*136 Decisions will be entered under Rule 50.
1. Where in certain investment trusts the depositor had the right to vary the existing investment of participating certificate holders at will, held, the trusts are associations taxable as corporations under the provisions of section 3797 (a) (3) of the Internal Revenue Code.
2. Where in certain investment trusts no powers were granted to, or in fact exercised by, the trustee, the depositor, or the two combined, beyond those necessary to the incidental preservation of the trust property, the collection of the income therefrom, and the distribution of the net proceeds to the participating certificate holders, held, the trusts are strict investment trusts not taxable as associations under the provisions of section 3797 (a) (3) of the Code.
*466 The respondent determined deficiencies in the income tax of the petitioners as follows: *467
| Docket | |
| No. | Petitioner |
| 32678 | Royalty Participation Trust, Commonwealth Trust |
| Company, Trustee. | |
| 32679 | Major Royalty Trust, Series A, Commonwealth Trust |
| Company, Trustee. | |
| 32680 | Oklahoma Royalty Trust, Series R, Commonwealth Trust |
| Company, Trustee. | |
| 32681 | Trusteed Diversified Royalty Trust, Series C, Commonwealth |
| Trust Company, Trustee. | |
| 32682 | Trusteed Diversified Royalty Trust, Series D, Commonwealth |
| Trust Company, Trustee. | |
| 32683 | Trusteed Properties, Series A, Commonwealth Trust |
| Company, Trustee. | |
| 32684 | Mutual Trust, Series TG-1, Commonwealth Trust Company, |
| Trustee. | |
| 32685 | Trusteed Diversified Royalty Trust, Series B, Commonwealth |
| Trust Company, Trustee. | |
| 32686 | Trusteed Diversified Royalty Trust, Series A, Commonwealth |
| Trust Company, Trustee. | |
| 32687 | Underwriters Group Diversified Royalty Trust, Series J, |
| Commonwealth Trust Company, Trustee. | |
| 32688 | Underwriters Group Diversified Royalty Trust, Series H, |
| Commonwealth Trust Company, Trustee. | |
| 32689 | Underwriters Group Capital Retirement Plan, Series |
| UG-B, Commonwealth Trust Company, Trustee. | |
| 32690 | Underwriters Group Capital Retirement Plan, Series |
| UG-A, Commonwealth Trust Company, Trustee. | |
| 32691 | Major Royalty Trust, Series C, Commonwealth Trust |
| Company, Trustee. | |
| 32692 | Oklahoma Royalty Trust, Series T, Commonwealth |
| Trust Company, Trustee. | |
| 32693 | Oklahoma Producing Royalty Trust, Series M, Commonwealth |
| Trust Company, Trustee. | |
| 32694 | American Royalty Trust, Commonwealth Trust Company, |
| Trustee. | |
| 32695 | Basic Commodity Trust, Series NP, Commonwealth |
| Trust Company, Trustee. | |
| 2696 | Empire Investors Trust, Series A, Commonwealth Trust |
| Company, Trustee. | |
| 32697 | Trusteed Diversified Royalty Trust, Series E, Commonwealth |
| Trust Company, Trustee. |
| Deficiencies | |||
| Docket | |||
| No. | |||
| 1947 | 1948 | 1949 | |
| 32678 | $ 43.54 | $ 66.21 | $ 57.82 |
| 32679 | 17.64 | 52.05 | 17.96 |
| 32680 | 99.79 | 137.69 | 63.57 |
| 32681 | 85.96 | 129.26 | 142.79 |
| 32682 | 166.53 | 214.07 | 240.35 |
| 32683 | 264.24 | 386.69 | 245.05 |
| 32684 | 49.94 | 78.01 | 71.35 |
| 32685 | 44.33 | 60.30 | 90.13 |
| 32686 | 17.71 | 39.54 | 55.23 |
| 32687 | 2,446.44 | 3,788.73 | 3,203.36 |
| 32688 | 982.21 | 1,487.37 | 1,342.51 |
| 32689 | 198.81 | 1,163.42 | 956.79 |
| 32690 | 1,491.72 | 2,025.46 | 1,677.51 |
| 32691 | 97.44 | 121.72 | 112.21 |
| 32692 | 35.42 | 34.05 | 53.33 |
| 32693 | 11.50 | 48.46 | 12.25 |
| 32694 | 106.50 | 225.63 | 199.87 |
| 32695 | .84 | 15.71 | 29.60 |
| 2696 | 100.84 | 167.16 | 134.36 |
| 32697 | 257.17 | 464.52 | 544.78 |
These cases were consolidated for hearing and decision upon oral motion of counsel.
The issue presented is whether the petitioners are associations taxable as corporations under the provisions of section 3797 (a) (3) of the Internal Revenue Code.
FINDINGS OF FACT.
The trust instrument of each of the trusts herein involved was admitted in evidence as an exhibit. Such exhibits are included herein by reference and are made a part of our Findings of Fact.
Fiduciary income tax returns with respect to the trust here involved were filed for the *138 years in question with the collector of internal revenue for the district of Delaware.
All of the trusts involved herein were organized by various promoters during the period 1931 through 1937 to facilitate the promoters' plans for selling participating certificates to speculative investors expecting profits.
All of the trusts are of the same general nature, commonly known in the trade as oil royalty trusts.
*468 The principals in each of the trust agreements here before us were a trustor, hereinafter referred to as the depositor, the trustee, and the owners of participating certificates, hereinafter referred to as the beneficiaries.
Generally, the trusts here involved were organized as follows: The depositors, owners of fractional oil and gas royalty interests, overriding oil royalty interests, etc., would deposit royalty deeds with the trustee, conveying thereby legal title in the interests to the trustee, who filed the deeds for record in the county and state in which the property was located. The trustee then would file transfer or division orders with the production companies, thus putting the properties in line for payment direct to the trustee. Participating certificates*139 were issued against the property covered by the deposited deeds, usually in multiples of $ 100. After the participating certificates had been issued by the trustee to the depositor, the depositor sold the certificates to speculative investors.
The Commonwealth Trust Company, a Delaware corporation, was the trustee of all the trusts here involved during the taxable years in question. Under the provisions of each of the trust agreements the trustee was a medium for the transaction of business incident to the operation of the trust, collecting the profits and disbursing them to the beneficiaries as their interests appeared, less taxes, fees, expenses, and amounts held in such reserve accounts as each of the separate trust agreements provided.
Each of the trusts was a continuing operation and in none of them was liquidation contemplated. The trustee held legal title to all of the property in each of the trusts. The provisions of each trust provided for unity of management in the trustee and the depositor. Deaths among participating certificate holders did not affect the operation of any of the trusts. The mechanism for transfers by beneficiaries of interest in each of the trusts*140 is identical to that usually provided for the transfer of stock certificates. The trustee operated as transfer and registrar agent for each of the trusts. The beneficiaries were not personally liable for the debts or obligations of the trusts.
All beneficiaries in a given trust had equality of standing. Each was entitled to one vote per unit of ownership at a meeting of certificate holders. The original beneficiaries acquired their interests in the various trusts by purchase. The purpose for which each of the trusts was founded, so far as the beneficiaries were concerned, was for profit from a speculative investment.
The original depositors in each of the trusts gradually dropped out of the picture and have not been involved since 1940. In the place of the depositor the trustee acts. There were no changes in the corpus *469 of any of the trusts except the purchase of new properties, against which participating certificates were not issued. There was an accumulation of funds for that purpose. The trustee had full discretionary power to sell any and all properties and to discharge obligations, such as unpaid taxes, fees, charges, supervision expenses, liens, and the like. *141 A common bank account was used for all funds involved in the trusts.
The trustee at times turned over reserve fund moneys for reinvestment at the demand of the depositor, and at times the trustee made reinvestments of the reserve funds. The trustee has not taken any steps towards liquidating any of the trusts up to the present time.
The trust agreements involved in Docket Nos. 32681, 32682, 32685, 32686, and 32697 were entered into on May 18, 1933, and amended by an amended trust agreement in each case on November 4, 1937. The amended agreements provided in paragraph 21 thereof as follows:
21. The Trustor shall have the exclusive right, from time to time, and at any time, to substitute the properties heretofore deposited in the consolidated corpus and to be deposited therein in the future, in his sole discretion and judgment and to sell, transfer and exchange, and otherwise convey the said properties included in the Trust Estate herein, and to replace, substitute and/or purchase for the same, other properties which the Trustor believes to be beneficial and for the best interests of the Certificate holders hereof, and the Trustee herewith agrees that it will execute any and all *142 documents necessary for the fulfillment of powers granted to the Trustor under this paragraph.
The trust agreements involved in Docket Nos. 32679, 32684, 32689, 32691, and 32696 each contained provisions substantially as follows in paragraphs IV, 2 (a), 3, IV, and 1 d, respectively:
IV. The Trustor shall have the exclusive right and privilege from time to time to substitute the Oil Royalty Deeds and/or Oil Working Interests and/or any other property heretofore deposited hereunder in its sole discretion and judgment and to sell, transfer and exchange and otherwise convey the said property included in the trust property herein and to replace, substitute and/or purchase for the same, other properties which the Trustor believes to be beneficial for and for the best interests of the holders of the Trust Certificates and Refunding Certificates hereof, * * *The trust agreement involved in Docket No. 32683, in paragraph 3 thereof, provides as follows:
3. The Trustor shall have the exclusive right, from time to time, and at any time, to substitute the properties hereunder deposited, in its sole discretion and judgment and to sell, transfer and exchange and otherwise convey said properties *143 included in the Trust Estate herein, and to replace, substitute and/or purchase for the same other properties which the Trustor believes to be beneficial and for the best interests of the certificate holders hereof, providing, however, that these substituted properties are to be subject to the conditions set forth in Paragraph 2. The Trustee herewith agrees that it will execute any and all documents necessary for the fulfillment of powers granted to the Trustor under this Paragraph.
*470 The trust agreement involved in Docket No. 32687 contains the following language:
On the last day of each calendar month, the Trustee shall allocate all available funds in the Income Account, after the aforesaid deductions as outlined in Paragraph 36, as follows: There shall be transferred to the Reinvestment Fund, a sum equivalent to Twenty-seven and One-half Percent (27 1/2%) of the balance of the Income Account before taking into consideration provisions for the items enumerated in Paragraph 36: (b) There shall be transferred to the Disbursement Fund a sum equivalent to One Percent (1%) of the face value of all Unencumbered Trust Certificates issued and outstanding as of the said last day *144 of said calendar month; (c) After provision for the items specified in Paragraph 36, and the allocation with respect to the provisions for the Reinvestment and Disbursement Funds under Paragraph 37, Subdivision A and B, any balance then remaining in the Income Account shall be allocated and transferred to the Redemption Fund. If at any time the gross revenues received or receivable during any calendar month, after making calculations for provision for an allocation to the Reinvestment Fund under this Paragraph, and further providing for the items specified and enumerated in Paragraph 36, the balance remaining shall be insufficient for the provision set forth in Subdivision B of this Paragraph, then in that event, the Trustor shall have the discretionary right to reduce either the provision of Subdivision A and/or Subdivision B of this Paragraph.
* * * *
The Trustor is to have full powers of substitution, sale, or exchange of properties and/or securities in this Reinvestment Fund whenever in its discretion such substitution, sale or exchange shall be deemed beneficial to the Certificate holders.
If, in the opinion of the Trustor, it shall be deemed inadvisable either temporarily or*145 permanently to make additional purchases of properties and/or securities for the Reinvestment Fund, the Trustor may in its discretion require the Trustee to transfer any available funds and/or subsequent allocations in the Reinvestment Fund to the credit of the Redemption Fund, as provided for in Paragraphs 52 and 53 hereof.
The trust agreement involved in Docket No. 32688 contains the following language:
The TRUSTOR shall have the exclusive right from time to time to substitute the OIL ROYALTY DEEDS and/or GAS ROYALTY DEEDS and/or OIL WORKING INTERESTS and/or OIL PAYMENTS in his sole discretion and judgment, and to sell, transfer and exchange, and otherwise convey the OIL ROYALTY DEEDS and/or GAS ROYALTY DEEDS and/or OIL WORKING INTERESTS and/or OIL PAYMENTS included in the Trust property herein, and to replace, substitute, and/or purchase for the same and other OIL ROYALTY DEEDS and/or GAS ROYALTY DEEDS and/or OIL WORKING INTERESTS and/or OIL PAYMENTS which the TRUSTOR believes to be beneficial and for the best interests of the Certificate holders hereof, provided, however, that these substituted properties be subject to the conditions set forth in Section 1A, and the Trustee agrees*146 that it will execute any and all documents necessary for the fulfillment of the powers granted under this clause.
The trust agreement involved in Docket No. 32690 contains the following language:
The Trustor shall have the exclusive right, from time to time, and, at any time, to substitute the properties hereunder deposited, in its sole discretion and *471 judgment and to sell, transfer and exchange and otherwise convey said properties included in the Trust Estate herein, and to replace, substitute and/or purchase for the same, other properties which the Trustor believes to be beneficial and for the best interests of the certificate holders, hereof, providing however that these substituted properties are to be subject to the conditions set forth in Paragraph 2, but said paragraph is not to apply to any properties substituted in place and/or stead of properties contained in or purchased with the proceeds of the Sinking Fund portfolio, and the Trustee herewith agrees that it will execute any and all documents necessary for the fulfillment of powers granted to the Trustor under this Paragraph. After deeds and/or other documents executed by the Trustor transferring to the Trustee*147 properties of the kind above mentioned, are delivered to the Trustee, it shall forward said instruments to the County Clerk, or other recording office or person similar thereto, of the Counties and States wherein the interests described in said deeds and/or other documents are located, for the purpose of having said documentary evidence of ownership duly recorded in the Trustee's name, and the Trustee shall forward all transfer orders from the Trustor to the Trustee in connection with the aforesaid properties to the Producing or Pipe Line Companies designated by the Trustor to the end account of the Trustee may be placed in line for payment.
In the trusts involved in Docket Nos. 32679, 32681, 32682, 32683, 32684, 32685, 32686, 32687, 32688, 32689, 32690, 32691, 32696, and 32697 the depositor had the right to vary the properties going to make up the trust res in his sole discretion and judgment. In the trusts involved in Docket Nos. 32678, 32680, 32692, 32693, 32694, and 32695 there were no powers granted to, or in fact exercised by, the trustee, the depositor, or both combined, beyond those which are incidental to the preservation of the trust property, the collection of the income*148 therefrom, and its distribution to the holders of participating certificates.
OPINION.
The respondent contends that all of the trusts here involved are associations taxable as corporations within the meaning of section 3797 (a) (3) of the Internal Revenue Code. 2 Specifically, he argues that the participating certificate owners in each of the trusts have associated themselves in a joint enterprise for the transaction of a business.
As we have found, each of the trusts has the following features in common: (1) title to the trust property is held by the trustee; (2) a centralized management is created in the depositor and trustee, or in the trustee alone; (3) the continuity of the trust or enterprise is uninterrupted by the death of owners of*149 the beneficial interests, and the beneficial interests evidenced by participating certificates may be *472 transferred without affecting the continuity of the trusts; and (4) the personal liability of the beneficiaries is limited. Therefore, each of the trusts involved is sufficiently analogous to the corporate organization to justify tax treatment under section 3797 (a) (3) if the trusts, which purport to be strict investment trusts, were in fact organized to enable the participants to carry on a business and divide the gains accruing from their common undertaking.
The powers granted by the trust indenture, and not the extent to which they are used, must determine whether or not each of the trusts constitutes an association taxable as a corporation. Morrissey v. Commissioner, 296 U.S. 344">296 U.S. 344. The powers and duties of the trustee must be added to those granted by the trust instrument to the depositor in order to arrive at the full amount of permitted managerial activity and its object, Commissioner v. Chase National Bank of the City of New York, 122 F. 2d 540, affirming 41 B. T. A. 430,*150 for it is well settled that in investment trust cases classification as an association, on the one hand, or as a strict investment trust, on the other hand, depends upon whether any business discretion, other than that incidentally required by the nature of the trust, is reposed in the trustees or those who share the management functions with them under the terms of the trust instrument. American Participations-Trust, 14 T.C. 1457">14 T. C. 1457.
An examination of each of the trust instruments is then in order. The trust agreements involved in Docket Nos. 32679, 32681, 32682, 32683, 32684, 32685, 32686, 32688, 32689, 32690, 32691, 32696, and 32697 contain language substantially as follows:
The Trustor shall have the exclusive right and privilege from time to time to substitute the Oil Royalty Deeds and/or Oil Working Interests and/or any other property heretofore deposited hereunder in its sole discretion and judgment and to sell, transfer and exchange and otherwise convey the said property included in the trust property herein and to replace, substitute and/or purchase for the same, other properties which the Trustor believes to be beneficial for and for the best*151 interests of the holders of the Trust Certificates and Refunding Certificates hereof, * * *
The trust agreement involved in Docket No. 32687 contains the following language:
On the last day of each calendar month, the Trustee shall allocate all available funds in the Income Account, after the aforesaid deductions as outlined in Paragraph 36, as follows: There shall be transferred to the Reinvestment Fund, a sum equivalent to Twenty-seven and One-half Percent (27 1/2%) of the balance of the Income Account before taking into consideration provisions for the items enumerated in Paragraph 36: (b) There shall be transferred to the Disbursement Fund a sum equivalent to One Percent (1%) of the face value of all Unencumbered Trust Certificates issued and outstanding as of the said last day of said calendar month; (c) After provision for the items specified in Paragraph 36, and the allocation with respect to the provisions for Reinvestment and Disbursement Funds under Paragraph 37, Subdivision A and B, any balance then remaining in the Income Account shall be allocated and transferred to *473 the Redemption Fund. If at any time the gross revenues received or receivable during any calendar*152 month, after making calculations for provision for an allocation to the Reinvestment Fund under this Paragraph, and further providing for the items specified and enumerated in Paragraph 36, the balance remaining shall be insufficient for the provision set forth in Subdivision B of this Paragraph, then in that event, the Trustor shall have the discretionary right to reduce either the provisions of Subdivision A and/or Subdivision B of this Paragraph.
* * * *
The Trustor is to have full powers of substitution, sale or exchange of properties and/or securities in this Reinvestment Fund whenever in its discretion such substitution, sale or exchange shall be deemed beneficial to the Certificate holders.
If, in the opinion of the Trustor, it shall be deemed inadvisable either temporarily or permanently to make additional purchases of properties and/or securities for the Reinvestment Fund, the Trustor may in its discretion require the Trustee to transfer any available funds and/or subsequent allocations in the Reinvestment Fund to the credit of the Redemption Fund, as provided for in Paragraphs 52 and 53 hereof.
In each of these trusts the depositor had the right to substitute the properties*153 going to make up the trust res, to sell them, transfer them, or exchange them, to replace, substitute, or purchase trust property in his sole discretion and judgment, limited only by what the depositor believed to be beneficial for, and to the best interests of, the holders of participating certificates.
In short, the depositor had the power to vary at will the existing investments of all participating certificate holders. We can perceive no reason, other than the obvious business reason involved, for the existence of such a wide latitude of business discretion and managerial powers. Therefore, after careful consideration of the evidence submitted by the parties, the trust agreements involved, and the record as a whole, we hold the trusts involved in Docket Nos. 32679, 32681, 32682, 32683, 32684, 32685, 32686, 32687, 32688, 32689, 32690, 32691, 32696, and 32697 to be associations taxable as corporations within the meaning of section 3797 (a) (3) of the Code. Commissioner v. North American Bond Trust, 122 F.2d 545">122 F. 2d 545, certiorari denied 314 U.S. 701">314 U.S. 701; Pennsylvania Co. for Insurances on Lives & Granting Annuities, Trustee v. United States, 138 F.2d 869">138 F. 2d 869,*154 certiorari denied 321 U.S. 788">321 U.S. 788.
It is not important that the broad powers granted have never been exercised, or have been exercised to only a limited extent. Each trust must be adjudged not by what has been done but by what could have been done under the trust agreement. Commissioner v. North American Bond Trust, supra.
The evidence submitted by the parties and the record as a whole support the contention of the petitioners with respect to the trusts involved in Docket Nos. 32678, 32680, 32692, 32693, 32694, and 32695. The trustee's power was limited to collecting the income, payment of *474 expenses, and disbursing the net proceeds of the trusts to the beneficiaries. It is true that some of the indicated trusts did contain provisions requiring the trustee to set apart 5 per cent of the income produced by the trust as a reserve fund from which the trustee was permitted to acquire additional properties for the trust. However, this power existed because of the wasting quality of the assets involved, that is, oil and gas properties subject to natural depletion. We do not think the existence of this limited power*155 in the indicated trusts sufficient to taint them with the business character necessary to render them taxable as associations within the meaning of section 3797 (a) (3) of the Internal Revenue Code, and we so hold.
Decisions will be entered under Rule 50.
Footnotes
1. Proceedings of the following petitioners are consolidated herewith: Major Royalty Trust, Series A, Commonwealth Trust Company, Trustee, Docket No. 32679; Oklahoma Royalty Trust, Series R, Commonwealth Trust Company, Trustee, Docket No. 32680; Trusteed Diversified Royalty Trust, Series C, Commonwealth Trust Company, Trustee, Docket No. 32681; Trusteed Diversified Royalty Trust, Series D, Commonwealth Trust Company, Trustee, Docket No. 32682; Trusteed Properties, Series A, Commonwealth Trust Company, Trustee, Docket No. 32683; Mutual Trust, Series TG-1, Commonwealth Trust Company, Trustee, Docket No. 32684; Trusteed Diversified Royalty Trust, Series B, Commonwealth Trust Company, Trustee, Docket No. 32685; Trusteed Diversified Royalty Trust, Series A, Commonwealth Trust Company, Trustee, Docket No. 32686; Underwriters Group Diversified Royalty Trust, Series J, Commonwealth Trust Company, Trustee, Docket No. 32687; Underwriters Group Diversified Royalty Trust, Series H, Commonwealth Trust Company, Trustee, Docket No. 32688; Underwriters Group Capital Retirement Plan, Series UG-B, Commonwealth Trust Company, Trustee, Docket No. 32689; Underwriters Group Capital Retirement Plan, Series UG-A, Commonwealth Trust Company, Trustee, Docket No. 32690; Major Royalty Trust, Series C, Commonwealth Trust Company, Trustee, Docket No. 32691; Oklahoma Royalty Trust, Series T, Commonwealth Trust Company, Trustee, Docket No. 32692; Oklahoma Producing Royalty Trust, Series M, Commonwealth Trust Company, Trustee, Docket No. 32693; American Royalty Trust, Commonwealth Trust Company, Trustee, Docket No. 32694; Basic Commodity Trust, Series NP, Commonwealth Trust Company, Trustee, Docket No. 32695; Empire Investors Trust, Series A, Commonwealth Trust Company, Trustee, Docket No. 32696; Trusteed Diversified Royalty Trust, Series E, Commonwealth Trust Company, Trustee, Docket No. 32697.↩
2. SEC. 3797. DEFINITIONS.
(a) When used in this title, where not otherwise distinctly expressed or manifestly incompatible with the intent thereof --
* * * *
(3) Corporation. -- The term "corporation" includes associations, joint-stock companies, and insurance companies.↩