating $1,578,500, and notes aggregating $3,262,000, or total liabilities of $4,840,500. Those securities had been sold through the Citizens Savings & Trust Co., the Guardian Savings & Trust Co., the First Trust & Savings Co. (later merged into the Union Trust Co.), Bonbright Herrick & Co., Hayden Miller & Co., and other banks and investment houses in the city of Cleveland. Furthermore, it became essential to establish a rapid transit service on a private right of way from Shaker Heights to the public square of Cleveland, in order to increase the desirability and marketability of the real estate. To provide for such expenditures and to liquidate its matured and maturing obligations, *2364 a method to rehabilitate the company's financial status was adopted and called "The Van Sweringen Company Plan for Readjustment of Real Estate, Mortgage and Unsecured Indebtedness." Due to the intervention of the World War, the operation of this "Plan" was suspended until 1919, when it was revived on February 1 of that year with inconsequential modifications, but with material additions, as will be noted hereafter. The Plan was comprehended primarily in the following five documents, all bearing date February 1, 1919.
1. The Van Sweringen Company Plan for Readjustment of Real Estate Mortgage and Unsecured Indebtedness.
2. The Van Sweringen Company Plan for Underwriting a Portion of New Notes described in the Van Sweringen Company's Plan for Readjustment of Real Estate Mortgage and Unsecured Indebtedness and Note Purchase Syndicate Agreement.
3. First Mortgage and Collateral Trust Agreement between The Van Sweringen Company and The First Trust and Savings Company, Trustee.
4. Agreement and Declaration of Trust between The First Trust and Savings Company, as Trustee, and the Holders of Land Trust Certificates of Equitable Ownership in Property Leased to the Van Sweringen*2365 Company.
5. Lease from the First Trust and Savings Company, Trustee, to The Van Sweringen Company.
For various reasons six supplemental agreements were attached and made part of the various documents above enumerated and are as follows:
1. Supplemental Syndicate Agreement dated Oct. 20, 1921.
2. Second Supplemental Syndicate Agreement dated July 25, 1923.
3. Supplemental Lease Agreement dated Oct. 20, 1921.
4. Second Supplemental Lease Agreement dated July 25, 1923.
5. First Supplemental Land Trust Agreement dated October 20, 1921.
6. Second Supplemental Land Trust Agreement dated July 25, 1926.
The first five documents mentioned above, dated February 1, 1919, set forth in elaborate detail the plan for readjustment and financial resuscitation, and comprise many pages of printed matter. The Plan *586 was initiated by the Van Sweringen Brothers and was participated in by the following persons, representing various creditor interests:
J. R. Nutt, president and chairman of the board of the Union Trust Co. (formerly president of the Citizens Savings & Trust Co.).
J. A. House, president of the Guardian Trust Co. (formerly the Guardian Savings*2366 & Trust Co.).
C. L. Bradley, president of the Cleveland Union Terminals Co. (formerly vice president of Union Commerce Bank).John Sherwin, president of Metropolitan Railways (formerly chairman of the board of the Union Trust Co., and before that president of the First National Bank).
W. S. Hayden, senior partner of Hayden, Miller & Co., investment bankers.
Frank H. Ginn, attorney.
C. W. Stage, office counsel for the Van Sweringen Co.In 1919, $1,818,500 of bonds and notes of the Van Sweringen Co. had matured and remained unpaid. In addition the company had other obligations in large amounts which likewise it could not pay. It owned an extensive acreage of valuable real estate which was non-productive and unimproved. With frozen assets of such a character the company could not appeal to the public for funds. In addition, over $2,000,000 was required to pay taxes and other pressing obligations and to complete the construction of the rapid transit line from Shaker Heights to the public square of Cleveland. Consequently, as a part of the Plan the following persons obligated themselves to secure the advancement of $2,075,000 under the conditions hereinafter set forth, *2367 and to receive notes therefor:
| The Terminal Properties Co | $1,200,000 |
| J. J. Albright, W. H. Gratwick, and O. P. and M. J. Van Sweringen | 375,000 |
| J. R. Nutt | 100,000 |
| Hayden, Miller & Co | 100,000 |
| C. L. Bradley | 100,000 |
| K. V. Painter | 100,000 |
| F. E. and P. A. Myers | 100,000 |
| 2,075,000 |
The most simple method of securing the money from the above persons to assist the Van Sweringen Co. in its financial difficulties was for them to mak a direct loan to that company. However, the notes evidencing such a loan would have been taxable as personal property in Cuyahoga County. To avoid this tax burden the issuance of land trust certificates in lieu of such notes was incorporated as a part of the Plan, such certificates being nontaxable as personal property in the State of Ohio. This feature created unusual complications in the fabrication, development and consummation of the Plan.
*587 As perfected, the Plan was projected and established in its entirety as of February 1, 1919. In its essentials it is as follows:
The Readjustment Plan set forth the existing obligations of the Van Sweringen Co., the cash requirements needed for the payment of its unsecured*2368 debts and for the completion of the rapid transit line and for new working capital, and also the proposed issue of new securities and the disposition of the funds arising therefrom. Notes for $4,000,000 secured by a first mortgage on certain specified properties executed to the First Trust & Savings Co., trustee, and a first preferred cumulative 8 per cent stock issue for $1,017,805 constituted such securities. Of the said $4,000,000 of notes, $2,075,000 represented the amount allotted to the payment of unsecured debts, the construction of the rapid transit line and the acquisition of new capital. A financial statement of the Van Sweringen Co. was included in the document. The Plan contained also a detailed description of the notes and the preferred stock and also the provisions relating to the rights of the owners of those securities. John Sherwin, Parmely Herrick, J. R. Nutt, J. A. House, and W. S. Hayden were named as "readjustment managers" to represent the noteholders and were given power to determine the usual details of operation.
The Underwriting Plan supplemented the Readjustment Plan. It provided that the $2,075,000 in notes, as above mentioned, should be underwritten*2369 by a syndicate. A note purchase syndicate agreement attached to the Underwriting Plan designated J. R. Nutt, J. A. House, and C. L. Bradley as "managers" and they are known generally in this proceeding as "syndicate managers." It is this syndicate which is charged by the respondent to be liable for the taxes involved in this proceeding. The Underwriting Plan provided that notes should be purchased at 97 1/2 per cent of their par value, but not until a loan equivalent to 60 per cent of the entire note issue should be secured. Immediately upon payment of the remaining 37 1/2 per cent by the subscribers to the syndicate, the notes so purchased were to be converted into equitable interests in real estate as evidenced by land trust certificates. Each certificate was to represent 1/4150 of the trust estate and was of the par value of $500. The method of procedure pertinent to the issuance of such certificates was contained in the Agreement and Declaration of Trust hereinafter described. The real estate securing the $2,075,000 note issue was to be leased to the Van Sweringen Co. for $145,250 per annum, thus returning to the noteholders interest on their notes at the rate of 7 per cent*2370 per annum. The lessee was given the option to purchase the said real estate as specifically listed in the Trust Agreement and described in great detail in the lease hereinafter mentioned, for the sum of $2,697,500, calculated on the schedule of prices set forth *588 in the Declaration of Trust. This document contained the statements that the Land Trust Certificates would not be subject to personal property taxes in Ohio and that any underwriters' profit would accrue at such time as the real estate was sold. The Agreement concluded with the following paragraph:
The Managers mentioned in the Syndicate Agreement are to have full power and authority to agree upon, conclude and decide the exact terms and conditions of the Syndicate Agreement, the Agreement and Declaration of Trust, and the Land Trust Certificates and the Syndicate Loan and to act for and in respect of the syndicate subscribers for all matters arising in connection with carrying out the provisions of the Plan.
The Note Purchase Syndicate Agreement contained elaborate provisions for the formation of the syndicate and of the rights, privileges and duties of its component subscribers. The provisions germane*2371 to this case are as follows:
The Subscribers hereby irrevocably nominate and appoint the Managers as their attorneys and agents with full power and authority to do any and all acts and enter into and execute any and all agreements or other instruments necessary or proper or by the Managers deemed expedient in the premises to carry out and perform the purposes of this agreement, and to that end have absolute control of the notes to be purchased as fully and in all respects as if they were the absolute owners thereof with full power to borrow money thereon and upon the Land Trust Certificates issued in lieu of said notes upon conversion of the same as provided in said Underwriting Plan, dated February 1, 1919, and to pledge the same or any part thereof, and the liability of the Subscribers under this agreement as security for the payment of money borrowed; also to sell and dispose of the Land Trust Certificates constituting the trust estate at such prices and upon such terms as the Managers in their judgment shall deem for the best interests of the Syndicate.
* * *
The Managers are hereby invested with full and complete authority by and on behalf of the Subscribers to agree upon, *2372 conclude and decide the exact terms and conditions of the Agreement and Declaration of Trust and of the Land Trust Certificates, and all matters involved in the Underwriting Plan of February 1, 1919, and the Managers may organize and act as a Board choosing a chairman and a secretary who need not be one of the Managers, and the Managers shall have power to act only upon affirmative vote of all members present at a called meeting or by unanimous agreement of all members evidenced by instruments in writing. In the event of the operations of the Syndicate resulting in loss, such losses shall be borne by the Subscribers pro rata.
The First Mortgage and Collateral Trust Agreement was a lengthy document covering 91 printed pages. It conveyed hundreds of acres of land in Shaker Heights and its vicinity and also various rights, interests and other personal property owned by the Van Sweringen Co. It set forth in elaborate detail the rights of the Van Sweringen Co. and the noteholders or beneficiaries and the duties of the trustee under the trust. It contained extended provisions governing the release of land upon the payment of certain amounts and the privilege *589 afforded to*2373 the preferred stockholders of the Van Sweringen Co. and to the said noteholders to convert their securities into real estate. The right of conversion accruing to the holders of the notes in the amount of $2,075,000, as described above, applied to certain lands in their entirety as segregated and listed in "Division II" of the real estate conveyed. Such lands were the same as were made the subject of the lease from the trustee to the Van Sweringen Co.
The Agreement and Declaration of Trust made by the First Trust & Savings Co., its successor being the Union Trust Co., declared that it held as trustee for the use and benefit of its beneficiaries those lands enumerated in "Division II" above mentioned. Those lands, however, were subject to the lease described hereafter. The beneficial interest in the trust estate was divided into 4,150 equal shares, represented by certificates of equitable ownership termed "land trust certificates." They were in the following form:
Number
Interest 4150ths.
UNITED STATES OF AMERICA,
STATE OF OHIO
CONVERTIBLE LAND TRUST CERTIFICATE
OF
EQUITABLE OWNERSHIP
IN
PROPERTY LEASED TO
THE VAN SWERINGEN COMPANY
This Certifies That is*2374 the owner of four-thousand one hundred and fiftieths ( /4150ths) of the equitable ownership and beneficial interest in certain property in Cuyahoga County, Ohio, title to which is held by The First Trust and Savings Company, of Cleveland, Ohio, as Trustee, for the benefit of the holder or holders of this certificate and of similar certificates issued or to be issued by said Trustee to evidence ownership in said beneficial interest in said property so held by it in trust. All of said certificates are issued or are to be issued under the in pursuance of an agreement and declaration of trust in which said property is specifically described, dated February 1, 1919, between said Trustee and such persons, partnerships or corporations as parties of the second part, as may become parties thereto by the acceptance of certificates of equitable ownership of like tenor herewith in the trust thereby created, which agreement and declaration of trust, hereinafter referred to as the "Declaration," is of record in the office of the Recorder of Cuyahoga County, Ohio, to which reference is hereby made for a statement of the rights of the holders of this certificate and of the other certificates issued*2375 under the Declaration, in said property and the terms and conditions of this trust.
The Trustee will pay to the registered holder of this certificate on the first day of February, May, August and November, in each year, his pro rata share of the net proceeds which may be derived from the rental of the property described in the Declaration and constituting the Trust Estate, and upon sales of the property comprising the Trust Estate will pay to the registered holder hereof his pro rata share of the net proceeds derived from such sales, all as in the manner provided in the Declaration.
*590 The properties comprised in the Trust Estate are leased to The Van Sweringen Company for the term ending midnight January 31, 1924, and the rental payable quarterly under said lease in gross amount equals the sum of Eight and Seventy-five hundredths Dollars ($8.75) in respect of each one-four-thousand one hundred and fiftieth interest in the Trust Estate.
Said lease grants the Lessee the option to purchase the leased premises at certain schedule prices set forth therein, the total minimum purchase price being Two Million, Six Hundred Ninety-seven Thousand Five Hundred Dollars ($2,697,500) *2376 and in the event and so often as the Lessee purchases portions or parcels of the leased premises to the amount of One Hundred Thousand Dollars ($100,000) and pays therefor to the Trustee, thenceforth the rental payments to be made quarterly under said lease will be reduced pro rata based upon a total reduction of Seven Thousand Dollars ($7,000) per annum and in respect of each such One Hundred Thousand Dollars ($100,000) so paid to the Trustee.
The equitable interest represented by this certificate is convertible into fee title of real estate in severalty upon terms and conditions set forth in the Declaration.
The holder of this certificate, by the acceptance hereof, expressly assents to all the terms and conditions of the Declaration and becomes a party thereto as fully to all intents and purposes as if such holder had signed the Declaration.
Subject to the terms jand conditions of the Declaration, this certificate and the interest represented thereby may be assigned and transferred upon the books of the Trustee by the holder hereof in person or by duly authorized attorney, upon surrender of this certificate duly assigned, and the transferee shall by accepting this certificate*2377 or any certificate which may be issued in place hereof, become a party to the Declaration and be bound thereby and entitled to all rights thereunder.
IN WITNESS WHEREOF, THE FIRST TRUST AND SAVINGS COMPANY, TRUSTEE, has caused these presents to be signed in its corporate name, by its President or Vice President, and its corporate seal to be hereto affixed, attested by its Secretary or Assistant Secretary, as of the first day of February, 1919.
THE FIRST TRUST AND SAVINGS COMPANY, TRUSTEE,
By
President.
Attest:
Secretary.
COUNTERSIGNED:
, 19 .
Transfer and Register Clerk.
(FORM OF ASSIGNMENT)
* * *
Only one such land trust certificate was actually issued. It called for 4150/4150 of the equitable ownership and beneficial interest in the above lands and was issued to J. R. Nutt, J. A. House, and C. L. Bradley, syndicate managers. The trustee agreed to distribute among the beneficiaries on the first day of February, May, August. and November of each year all the net income which it might receive from the trust estate. It was authorized to comply with all necessary formalities in the completion of sales made by the lessee, *591 *2378 the Van Sweringen Co. Provision was made for the surrender of the certificates under certain conditions. If the lessee failed to exercise its option to purchase portions and ultimately all of the land under trust the trustee was empowered to liquidate. The trustee also was given the right to sell the property, comprising the trust estate, at a net price of $2,697,500 and thereby terminate the trust. The trustee further was given the right to enter into agreements dedicating land for public uses. It was given other and extensive powers usual and necessary in the execution of a trust. The beneficiaries were given the right to convert their beneficial interests into holdings of fee title in severalty, under stated conditions. A schedule of option purchase values and conversion values of the various tracts composing the trust estate was incorporated in the document.
The lease between the First Savings & Trust Co. and the Van Sweringen Co. conveyed the lands in question and referred specifically to the other instruments in the series. It contained detailed provisions relating to the payment of taxes, assessments, uses and enjoyment of the property and other essentialparts of such*2379 a contract. The yearly rental was set at $145,250 payable in four equal quarterly installments on the first day of February, May, August, and November of each year and constituted a 7 per cent return on the loan or money advanced. The lessee was given the right to purchase the demised premises at theprices contained on the schedule of option purchase values and was also given the option to purchase the entire premises at $2,697,500. The usual provisions relating to forfeiture were included in the lease.
Two supplemental agreements attached to the Syndicate Agreement, the Lease Agreement and the Land Trust Agreement were executed on October 20, 1921, and July 25, 1923, respectively. These agreements enlarged somewhat the powers of the syndicate managers and modified the terms of payment under the lease.
The land trust certificates were a common and convenient form of financing in Ohio. The conversion or exchange of $2,075,000 worth of notes into such certificates was accomplished by the execution of the Trust Agreement, Declaration of Trust and Lease mentioned above. These documents described and established the potential activities of the syndicate managers and constituted*2380 an agreement under which they might take action if it became necessary to do so and they so desired.
The syndicate subscribers paid their pledged amounts and a loan covering the balance thereof was secured by O. P. and M. J. Van Sweringen. Thereupon the syndicate managers nominally assumed their duties as such. The Van Sweringen Co. readjusted its liabilities, proceeded with the construction of the rapid transit line, obtained *592 additional working capital, and continued with renewed vigor its attempts to develop and sell lots and tracts of land in Shaker Heights. The Van Sweringen Co. paid the rent named in the lease to the trustee and often was in arrears in its payment. Distributions of the returns and profits accruing under the Plan were made by the banks pursuant to the formal order of the syndicate managers. Such distributions resulted in the alleged taxable income for the year in question. In 1925 the Van Sweringen Co. exercised its option to repurchase the land specified in the Declaration of Trust and Lease at the price therein named. That action formed the basis of a large tax assessment for that year.
During the entire period from 1919 to 1925 the Van*2381 Sweringen Co. remained in possession of the property involved in this proceeding. It handled its real estate sales as if the land were its own. The purchasers dealt only with the Van Sweringen Co.
Aside from the nominal and formal orders required in connection with the administration and protection of the fund advanced through the syndicate subscribers, the syndicate managers did not engage in the activities outlined and comprehended in the projected scheme. They merely contributed their name and credit to the movement for the purpose of securing adequate financial support for the Van Sweringen Co. enterprises. Even the strict matters of routine, such as alloting the proper proportion of rentals and profits to the syndicate subscribers, were taken care of by the trustee. All documents of conveyance and release were drafted in the office of the Van Sweringen Co. and presented to the proper persons for signature. All details relating to the Plan and the connection of the syndicate managers therewith were arranged by the attorney, Frank Ginn, in advance of their approval by the trustee and the syndicate managers, and the necessary appropriate documents therefor were so prepared*2382 by him. Such formal records as he deemed necessary upon the establishment of the syndicate were made by him and presented to the persons interested for their signatures. All expenses required throughout the entire process of refinancing the Van Sweringen Co., including legal fees, appraiser fees, etc., were paid by that company.
The syndicate managers did not organize as such, never had a meeting, kept no records or books of account, had no office and had no connection whatever with the sale of the real estate involved. They did not obtain the syndicate subscriptions, did not accept or reject the proposed subscribers, nor allot the subscriptions. They even had no part in determining the terms and conditions of the Agreement and Declaration of Trust, all of which were prepared in their final form before their nominal adoption and approval by the syndicate managers.
*593 By reason of the return from its investment in the syndicate and profits accruing upon the sale of real estate, the Terminal Properties Co. and other syndicate members included such profits in their income-tax returns. No returns were filed by the Nutt-House-Bradley Syndicate for any of the years under*2383 consideration.
The syndicate was not organized and did not function or operate in the manner usually employed by corporations. It was not engaged in a trade or business during the period involved.
OPINION.
VAN FOSSAN: The question before us in this case is whether or not the Nutt-House-Bradley Syndicate was an association taxable as a corporation.
An association is an unchartered organization employing the characteristics, form and procedure of a corporation in the prosecution of a business enterprise. The test to be applied is pragmatic. Did the syndicate in its purpose, form and operations so resemble a corporation that it should be taxed as such? In , we said: "It seems to us to be fundamentally unsound to determine income-tax liability by what might have taken place rather than by what actually occurred." So in this case.
There are three parties in the picture before us - (1) the Van Sweringen Co., the original owner of the property involved, which company in the course of developing and marketing the land had bcome deeply involved and was unable to proceed without financial assistance; (2) the trustee, the First*2384 Trust & Savings Co. (later the Union Trust Co.), to which the property was transferred under the Mortgage and Trust Agreements; and (3) the syndicate which purchased or underwrote a large block of the new notes of the Van Sweringen Co.
After the perfection of the several parts of the refinancing plan the Van Sweringen Co., which, under the Plan, had leased from the trustee the lands trusteed and had options to repurchase the same on stated conditions, continued its usual real estate operations, developed, subdivided, improved and sold the lots, completed the rapid transit line and in all respects functioned as before the Plan was adopted.
The trustee executed such releases and other papers as were necessary to accomplish the sales negotiated by the Van Sweringen Co. and received and distributed such moneys as properly came into its hands.
The syndicate which, by the terms of its creating agreement, had constituted three members irrevocably as syndicate managers, did *594 nothing beyond signing the creating papers, contributing the agreed funds and ordering and accepting the distributions from the trustee. These distributions of profits were severally returned for income-tax*2385 purposes by the members of the syndicate.
During all of the period involved the Van Sweringen Co. was in possession of the property and dealt with the same as though it were the absolute owner thereof. The Purchasers of lots dealt only with the Van Sweringen Co. and knew no other parties.
Except as indicated, the syndicate managers engaged in none of the activities comprehended or permitted by the Plan. They contributed their names and credit to the movement which had as its objective the resuscitation of the Van Sweringen Co. The syndicate managers never organized, had no meetings, kept no records or books of account, never had an office and had no connection with the sale of real estate. They took no part in creating or formulating the Plan or its several parts or, except to the very limited extent indicated, in its execution. The creation of the syndicate and the designation of the syndicate managers was merely a formal step in the Plan useful only in that the members underwrote or purchased more than $2,000,000 worth of the Van Sweringen notes. It was never intended that the syndicate should, nor did it in fact, take over the real estate activities of the Van Sweringen*2386 Co. Its sole function was that of providing temporary financial backing.
We are not concerned with the fact that the land trust certificates were nontaxable in Ohio and that this was the reason for the adoption of this method of refinancing. We are concerned, however, with the activities engaged in by the syndicate. Actual performance rather than potential capacity is the proper criterion.
We think it clear from what we have said that the Nutt-House-Bradley Syndicate did not engage in or carry on the real estate business. That was solely the province of the Van Sweringen Co. after the adoption of the Plan, as before. Likewise, we are not impressed by the suggestion of counsel for the Government that the syndicate was engaged in the banking business. Not every investor or lender of money is engaged in the banking business. Viewing the facts as they were, we are of the opinion that the syndicate was not engaged in any business enterprise within the intendment of the statute as defined above.
Concluding, as we do, that the syndicate was not engaged in any business enterprise, it follows per necessitate that it did not employ the forms and procedure usually followed*2387 by incorporated bodies in carrying on a business. Assuming a contrary conclusion, however, the form and limited activities of the syndicate bear slight resemblance to a corporation. The syndicate managers were irrevocably *595 appointed and were in no wise amenable to the syndicate members. The members of the syndicate agreed to share losses ratablyproportionate to their contributions. The managers never met, never organized, and had neither office, books, nor accounts. They had no officers or employees. They were consistently inactive. In none of these things did they resemble the usual corporate form or procedure. See ; ; , and cases therein cited.
Judgment will be entered for the petitioner.