Bateman v. Commissioner , 43 B.T.A. 69 ( 1940 )

LADY MARIAN BATEMAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Bateman v. Commissioner

Docket No. 98766.

United States Board of Tax Appeals

43 B.T.A. 69; 1940 BTA LEXIS 853;

December 11, 1940, Promulgated

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Where petitioner, the grantor of a trust terminating upon her death, reserves in the trust instrument a power to appoint the corpus by will or deed and the power is revocable during her life, held, she is not taxable in respect of that part of the trust income which, under the trust, is to be added to corpus, under sections 22(a), 166, or 167 of the Revenue Acts of 1934 and 1936.

Claude R. Branch, Esq., Charles Ryan, Esq., and Abbot P. Mills, Esq., for the petitioner.

Davis Haskin, Esq., for the respondent.

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LEECH

This is a proceeding to redetermine deficiencies in income tax for the calendar years 1935 and 1936 in the respective amounts of $1,223.11 and $677.41. The principal issue is whether petitioner is taxable upon the entire domestic income of a trust under sections 22(a), 166, or 167 of the Revenue Acts of 1934 and 1936. If this question be resolved against petitioner, the additional issues would be whether gains from sales of foreign securities held by the trust are taxable to petitioner as a nonresident alien, and whether she is entitled to certain expense deductions.

FINDINGS OF FACT.

During the taxable years petitioner was a nonresident alien individual, residing in England. On July 6, 1904, in contemplation of marriage with one William Spencer Hanbury, Lord Bateman, she established a trust consisting of stocks and bonds, with two individual third-party trustees. The trustees were to hold, manage, invest, and reinvest the trust property and to receive the income therefrom. They were to invest as part of the trust estate and add to principal, 5 percent of the net income. The balance of the income was to be paid as follows: $3,000 annually to her intended husband and the balance to petitioner. Upon petitioner's death, her husband was to receive $50,000; and the balance of the trust estate, or the entire trust estate if her husband should then be dead, was to be paid over to such persons as petitioner should, by her last will or by any written instrument signed before two witnesses, appoint. Any appointment made by her during her life in either manner was to be revocable. In default of such appointment, the trust estate was to be transferred to such of petitioner's blood relations as would take under the New York laws of intestacy had petitioner died intestate leaving no husband. The trust, however, was not to be terminated during petitioner's lifetime, and neither she nor her husband were to become entitled during her life to demand or receive from the trustee any conveyance of all or part of the principal of the trust estate.

All powers of management and control of the trust property were vested in the trustees. Except as previously stated, all questions arising under the trust instrument were to be governed by the laws of massachusetts. The trustees had power to appoint successor trustees, and this power was exercised from time to time. In the taxable years the trustees were two individuals, Francis R. Hart and S. Parkman Shaw, Jr., both residents of Massachusetts. Petitioner has never been a trustee of the trust. The books and corpus of the trust were kept in Boston, Massachusetts.

During the taxable years all capital gains were allocated to the corpus of the trust. Five percent of the net income was accumulated and added to corpus. Petitioner's husband died in 1932, and in the taxable years, she received 95 percent of the net income of the trust.

On April 1, 1932, petitioner executed a note to the trust in the amount of $27,025.86, representing the unpaid balance of two previous advances made to petitioner and her husband. The note bore interest at 5 percent, which was paid by deducting such interest from the net income distributed by the trustees to petitioner. No payments on the principal of the note were made during the taxable years. The note was secured by 157 1/2 shares of the stock of the Murray Co., given December 12, 1935, and by an appointment made by petitioner in 1932 in favor of the trustees, making her loan a first charge against her estate. The trustees reported the interest received on the note in their fiduciary returns.

The fiduciary returns of the trustees for the taxable years disclosed the following items:

	1935		1936
Income
Interest (ordinary)		$4,566.27		$3,953.24
domestic		5,650.00		5,150.00
Tax free covenant bond interest foreign		2,100.00		1,050.00
Capital gain		2,556.66		3,495.91
income		14,342.40		20,834.45
Dividends, domestic principal		201.33
Dividends, foreign		1,416.09		1,418.77
Foreign bond interest		36,954.76		35,747.85
Interest on note of petitioner		1,351.29		1,351.29
Total income		69,138.80		73,001.51
Deductions
Taxes (alleged)	$15.32		$7.90
Expenses of administering trust	2,307.68		2,693.65
Total deductions		2,323.00		2,701.55
Net income		66,815.80		70,299.96
Interest on obligations of instrumentalities of United States				$487.08

The item of $201.33 represent the value of stock of the Mission Corporation received by the trust in 1935 as a divident from the Standard Oil Co. Of the capital gains above set forth, the respective amounts of $563.60 and $3,368.41 represented net gains upon the sales of foreign securities. Such securities were sold in the United States. The trustees apportioned expenses between foreign and domestic income in proportion to the respective amounts of such income.

OPINION.

LEECH: Petitioner and respondent are at issue here solely in regard to the 5 percent of the trust income which, by the indenture, was to be added to corpus, there being no question, of course, that the balance of the income is taxable to petitioner. Concisely stated, respondent's position is that petitioner's reservation of the power to appoint the corpus makes her taxable on the entire income arising therefrom. From his brief it would appear that he is relying mainly on section 22(a) of the Revenue Acts of 1934 and 1936, and . He points specifically to petitioner's ability, as demonstrated by her borrowings from the trust in 1932 and preceding years, to secure full economic benefits from the trust corpus merely by obtaining loans from the trustees and appointing sufficient of the trust corpus to the trustees to secure them.

We first consider the fact that petitioner borrowed from the trust and pledged the appointment of trust property for security, as bearing on the taxability to her of the entire trust income. The trust was created long prior to the passage of the first Federal income tax law, and no scheme for tax avoidance is shown. This borrowing transaction was certainly vested with all the outward formalities of an ordinary borrowing. Petitioner paid 5 percent on the loan and collateralized it with stock. In our opinion, the fact that petitioner borrowed from the trust and appointed corpus tanto quanto to secure these loans, is of no moment so far as her taxability on the income of the trust is concerned. Petitioner, as settlor, did not reserve any power whatever in the trust instrument to borrow any or all of the corpus from the trustee. On a similar state of facts we recently refused to sustain a tax proposed against a settlor under section 22(a), although in that case the taxpayer had borrowed from the trusts he created and subsequently collateralized the notes given therefor, and, in addition, had reserved in the trust deeds the power to approve the trustee's investments. . See also . The present situation is a fortiori a stronger one for the taxpayer, for she relinquished all powers of management, including those of investment and reinvestment, to the trustees, reserved no powers save a revocable power of appointment, and put up outside collateral for the one loan she did make and paid interest thereon. Cf. , where the grantor was held taxable because of his reservation of a power to borrow of the trustee on unsecured notes.

Moreover, we are not impressed with respondent's contention that petitioner, by reserving a power to appoint the reversionary interest in the trust estate, retained such dominion over the corpus as to make her taxable under section 22(a). The facts that the trust was coterminus with the grantor's life and that the third-party trustees were given no power to name petitioner as a successor trustee, taken in conjunction with the considerations mentioned in the preceding paragraph, prevent application of that section here. Cf. .

There remains to be considered the effect of the reserved power under sections 166 and 167 of the Revenue Acts of 1934 and 1936. Petitioner relies on , which held that a power of appointment did not make a settlor taxable under section 166 of the Revenue Act of 1928. The reason given by the Board was, however, that until the power was exercised, those who would take in default of appointment had an interest adverse to the revesting of the corpus in the settlor. That type of interest has been held not to be "substantially adverse" under the change in the statute effected by the Revenue Act of 1932. . Nevertheless, we think petitioner must prevail for other reasons.

The trust deed provides that petitioner can not secure title to the corpus or any part thereof during her life. Even if she exercised the power in favor of her estate after the creation of the trust and failed to revoke that act, she could never, herself, acquire the trust estate. Such action would merely create a remainder interest in her heirs. A reversionary interest in the grantor has been held not to constitute a power to revest the corpus in the grantor under section 166. ; ; reversed on another point, ; certiorari denied, ; ; . A fortiori, a remainder interest enjoyable only by the grantor's heirs would not come within that section.

It is true that petitioner might have borrowed from the trustees or from some other creditor an amount equal to the value of the corpus, secured the loan by an appointment of the remainder interest in the corpus to the lender, and thus have enabled the lender to present a claim as a general creditor of her estate after her death. by controlling Massachusetts law, if the power of appointment were exercised, the estate would then have included the corpus of the trust. ; ; ; . Cf. ; . Whether a prospective lender would advance credit on the sole security of a revocable appointment and lend himself to litigation with petitioner's heirs, as a practical matter would seem, at least, very doubtful. It is noted here that the trustees required petitioner not only to exercise her reserved power in their favor, but also to put up outside collateral for the one loan she did contract. However, decisive of the case, in our opinion, is that section 166 requires, if the grantor is to be held taxable on the income of his trust, that there be vested in the grantor a present power to revest "in the grantor" title to any part of the corpus. ; . The power here to appoint the remainder in the corpus, revocable prior to the termination of the trust by the grantor's death, does not fall within the definitely expressed meaning of the statute. Since Congress has not yet covered the instant situation, it is beyond our power to do so. Minnie M. Fay Trust "A",. There is no ground, we conclude, for taxing this petitioner under section 166.

It would not be contended, we think, that the 5 percent of the trust income here in dispute was being accumulated for the grantor within section 167. The accumulation became part of the corpus and could never come into the hands of petitioner. We have been cited to no authority and we find none for the proposition that an accumulation of trust income which may at most redound to the benfit of the grantor's heirs requires taxation of the grantor under section 167. In fact, the contrary has just been held in .

We hold, therefore, that petitioner is not taxable on the entire income of the trust, but only on the 95 percent of net trust income distributed to her. The capital gains here involved were credited to corpus and do not constitute distributable income under controlling Massachusetts law. ; ; ; . Respondent does not contend that the gains are taxable to petitioner for any reasons other than those given for taxing the entire trust income to petitioner.

Petitioner is sustained on the principal issue. It follows that decision of the remaining questions, requisite only if petitioner were held taxable in respect of the entire trust income, will not be necessary.

Decision will be entered for the petitioner.