author: Steunhagen: Smith,

text:
    John B. Stewart, Petitioner, v. Commissioner of Internal Revenue, Respondent. Frank H. Whipple, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 57531, 57532.
    Promulgated January 17, 1934.

      Jokn H. Pigg, Esq., for the respondent.
   OPINION.

Steunhagen:

The Commissioner determined income tax deficiencies for 1928 of $5,064.54 as to Stewart and $5,221.29 as to Whipple, and the issue turns upon the proper treatment under the Revenue Act of 1928 of the receipt by them, in reduction of the par value of their shares of the Windsor Tobacco Growers Corporation, of fixed assets and cash worth in the aggregate $183,706.14. The facts are stipulated as follows:

1. Tlie petitioner, John B. Stewart, resides at Windsor, Connecticut, and the petitioner, Frank H. Whipple, resides at Hartford, Connecticut.
2. The Windsor Tobacco Growers Corporation is a Connecticut corporation, having been organized under the laws of that State prior to March 1, 1913. As at the beginning of the calendar year 1928, the corporation had an authorized and issued capital stock of $80,000, consisting of 800 shares of the par value of $100. On December 31, 1926, the stock of the corporation was owned and held as follows :
John B. Stewart (Petitioner, Dkt. No. 57531)_ 200 shares
Frank H. Whipple (Petitioner, Dkt. No. 57532)- 200 shares
Estate of I. J. Steane_ 200 shares
Estate of Alfred A. Olds_ 200 shares
John B. Stewart acquired the stock shown opposite his name, for cash, as follows: 100 shares prior to March 1, 1913, and 100 shares subsequent to that date. Frank H. Whipple acquired the 200 shares shown opposite his name prior to March 1, 1913, for cash.
3. On March 1, 1913, the Windsor Tobacco Growers Corporation had a surplus of $05,294.10. On December 31, 1925, its surplus was $125,629.95, of which amount the sum of $60,335.85 represented surplus or earnings accumulated subsequent to February 28, 1913. The net earnings of the corporation for the years 1926 and 1927 were $23,945.84 and $14,072.61, respectively. Its net earnings for the period January 1, 1928, to February 29, 1928, amounted to $5,334.24. During the years 1926 and 1927, the corporation paid dividends to its stockholders in the respective amounts of $16,000 and $4,000.
4. On December 31, 1926, the Windsor Tobacco Growers Corporation acquired from two of its stockholders; namely, the Estate of I. J. Steane and the Estate of Alfred' A. Olds, the 400 shares of its stock then owned and held by them, paying therefor cash and securities of the aggregate value of $127,473.40. The stock so acquired was held by the corporation as treasury stock until some time during the year 1027, when the same was issued to the petitioners, 200 shares each, as a stock dividend. At all times material herein, subsequent to the issuance of said shares as a stock dividend, the petitioners were the owners of the entire capital stock of the corporation, each owning 400 shares.
5. During the month of February, 1928, the Windsor Tobacco Growers Corporation filed the necessary papers with the proper state authorities for the purpose of reducing the par value of its capital stock from $100 to $65 per share. In pursuance thereof, and for the purpose of reflecting such reduction on its books of account, the corporation, on February 20, 1928, distributed to its then stockholders, the petitioners herein, all of its fixed assets, consisting of a tobacco plantation and operating equipment, and cash in the amount of $3,706.14. The fair market value of the fixed assets, on the date of distribution, was $180,000.
6.In his determination of the deficiencies involved in these proceedings, the Commissioner determined that as a result of the distribution made by the Windsor Tobacco Growers Corporation on February 29, 1928, each of the petitioners received taxable dividends in the amount of $30,754.62. The computation employed by the Commissioner in arriving- at such determination is as follows:
Earnings accumulated subsequent to February 28, 1913, available for distribution on December 31, 1925_„$60, 335. 85
Less: Premium paid on 400 shares of capital stock acquired by corporation on December 31, 1926, as follows:
Surplus on March 1, 1913_$65, 294.10
Deduct: Premium on 400 Shares_ 87,473. 40
Excess of premium deducted from earnings accumulated subsequent
to February 28,1913_ 22,179. 30
Balance of earnings accumulated subsequent to February 28, 1913, available for distribution, as of December 31, 1925_$38,156. 55
Add: Earnings for 1926_23, 945. 84
Earnings for 1027_ 14,072.61
Total_$76,175.00
Less: Dividends paid in 1926_$16, 000. 00
Dividends paid in 1927_ 4, 000. 00
-- 20,000.00
Surplus or earnings available for distribution on January 1, 1928_$56,175. 00
Earnings for year 1928_$33,090.40
Add: Earnings for period January 1, 1928, to February 29, 1928— 5,334.24
Earnings available for distribution on February 29, 1928_$61, 509. 24
Amount distributable to the petitioners, one-half to each_$80, 754. 62
7. In his income tax return for the year 1928, each of the petitioners reported the amount of $1,068.44 as dividends received from domestic corporations, by reason of the distribution made by the Windsor Tobacco Growers Corporation, on February 29, 1928, as aforesaid.
8. The value ($180,000). of the fixed assets of the Windsor Tobacco Growers Corporation distributed on February 291, 1928, included an unrealized appreciation in value of $127,297.79, of which $109,032.93 had accumulated prior to March 1, 1913, and $18,264.86 had accumulated between February 28, 1913, and February 29, 1928.
9. The 400 shares owned by the petitioner Whipple on February 29, 1928, comprised 200 shares purchased prior to March 1, 1913, and 200 shares received as a stock dividend in 1927. The basis of these 400 shares, computed in accordance with Section 113 of the Revenue Act of 1928, was $63,826.10. (The 200 shares purchased prior to March 1, 1913, cost $15,479.35; the March 1, 1913, value thereof was $63,826.10.)
10. The 400 shares owned by the petitioner Stewart on February 29, 1928, comprised 100 shares purchased prior to March 1,. 1913, 100 shares purchased in 1917, and 200 shares received as a stock dividend in 1927. The basis of these 400 shares, computed in accordance with Section 113 of the Revenue Act of 1928, was $57,913.05. (The 100 shares purchased prior to March 1, 1913, cost $10,000; The March 1, 1913, value thereof was $31,913.05. The 100 shares purchased in 1917 cost $20,000.)

Recast into chronological sequence, the facts are these: The corporation was organized before March 1, 1913. Before that date Stewart had acquired 100 shares for $10,000, and Whipple, 200 shares for $15,479.35. The total number of shares issued or outstanding is not shown, although perhaps we can assume it to be 400. On that date, according to the stipulation, the value of each share was $319.1305; the surplus of the corporation, $65,294.10; and the “ unrealized appreciation in value ”, $109,032.93. The mathematical disparity in those figures of March 1,1913, is not cleared up by anything in the record.

In 1917 Stewart bought 100 shares at a cost of $26,000, or $260 a share.

On December 31, 1925, the earned surplus had ’ increased since March 1,1913, by $60,335.85, to $125,629.95.

In 1926 the net earnings were $23,945.84 and a dividend of $16,-000 was paid to the four owners of 200 shares each. This left $7,945.84 addition to surplus, which brought accumulated earnings and undivided profits up to $133,575.79. The corporation then acquired and held in its treasury the 400 shares of the Steane and Olds estates, giving to them $127,473.40 in cash and securities, being $318.6835 a share. This $127,473.40 the Commissioner now treats as $40,000 return by the corporation of capital contribution, and $87,-473.40 as “ premium ” paid out of surplus earnings. How he treated it for the purpose of 1926 tax to the Steane and Olds estates does not appear.

During 1927, at unstated times, the corporation earned $14,072.61, paid dividends of $4,000, and reissued the 400 shares of treasury stock as a stock dividend to Stewart and Whipple, making them, on January 1, 1928, the sole owners in equal shares of the 800 shares outstanding.

In 1928, between January 1 and February 29, the net earnings were $5,334.24. On the latter date, the “ unrealized appreciation of assets ” was $127,297.79, of which $109,032.93 existed prior to March 1, 1913, and $18,264.86 occurred after. On February 29, 1928, the corporation with due formality reduced the par value of its shares from $100 to $65, and distributed $183,706.14, consisting of $180,000 fixed assets (plantation and equipment) and $3,706.14 in cash.

The Commissioner treated $61,509.24 of the amount received by petitioners in 1928 as the distribution of an ordinary dividend taxable at surtax rates. The petitioner contends that the computation must proceed upon the assumption that the surplus of December 31, 1925, was disposed of to the Steane and Olds estates, and thus that the 1928 distribution was, to a greater extent than the Commissioner has allowed, attributable to capital and surplus of March 1, 1913, and, hence, tax-free.

There are several questions implicit in these facts which, if the record were more complete, would still be difficult to answer satisfactorily. But they are eliminated from our decision both, by reason of the scope of the Commissioner’s determination and of the issues framed by the pleadings, and by the confused and inadequate facts which have been stipulated.

The respondent by an amended answer seeks an increase in the deficiency as the result of the newly pleaded concept of the distribution of F'ebruary 29, 1928, as a distribution in partial liquidation. In support of this he points to the fact that the distribution of $183,106.14 by a method which included the reduction of par value was of such a large part of the corporation’s fixed assets of plantation and operating equipment as necessarily to indicate an intention to liquidate. This is a plausible view of the distribution. But mere plausibilty is not enough to support such a contention, and since the Commissioner is the one who presents the issue he must suffer from the inadequacy of the proof. It is entirely possible that a corporation could distribute such a large percentage of its net assets and reduce the par value of its shares with no thought of liquidation of its business or stock or of winding up the corporate existence. It could with what was left have a purpose of carrying on a more limited business indefinitely. In addition to this, the question would be controlled by the statutory definition of partial liquidation, section 115 (h), and it may be seriously doubted, without deciding, whether the reduction in par value of all the outstanding shares can be said to be a “ complete cancellation or redemption of a part of its stock ” and whether, in the absence of evidence that a complete winding up is in contemplation, such a distribution and reduction of par value can bo said to be “ one of a series of distributions in complete cancellation or redemption of all or a portion of its stock.” We hold, however, that because of the inadequate evidence the respondent’s contention that this was a distribution in partial liquidation can not be sustained.

Thus we are brought back to his original determination that this distribution was a dividend, a determination which the petitioner does not assail, and his further determination as to the 'extent to which such dividend is to be attributed to earnings and profits accumulated after March 1, 1913.

The evidence shows that at the time, December 31, 1926, when the corporation paid $127,473.40 to the estates of Steane and Olds in consideration for the turning back by them of their 400 shares, there were accumulated earnings and undivided profits of $133,-575.79. While that transaction, being from the standpoint of the shareholders a complete liquidation of their shares, was by section 201 (c), Revenue Act of 1926, regarded as in full payment in exchange for the stock, it was also, as-that statute clearly indicates, a distribution. Of course, as the last sentence of section 201 (c) provides, the extent to which it was properly chargeable to capital account ($40,000) was not to be considered .a distribution out of earnings or profits under subdivision (b). Therefore, by subdivision (b), it was made out of the most recently accumulated earnings or profits and it absorbed as fully as possible the earnings or profits accumulated after March 1, 1913, which, as the facts show, amounted to $68,281.69. The fact that this distribution, being in liquidation, was not taxed as an ordinary dividend does not militate against its treatment as a distribution in accordance with the express language of the statute. This is especially so when both section 201 (b) of the 1926 Act and section 115 (b) of the 1928 Act apply “for all purposes of the act.” Cf. Hadden v. Commissioner, 49 Fed. (2d) 709. The character of the payment in 1926 to Steane and Olds is governed entirely for tax purposes by the language and purpose of the revenue act, and not by the dictionary, by the nomenclature of the parties, or by the apportionment among the shareholders. Lincoln National Bank v. Burnet, 63 Fed. (2d) 131; affirming Estate of John W. Browner, 23 B.T.A. 1304. Nor may it be governed by a purpose of the corporation to hold the shares thus acquired in its treasury and later use them in discharge of a stock dividend; even if the stipulated facts made it clear that such a purpose existed when in 1926 the shares were acquired.

The question whether a holding that the 1926 transaction was a statutory distribution is at variance with all the implications of Woods Machine Co. v. Commissioner, 57 Fed. (2d) 635, needs no answer in this proceeding. Corporate shares in the hands of shareholders are unquestionably different property from the corporate assets, but it does not follow that their character as property exists when the shares are held by the corporation itself, cf. Eisner v. Macomber, 252 U.S. 189. We need not decide, nor even- recognize as a corollary, that when a large corporation buys a few of its shares on the stock exchange and soon resells them it makes a liquidation distribution and a subsequent issuance. The significance of such a transaction need not be determined until the issue is presented with all its circumstances. Here we have the simpler case of a small corporation with four shareholders paying off two shareholders who own half the shares, the tax significance of which arises under a fairly clear revenue statute.

Since the distribution of December 31, 1926, was in an amount-greater than the earnings or profits accumulated after February 28,, 1913, it was for present purposes a complete distribution of that amount, leaving at that time nothing for future distribution except (a) prior accumulated earnings and profits, (b) the increment reflected by the appreciation in value of assets, and (c) the original capital. Between December 31, 1926, and February 29, 1928, the corporation earned $15,406.85, and to this extent the distribution of the latter date was taxable as a dividend. Above that, it must be treated as a nontaxable distribution of March 1, 1913, capital to the extent of the petitioners’ cost or 1913 basis of their shares, the excess being taxable as profit.

Reviewed by the Board.

Judgment mil ~be entered wider Rule 50.

Smith,

dissenting: In the majority opinion it is held that when the Windsor Tobacco Growers Corporation acquired 400 shares of its stock on December 31, 1926, for cash and securities of an aggregate value of $127,473.40, it distributed by virtue of section 201 (b) of the Revenue Act of 1926 all of its earnings accumulated since February 28, 1913, in the amount of $68,281.69. I dissent. Section 201 provides, so far as material, as follows:

Sec. 201. (a) The term “ dividend ” when used in this title (except in paragraph (9) of subdivision (a) of section 234 and paragraph (4) of subdivision (a)of section 245) means any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits accumulated after February 28, 1913.
(b) For the purposes of this Act every distribution is made out of earnings or profits to the extent thereof, and from the most recently accumulated earnings or profits. Any earnings or profits accumulated, or Increase in value of property accrued, before March 1, 1913, may be distributed exempt from tax, after the earnings and profits accumulated after February 28, 1913, have been distributed, but any such tax-free distribution shall be applied against and reduce the basis of the stock provided in section 204.
(c) Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 202, but shall be recognized only to the extent provided in section 203. In the case of amounts distributed in partial liquidation (other than a distribution within the provisions of subdivision (g) of section 203 of stock or securities in connection with a reorganization) the part of such distribution which is properly chargeable to capital account shall not be considered a distribution of earnings or 'profits within the meaning of subdivision (b) of this section for the purpose of determining the taxability of subsequent distributions by the corporation.

The holding of the majority opinion can-only be sustained by holding that the exchange of assets for the 400 shares of stock, in question was a “ distribution ” within the meaning of paragraphs (b) and (c) quoted above.

The definition of the word “ distribute ” is “ To divide among several or many; to deal out; apportion; allot.” Each stockholder of the Windsor Tobacco Growers Corporation stood on the same plane; that is, there was only one class of stock. If a dividend had been paid by the corporation the dividend would have been distributed pro rata to the shareholders. If the assets had been divided among the stockholders in liquidation there would have been a pro rata apportionment to the several shareholders, and this is true whether there was a division of all of the assets or only a part of them.

I can not subscribe to the view that, where a corporation acquires a portion of its shares not for cancellation but for subsequent sale or for reissuance to its stockholders as a stock dividend, the amount paid in the acquisition of the shares is a distribution of the amount paid therefor within the contemplation of section 201. The reac-quirement by a corporation of a portion of its shares and the resale thereof or the reissuance thereof is a transaction too common to be ignored. As was stated by the circuit court of appeals in Commissioner v. Woods Machine Co., 57 Fed. (2d) 635; certiorari denied, 287 U.S. 613:

* * * where * * ⅜ a corporation has legally dealt in its own stock as it might in the shares of another corporation, and in so doing has made a gain or suffered a loss, we perceive no sufficient reason why the gain or loss should not be taken into account in computing the taxable income. * * *

The shares of stock of a corporation constitute property separate and apart from the property of the corporation. It may have a situs entirely independent of the situs of the assets of the corporation or even of the situs of the stockholder. Cf. DeGanay v. Lederer, 250 U.S. 376; Commissioner v. Brooks, 288 U.S. 378.

The facts here are that the corporation acquired 400 shares of its capital stock on December 31, 1926, at a cost of $127,473.40. The basis for the gain or loss to the stockholders selling the 400 shares is laid down by section 202 of the Revenue Act of 1926. If they realized a gain upon the transaction it is taxable to them, and if they realized a loss they are entitled to deduct the loss. The stipulated facts do not show that the corporation’s surplus or earnings were affected by such transaction. Neither did the corporation distribute anything to its stockholders when it reissued the 400 shares acquired as a stock dividend. Hugh R. Wilson, 3 B.T.A. 957. The only distributions by the corporation, so far as shown by the stipulated facts, subsequent to December 31, 1926, were the payment of dividends to its stockholders of $16,000 in 1926 and $4,000 in 1927, and the distribution of February 29, 1928, at which time the corporation distributed to its stockholders $3,706.14 cash and fixed assets of a fair market value of $180,000. I think that the respondent was correct in refusing to allow the contention of the petitioners that there was a distribution of any of its earnings at the time the corporation acquired 400 shares of its stock from the estates of I. J. Steane and Alfred A. Olds for $127,473.40 and in contending that the corporation did distribute to the petitioners on February 29, 1928, the total amount of its earnings accumulated since February 28, 1913, less those which had been distributed as dividends.

A necessary corollary to the holding in the majority opinion is that whenever a corporation purchases any of its outstanding shares it distributes earnings accumulated since February 28, 1913. I can not believe that this is a proper construction of the statute.

Black and Teammell agree with this dissent.


source: Caselaw Access Project

author: Aeundell :

license: Public Domain

text:
    Omaha National Bank, John Clapper and Katie Farrington, Executors of the Estate of F. J. Farrington, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 53237.
    Promulgated January 18, 1934.

      Karl Reimer, Esq., for the petitioners.

      R. W. Wilson, Esq., for the respondent.
   OPINION.

Aeundell :

The petitioners contend that the delivery of the stock to Farrington in 1928 was in fulfillment of a right of purchase that he acquired in 1918, and that since that right was property no income resulted from its exercise. The appreciation in the value of the right, it is argued, is not income until realized by sale or exchange of the stock acquired by virtue of the right. The respondent, on the other hand, points to the several contracts and argues that they were essentially contracts of employment under which the stock was received by Farrington as compensation for services rendered.

We think there can be no doubt that the plan under which Far-ington acquired the stock in its inception was one based on his employment by the company. The transaction did not start with the contract of April 8, 1918. The contract refers to the one of 1911, as modified in 1914, and cancels the earlier agreements only in respect of “ the purchase ” of the stock. It left the prior agreements in effect in so far as they pertained to other matters. The 1911 contract, after stating the cash salary to be paid provided that “in further consideration of the services to be rendered” by Far-rington, the company “agrees to sell”'and Farrington “agrees to buy ” 500 shares of stock of the company. When in 1914 the period of employment was extended for a year, and a new note was executed by Farrington, the continuing existence of the original contract . was recognized by a provision in the new note that:-

This note is given in modification of a personal service and stock' purchase contract heretofore made with the undersigned, and is subject to the provisions of the original contract — except as so modified.

In the 1918 contract, as pointed out above, only the provisions of the earlier contracts relating to the so-called purchase of stock were modified. Thus at all times from 1911 the parties to the agreements recognized that the stock was to be issued “ in further consideration of services to be rendered.” The only difference in substance between the 1911 and 1914 contracts and that of 1918 was that under the earlier ones it was contemplated that Farrington would pay $50 per share, while under the last one it would not be necessary for him to pay anything if he waited until dividends and arbitrary credits to his account were sufficient to make up the $50. The consideration, for the stock was still the same, namely, services of Farrington plus $50 per share. In order for him to receive the. stock without himself paying the $50 per share it was necessary, under the 1918 contract, for him to remain in the service of the company. An option existed under the contract whereby, in the event of death or discontinuance of services on account of age or disability, arbitrary credits and dividends could be allowed to accumulate until the stock was paid for. There is no provision, however, in the contract under which credits would accumulate and the stock be issued without payment by Far-rington if he voluntarily left the employ of the company. Hence, if he lived and was able to continue in the employ of the company he had a choice of two methods of acquiring the stock, either by paying cash of $50 per share or remaining in the service of the company until the credits to his account were sufficient to permit him to withdraw the stock without payment. He chose the latter method and during the succeeding years of his employment entered into several contracts with the company under which he agreed to continue in its service until November 1, 1929. In view of the original intent of the parties that Farrington was to be permitted to acquire the stock at the specified figure in consideration of his services, and that when later it was decided to issue it to him without cost but only on condition that his employment continued, the conclusion is inescapable that the stock was received as compensation for services. Petitioners do not challenge the long established holding that stock received as compensation is income. James R. Lister, 3 B.T.A. 475; Charles R. Johnson, 8 B.T.A. 992; C. A. Tilt, 14 B.T.A. 437. It is immaterial that the stock is received for services rendered in the past. See Lyle H. Olson, 24 B.T.A. 702; Old Colony Trust Co. et al., Administrators, 22 B.T.A. 1062; affd., 59 Fed. (2d) 168.

Granting that Farrington acquired a valuable right in 1918 under the contract of that year, it does not follow that that represented income then realized. Cf. Burnet v. Logan, 283 U.S. 404. The promise in this case — to deliver stock — was not unconditional. Something remained to be done before the employee could draw down the stock. He had either to pay $50 per share or remain in the service of the company until credits to that amount had accumulated. Under such circumstances it seems clear that to one on the cash basis no income is realized until payment is actually received, which in this case was in 1928. The case of Durkee v. Welch, 49 Fed. (2d) 339, cited by petitioners is not in point. There it was necessary for the recipients of the stock to pay for it by means of permitting deductions from their salary checks.

We conclude that the stock received in 1928 was income to the extent of its value at the time of receipt. Cf. Albert Russel Erskine, 26 B.T.A. 147.

Reviewed by the Board.

Decision will be entered for the respondent.


author: Seawell: Arundell and Murdock,

text:
    Charles E. Ives, Petitioner, v. Commissioner of Internal Revenue, Respondent. Julian S. Myrick, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 40423, 40424, 51526, 51527, 63376.
    Promulgated January 18, 1934.

      Watson Washburn, Esq., for the petitioners.

      Frank A. Surine, Esq., for the respondent.
   OPINION.

Seawell:

The deficiencies in income taxes asserted by the respondent are for the years 1923, 1928, and 1929. The statutes involved, though not here quoted, are sections 212 (a), 213 (a), 218 (a), (b), (c), and 224 of the Revenue Act of 1921, and sections 21, 22 (a), 181,182 (a), 183,184, and 189 of the Revenue Act of 1928.

The record shows quite clearly that in executing the trust instruments bearing dates of May 1, 1923, and February 15, 1924, as set, forth in our findings of fact, it was the intent of petitioners to reduce their tax liability by transferring their interests in their partnership of Ives & Co., also known as Ives & Myrick, to trustees for the benefit of their wives or relatives. Whether they accomplished their purpose as regards the taxes and years in issue, by resort to the means and methods adopted, is the question for our determination.

The wording of the indentures of May 1, 1923, and February 15, 1924, shows that the petitioners, each, did “ assign, set over and transfer to the trustee [or trustees] all his right, title and interest in the partnership,” of Ives & Co. or Ives & Myrick, “ and all the assets and good will thereof * * * with full power to carry on the said partnership.” The expressions used in the instruments are general and inclusive' enough to constitute, in our opinion, a complete transfer of the partnership interests to the trustees named and to effect the purpose for which intended, unless rendered ineffective by operation of some law or by certain conduct of the parties.

The respondent contends that the trusts created by petitioners’ in the first instance — those dated May 1, 1923 — were revocable during that year" and that therefore the income from the partnership interests for that year is taxable to the grantors, the petitioners. citing as authority Grace Whitney Hoff, 20 B.T.A. 86, and Cleveland Trust Co., Executor, 24 B.T.A. 132.

The petitioners, through their counsel, insist that the revocability of the trust instruments during 1923 does not make the income of the partnership attempted to be created by or through the operation of the trusts taxable for that year to the grantors or (as termed by petitioners’ counsel) donors, and an extended argument based largely on the dissenting opinion in N. H. Boynton, 11 B.T.A. 1352, 1364-1374, and numerous court authorities cited, are relied on.

While we have carefully considered all arguments and citations, we do not, in the view we take of this particular question, deem it necessary to discuss the subject at great length.

In Cleveland Trust Co., Executor, supra, we held that the agreement under consideration was one of mere agency and not a trust instrument, following our holding to the same effect in N. II. Boynton, supra. In the Grace Whitney Hoff case, supra, however, there was a trust revocable in 1923, as in the instant proceedings, and in view of the fact that the petitioner therein had full power under the trust instrument to control both the corpus and the income thereof we held, as we conceived, in accordance with the principle enunciated by Mr. Justice Holmes in Corliss v. Bowers, 281 U.S. 376, that she was taxable on the 1923 income. While the question in that case was a constitutional one, involving section 219 (g) and (h) of the 1924 Revenue Act — which is not found in the 1921 Revenue Act, involved in the instant proceedings — the issue related to 1924 income of a revocable trust created in 1922 and the Court in its opinion used very broad and inclusive language, saying in part:

* * * The income that is subject to a man’s unfettered command and that he is free to enjoy at his own option may be taxed to him as his income, whether he sees fit to enjoy it or not'. We consider the case too clear to need help from the local law of New Yort or from arguments based on the power of Congress to prevent escape from taxes or surtaxes by devices that easily might be applied to that end.

The income for 1924, in the circumstances stated, was held taxable to the grantor. Some other and later decisions in which similar questions were involved are Burnet v. Guggenheim, 288 U.S. 280; Reinecke v. Smith, 289 U.S. 172; and Burnet v. Wells, 289 U.S. 670.

In none of these cases, nor in others considered, do we find any expressions which, in our opinion, justify a departure from the principle announced in Corliss v. Bowers, supra, and followed by us in Grace Whitney Hoff, supra. In fact we are on the contrary rather confirmed by the decisions in those cases of the correctness of our holding and statement in the Hoff case, supra, that it is clear from the Supreme Court’s opinion in Corliss v. Bowers, supra, that, irrespective of the special provisions of section 219 (g) and (h) of the 1924 Revenue Act, control by the petitioner over the income has the effect of constituting it her income and so taxable.

In the instant proceedings it is clear from the record that the trusts created by the petitioners on May 1, 1923, were revocable by them during the remainder of that year and in our opinion, and we so hold, the income of the respective trusts created by petitioners Charles E. Ives and Julian S. Myrick should be included in computing their net income for 1923, as determined by the respondent.

On February 15, 1924, the record shows, the trusts of May 1, 1923, were revoked by petitioners and on the same day other trusts were executed by them which were irrevocable in their nature, and, petitioners insist, these trusts constituted a complete transfer of the partnership assets to the trustees. In view of the conclusion we have already reached and stated in reference to income of the trust partnership during the year 1923, we shall consider the trust instruments after they were made irrevocable and only for the years involved herein, 1928 and 1929.

The respondent contends that the petitioners continued as partners in the business conducted under the name of Ives & Co. or Ives <& Myrick, regardless of the alleged transfer of their interests therein. Such insistence is based on the fact that there was no change made in the name under which the business of the partnership was carried on; that the business was conducted in the same office rooms as before the asserted transfers, where the original or old partners were always available for rendering assistance in the operation of the business; that the only notice of the alleged change in the partnership was notice thereof sent to the bank where the partnership account was kept, which account continued as formerly in the name of Ives & Co.; that insurance agents continued to sell their renewal commissions to the partnership of Ives & Co.; and that the insurance company which paid the commissions was not notified of the alleged change until 1928. In behalf of the respondent it is also insisted that such a partnership as petitioners assert was created and carried on after their alleged transfer of their partnership interests to the aforesaid trustees could not legally exist under the statutes of New York, no certificate being filed in the clerk’s office of the county where the business of the partnership was to be conducted.

The continued use by the trustees of the partnership name, Ives & Co. or Ives <⅞ Myrick, in conducting their alleged partnership business, without filing a partnership certificate with the clerk of the county where the partnership business was to be carried on, as directed by section 81, McKinney’s Consolidated Laws of New York, Annotated (Book 38, Partnership Law), did not, in our opinion, constitute a violation of any penal law of the state or make such partnership absolutely null and void. See secs. 440 and 924, McKinney’s Consolidated Laws of New York, supra, Book 39. See also In re Richardson Bros., 206 Fed. 932; affd., 234 Fed. 1023, in which a statute asserted by the court to be identical with that of New York is construed and decisions of courts of New York and of numerous other states having similar statutes are cited as having rendered decisions thereon holding the use of partnership names similar to the one now in question, under circumstances of like character to those in the instant case, does not make such partnership business unlawful.

We have heretofore recognized the principle that in the State of New York a valid partnership may exist with a trustee as one of tile partners. M. A. Reeb, 8 B.T.A. 759. See also Richard H. Oakley, 24 B.T.A. 1082. If, however, the trustees mentioned in the indentures or trust instruments herein were incapable of forming and operating a valid partnership in New York State, they could certainly take a transfer or assignment of the renewal commissions and bank account standing in the name of Ives & Co., own such jointly, receive payment of renewals, deposit same in the aforesaid bank account and reinvest the money in the purchase of other renewals, which the record shows was done. The trust instruments executed by petitioners conveyed “ all the right, title and interest ” which they had in the partnership assets. The record shows conclusively, in our opinion, that it was the intention of petitioners to make an absolute assignment of their partnership interests, subject to revocation between May 1, 1923, and February 15, 1924, and thereafter irrevocable. The evidence on this point is clear and uncontradicted. Their action in the matter was under advice of counsel and the fact that such action was with a view to reducing or avoiding to some extent the amount of income taxes which they would otherwise have to pay does not render the trust instruments ineffective or invalid. The tax liability of the trustees and beneficiaries would be the same as joint adventurers or as partners.

The respondent contends that the facts herein bring these cases within the rule and principle applied in Lucas v. Earl, 281 U.S. 111; Burnet v. Leininger, 285 U.S. 136; Bishop v. Commissioner, 54 Fed. (2d) 298; Dickey v. Commissioner, 56 Fed. (2d) 917; Battleson v. Commissioner, 62 Fed. (2d) 125, and other cases of like nature. There are facts in the instant cases similar to those in the cases cited, but there are also material differences, in view of which those cases, in our opinion, are not controlling herein.

The fact that nearly all the renewal commissions which were acquired by the trust partnership after the execution of the trusts were derived from insurance written by agents or persons other than the petitioners is established by the uncontradicted testimony of witnesses. It was virtually stipulated at the hearing that of the renewal commissions acquired as stated only a few hundred dollars’ worth arose from insurance written by the petitioners. The record further shows that the renewal commissions purchased by the trust partnership of Ives & Co. were paid for out of its bank account, carried in the same name, Ives & Co., under which the petitioners operated prior to the assignment. The Mutual Life Insurance Co. of New York was not notified of the assignment until April 11, 1928, prior to which date checks from the insurance company in payment of renewal commissions continued to be made payable to petitioners, were endorsed by them, and deposited in bank to the credit of the trust partnership account of Ives & Co., the petitioners having previously assigned, as shown by aforesaid trust instruments, all their right, title, and interest in such renewal commissions. However, under the circumstances of the instant case the failure to notify the insurance company did not, in our opinion, invalidate the assignment. The record shows that the petitioners, after making the revocable trusts of May 1,1923, of their partnership interests in renewal commissions, never asserted any right, title, or interest to any of the renewal commissions and never — though they might have done so before making the irrevocable trusts of February 15, 1924 — appropriated to their own use any of the same. All the renewal commissions paid after May 1, 1923, are shown by the evidence to have been paid into the bank account of the trust partnership and all renewal commissions purchased by or for the trust partnership were paid out of its Ives & Co. account, and after the execution of the irrevocable trusts such payments were, in our opinion, made with the money of the trust partnership and the income arising therefrom was in the sense of the law, as we view it, “ earnings ” of the trustee-partners or trust partnership and hence not taxable to the petitioners during the years in issue, 1928 and 1929.

In our opinion, the principles enunciated and applied in the cases cited below are controlling herein. What the petitioners assigned and transferred by irrevocable trust instruments were property (their Ives & Co. bank account) and rights to property (their interests in certain renewal commissions), as shown in our findings of fact. See Nelson v. Ferguson, 56 Fed. (2d) 121; certiorari denied, 286 U.S. 565; Rose v. Commissioner, 65 Fed. (2d) 616; Eugene Siegel, Executor, 20 B.T.A. 563; William Ernst Seatree, 25 B.T.A. 396.

We are, therefore, of the opinion and hold that each of the petitioners, for the years 1928 and 1929 involved herein, is liable for income taxes in issue only to the extent of income from renewal commissions derived from insurance personally written by him and paid into the trust partnership account of Ives & Co., which counsel at the hearing stated was only a few hundred dollars and indicated there would be no disagreement as to the amount.

Reviewed by the Board.

Judgment will he entered for the respondent in Docket Nos. 1ft 1$3 and and *n Docket Nos. 51526, 51527, and 63376 under Rule 50.

McMahon, GoodRich, and Leech concur in the result.

Black and Matthews dissent.

Sternhagen dissents in Docket Nos. 51526, 51527, and 63376, being of the opinion that the respondent’s determination should be sustained.

Arundell and Murdock,

dissenting: We dissent from the opinion in so far as it holds that income of a revocable trust was taxable under the Revenue Act of 1921 to the grantor.


author: McMahon :

text:
    Wanless Iron Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 46385, 49626, 63450.
    Promulgated January 23, 1934.

      Paul E. Short, Esq., for the petitioner.

      James K. Polk, Esq., and Harold F. Noneman, Esq., for the respondent.
   OPINION.

McMahon :

The petitioner contends that it and the leases involved herein are governmental instrumentalities or agencies of the State of Minnesota for the development and operation of its school lands, dedicated to the support of its public schools; and that therefore it is immune from Federal taxation.

It has been held that in maintaining its public schools a state is exercising a function strictly governmental in character.” Burnet v. Coronado Oil & Gas Co., 285 U.S. 123. To the same effect is G. Ridgely Sappington, 25 B.T.A. 1385.

The Supreme Court of the United States has prescribed tests and imposed limitations which must be applied in dealing with the doctrine of immunity as invoked by the petitioner. To be immune from Federal taxation, the agency or instrumentality of the state must be one through which the state immediately and directly exercises its sovereign powers; and must be intimately connected with the necessary fv/nctions of the government of the state. Metcalf & Eddy v. Mitchell, 269 U.S. 514. The application of this doctrine must be practical and have regard to the circwnstanees disclosed. Burnet v. Jergins Trust, 288 U.S. 508. It must be given such a practical construction “ as will not unduly impair the taxing power of the one or the appropriate exercise of its functions by the other.” Susquehanna Co. v. Tax Comm. (No. 1), 283 U.S. 291, 294. The agency or instrumentality of the state is not immune from Federal taxation unless it is shown affirmatively by the party having the burden of proof (in these proceedings the petitioner) that the tax will impose a substantial, (direct bu/rden upon the state. If the influence of the tax is remote there is no immunity. This principle of immunity from Federal taxation of the instrumentalities of the state “ has its inherent limitations.” Fox Film, Corp. v. Doyal, 286 U.S. 123; Willcuts v. Bunn, 282 U.S. 216. In Burnet v. Coronado Oil & Gas Co., supra, relied upon by petitioner, adhering to the rule approved in Gillespie v. Oklahoma, 257 U.S. 501, also relied upon by petitioner, the Supreme Court said:

We are disposed to apply the doctrine of Gillespie v. Oklahoma strictly and only in circumstances closely analogous to those which it disclosed. [Emphasis ours.]

An analysis of all of the facts, and more particularly the circumstances and relationships, disclosed in these proceedings, and a full appreciation of just what happened here, leads to the conclusion that the petitioner has not met any of these tests or brought itself within these limitations.

The State of Minnesota leased to Wanless mineral lands of which the state is still the owner. Wanless assigned the leases to petitioner, and, subject to subsequent subleases, the petitioner ever since has been the owner of these leases. Petitioner subleased to Butler Brothers and others some of the lands. One of these subleases was assigned by the subleasee to another assignee and subsequently -was by this assignee released back to the petitioner by deed. Neither Wanless, the lessee and assignor, nor petitioner, the assignee and sub-lessor, ever extracted or sold ore from the lands. The sublessees are the.only ones that produced and sold ore. Neither Wanless nor these sublessees are before us. Presumably, the ore that was produced by the sublessees was sold to others, fifth parties in the sequence of events which led to the realization of funds from the mined ore with which to pay the state its royalty of 25 cents per ton, which was the most that the state got for its ore and which was what the state was primarily interested in. In any event this 25-cent royalty was paid directly to the state by the sublessees. Petitioner paid no royalty to the state. This 25-cent royalty did not pass through petitioner to the state or appear on petitioner’s books of account or enter into its gross income. Petitioner produced and sold no ore. The capital, labor, skill, and other things required to produce and sell the ore and to realize and pay the royalty of 25 cents per ton belonging to the state was supplied by the sublessees; not by petitioner. The sublessees thus produced the income to the petitioner as a result of their operation of the mines and sale of the ore. Petitioner was merely the conduit through which the right or privilege of mining the ore and the resulting obligation of paying this royalty to the state were passed on from Wanless, the lessee and assignor, to sub-lessees. These could all have gone directly from Wanless to the sub-lessees without the intervention of the petitioner. Petitioner was not essential to the realization by the state of its 25-cent royalty.

Without owning the ore deposits which belonged to the state and without doing anything about the actual production and sale of the ore and the actual payment of the royalty to the state, petitioner received from the sublessees, after the payment of the 25 cents per ton royalty to the state by the sublessees and the payment of taxes by them, a liberal overriding royalty or profit, which, as to some tonnage, was not less than 50 cents per ton on each ton of ore for which the state, which owned the ore deposits, received only 25 cents per ton of royalty or not more than half as much. The principal consideration for its 25-cent royalty moving from the state was the ore in place. No such consideration moved from the petitioner for what it received. As detailed in our findings of fact, the subleases proved to be very profitable to the petitioner. This is well illustrated by the following ultimate figures. As of March 1, 1913, the aggregate total fair market value of petitioner’s interest or equity in the mineral lands covered by its subleases, being the then present worth of its expected future royalty receipts after operation, based on the unmined reserves of ore and the lives of the mines, was $627,978.26; and as of May 4, 1921, petitioner’s admitted assets were augmented by a similar value in the amount of $103,828, based on additional ore discovered on that' date in the land covered by one of the subleases.

From 1913 to 1929, inclusive, there were extracted from not more than 240 acres covered by the subleases, by the sublessees, or by them and the assignee of one of them, a total of 3,227,541 tons of ore, on which the state’s royalty of 25 cents per ton totals $806,885.25. The total tonnage for the one year of 1926 was 401,577 tons and the state’s royalty thereon totals $100,893.25. The tonnage for 1927, 1928, and 1929, the only years before us, was 766,950 tons and the state’s royalty thereon totals $191,737.50. The petitioner’s total receipts for these three years from its sublessees, based on such tonnage, was $306,875.27, or an average of $102,291.76 per year. The Federal income tax for these three years, as shown by the stipulated deficiencies and the alleged refunds sought, cannot exceed $6,242.75 per year, on the average, or less than 6 percent of these receipts. Its total disbursements for these three years were $14,173.91, or an average of $4,724.63 per year. Its other disbursements in those years consisted only of other taxes, office and miscellaneous expenses, and rent paid to the State of Minnesota. This item of rent is small and there is no explanation as to what it' covered.

Obviously, the sublessees produced the ore in such volume to sell it at a profit and found the extraction and sale of the ore profitable, after paying the 25 cents per ton to the state, the taxes required of them and the overriding royalties or profits to the petitioner. Otherwise, the sublessees would not have produced such a large volume of ore. Each sublease was either terminated or, at the election of the sublessees, terminable.

It is likewise obvious that those who purchased the ore from the sublessees, adequate provision having been made by lien and otherwise for the payment of the 25 cents per ton royalty to the state out of the proceeds of the sales by the sublessees, made profits resulting from such purchases. Otherwise, they would not have purchased such a large volume of ore from the sublessees. It is unnecessary for the purposes of this proceeding to trace any further the ore or the source of the 25-cent royalty which accrued to the state, or to pursue further this line of reasoning. We are concerned in these respects only with the question as to whether the receipts of the petitioner derived from the operations of the sublessees after the payments of this royalty and taxes by the sublessees are subject to taxation under Federal law, or, in other words, whether they are immune from such taxation.

All of the large amount of ore tabulated in our findings of fact was produced and the large amount of state royalties thereon accrued to the state upon the assumption, apparently, that the income of the petitioner therefrom was taxable under Federal law. It reported income therefrom for 1927, 1928, and 1929 and paid taxes thereon. The petitioner, at one time, by stipulation before the Board, consented to the determination of deficiencies based on such income. From the record it appears that it was not until after the decision in Burnet v. Coronado Oil & Gas Co., supra, was rendered that the petitioner questioned the imposition of such Federal income tax on the ground that it was not subject to such taxation.

There is no evidence that the state actually has been or will be unable to realize its royalty of 25 cents per ton on any of its ore covered by the subleases involved in these proceedings as a result of imposing a Federal income tax upon the income derived by the petitioner from the sublessees. No offer of evidence of this character was made.

In the leases from the state to Wanless we find the following provisions :

⅜ ⅜ ⅜ The party of tile second part [Wanless] agrees to pay all taxes, general or specific, upon tlie land so leased, which may be assessed either against said land and the improvements thereon, or the iron ore produce thereof, or any personal property at said mines, during the continuance of this lease; just the same as though the lands herein leased were owned in fee by the said party of the second part; * * *
The covenants, terms and conditions of this lease shall run with the land and be hi all respects binding and operative upon all sub-lessees and guarantees under the party of the second part. * * *
The party of the first part reserves, and shall at all times have, possess and hold a lien upon all ore mined', * * ⅜ for any unpaid balances due on this contract. [Emphasis ours.]

A similar tax provision was before the Supreme Court of Minnesota in Fryberger v. Inland Steel Co., 218 N.W. 553. The court in its opinion states:

* * * As indicated in the Marble case, [Marble v. Oliver Mining Co. (Minn.), 215 N.W. 71] the purpose of the parties to Minnesota mineral leases and assignments thereof ordinarily has been to pass on, from lessor to lessee and from lessee to sublessee, the entire taco burden, whatever form it may take. In solving such a problem of interpretation, the effort must always be to get into and understand the situation of the parties at the time. * ⅞ * The possibility of tacoes additional in burden and new in variety was plainly foreseen. Hence we find even in the state lease a general assumption of “ all taxes general and specific, which may he assessed against said land.”
The purpose of that tax assumption olause xoas made as far reaohmg and inclusive as could be. It was to put the lessee in the position, with respect to all [printed in italics] taxes, of an owner in fee. The state did not purpose to permit its lessee to participate in nor derive any benefit from the imimumty of its oton property <from taxation. Subletting or assignment by the lessee was contemplated and is Quite usual. With respect to the incidence of tacoes on the leasehold, the lessee was to be dealt with as an owner in fee. So any tax on the resulting interest of Crosby in the demised land was covered by his agreement, in the lease, to pay all taxes, general of specific, the same as though he had been the owner in fee instead of lessee.
* * * And although the lease from the state may not itself he the source of the lessee's obligation to pay a royalty taw on mcreased royalties gotten by him through an assignment, it is in a very real sense because of the lease and because he is lessee that he has to pay them} that is, the duty to pay the tax is one which rests upon the lessee as such. That is enough for present purposes because the assignment from Crosby to defendant put upon the latter the duty to pay all taxes imposed upon the “ lessee therein," there being nothing to require also that the obligation to pay be imposed by the lease itself rather than some law. It is enough to malee that covenant applicable that the tax is put upon the leasehold or something appwtenant to or carved out of it so that it becomes a duty of the lessee to pay it. [Emphasis ours.]

See also Fraser v. Vermillion Mining Co., 221 N.W. 13; and State ex rel. Oliver Mining Co. v. Armson, 232 N.W. 35.

As thus construed by the Supreme Court of Minnesota this is a sweeping tax provision designed to deny immunity from any tax burden, in any form, as if the state did not own the land or the iron ore product thereof. The denial of immunity applies to a “ tax put upon the leasehold or something appurtenant to or carved out of it.” All benefit from the immunity of its own property from taxation ” is with respect to “ all taxes ” thus denied by the state. [Emphasis ours.]

The position of the state as manifested by this provision is that immunity from taxation is not necessary to the extraction and sale of its ore and the realization of its 25-cent royalty. In fixing the royalty at the figure of 25 cents per ton the state, no doubt, took into consideration that immunity from all taxation was thus denied. In any event the state must have been satisfied from its experience, of which it apparently had considerable, that immunity such as that which petitioner is here seeking is not necessary to the realization of its royalty of 25 cents per ton on its ore; and Wanless, the petitioner, the sublessees, and the purchasers of ore from the sublessees did what they did, with the results to the state heretofore pointed out, notwithstanding this denial by the state of immunity from taxation, which is carried through to and binding upon all of them. None of them was deterred by this express sweeping denial of immunity imposed by the state. The provisions of the lease put them on notice as to this denial of immunity by the state.

A sovereign may by its own action voluntarily thus consent to the taxation of its governmental agencies and instrumentalities by another sovereign and thereby waive immunity from such taxation. Mid-Northern Oil Co. v. Walker, 268 U.S. 45. The Mid-Northern Oil Co. engaged in producing oil from lands in Montana leased by the United States under the Federal Oil and Gas Leasing Law. Under the laws of Montana every person engaged in producing petroleum or other mineral or crude oil within the state was required to pay to the state annually a license tax equal to 1 per centum of the gross value of the oil so produced during the year. The Mid-Northern Oil Co. challenged such state taxation. The act of Congress pursuant to which the lease was made contained a provision as follows:

That nothing in this Act shall be construed or held to affect the rights of the States or other local authority to exercise any right which they may have, including the right to levy , and collect taxes upon improvements, output of mines, or other rights, property, or assets of any lessee of the United States.

The United States Supreme Court, in holding that the Mid-Northern Oil Co. was not immune from the state taxation which it challenged, stated:

The more natural view, and the one we adopt, is that Congress, having provided for leasing the public lands to private corporations and persons whose property, income, business and occupations ordinarily were subject to state taxation, meant by the proviso to say in effect that, although the act deals with the letting of public lands and the relations of the government to the lessees thereof, nothing in it shall he so construed as to affect the right of the states, in respect of such private persons and corporations, to levy’ and collect taxes as though the government were not concerned. In other words, the purpose of Congress was to remove altogether from the field of controversy, among other questions, the very question which is here presented, and to put beyond doubt the authority of the states to impose taxes upon lessees in respect of their property, although arising from, and in respect of their taxable rights, although exercised under, the act, without regard to the origin thereof or to the interest of the United States in the lands or lease.

It seems to us, therefore, that in view of the provision in the state leases to the effect that the lessee shall pay all taxes just the same as though he owned the land leased, which ran with the land, the decisions of the Supreme Court of Minnesota construing the same, and the doctrine of this Mid-Northern Oil Co. case, the state has denied to the petitioner and thereby waived by consent immunity from Federal income taxation in so far as the petitioner, the assignee and sublessor under these school land leases are concerned. Bass v. Group No. 1 Oil Corp., 41 Fed. (2d) 483, and cases cited. (Affirmed at 283 U.S. 279, on other grounds.)

It is true that the denial of immunity in the Mid-Northern Oil Co. case is embodied in a statutory provision, while in the instant proceeding it is embodied in a lease or contract; but this lease or contract is not only authorized by statute, but, as to this provision, it is prescribed by statute. In other words, it is founded upon a statutory provision. Here, as well as there, the action of the sovereign is competent to accomplish its manifest purpose. We see no sound basis for a distinction on this ground. Too, neither the validity nor full force and effect of this provision of the lease or contract has been challenged in any way.

What was stated by the court as follows in Willcuts v. Bunn, supra, applies with equal force to the instant proceeding:

It must be remembered that we are Healing, not with any express constitutional restriction, hut only with an asserted implication. The constitutional provisions authorizing the Congress to lay tawes (article 1, §8; Sixteenth Amendment) are certainly broad enough to cover the tax in question, and oefore we can restrict their application upon the ground of a burden cast upon the State’s borrowing, where the tarn is not laid upon the contracts made by the State in the exercise of that power, or upon the amounts payable thereunder, but is laid upon the result of distinct transactions by pri/vate owners, it nvust clearly appear that a substantial burden upon the borrowing power of the State would actually be imposed. But we have nothing hut assertion and conjecture. [Emphasis ours.]

The Sixteenth Amendment is as follows:

The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration. [Emphasis ours.)

This amendment was ratified by the Legislature of the State of Minnesota on June 12, 1912.

In section 22 (a) of the Revenue Act of 1928, gross income is defined as follows:

(a) General definition. — “Gross income” includes gains, profits, and income derived from salaries, wages, or compensation for personal service, of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever.

A similar definition is to be found in section 213 (a) of the Revenue Act of 1926.

The petitioner’s claim of immunity from Federal taxation is not founded upon any express constitutional or statutory provision, but upon the doctrine or principle of implied immunity. Collector v. Day, 11 Wall. 133; Pollack v. Farmers' Loan & Trust Co., 157 U.S. 584; South Carolina v. United States, 199 U.S. 437; Metcalf & Eddy v. Mitchell, supra; Willcuts v. Bunn, supra; Indian Motorycle Co. v. United States, 283 U.S. 570; Burnet v. Coronado Oil & Gas Co., supra; Burnet v. Jergins Trust, supra; T. P. Wittschen, 25 B.T.A. 46.

Any doubt that may arise about the application of an implied Federal constitutional provision to a factual situation, such as we have here, as against the application to such factual situation of an express, comprehensive Federal constitutional provision and comprehensive legislation enacted pursuant thereto, must be resolved against the application of the implication. We have no such doubt here however.

The United States Supreme Court has also held that profits on the sale of bonds of municipal corporations, governmental instrumen-talities (Pollack v. Farmers' Loan & Trust Co., 157 U.S. 429, 584), constitute “ gains, profits and income ” from sales or dealings in property within section 213, Eevenue Act of 1924, and hence are taxable. Willcuts v. Bunn., supra. In this case the Court said:

But it does not follow because a tax on the interest payable on state and municipal bonds is a tax on the bonds and therefore forbidden, that the Congress cannot impose a nondiscriminatory excise tax upon the profits derived from the sale of such bonds. The sale of the bonds by their owners, after they have been issued by the States or municipality, is a transaction distinct from the contracts made by the government in the bonds themselves, and the profits on such sales are in a different category of income from that of the interest payable on the bonds. * * * The tax upon interest is levied upon the return which comes to the owner of the security according to the provisions of the obligation and without any further transaction on his part. The tax falls upon the owner by virtue of the mere fact of ownership, regardless of use or disposition of the security. The tax upon profits made upon purchases amd sales is an excise upon the result of the combination of several factors, including capital investment and, quite generally, some measure of sagacity; the gain may be regarded as “ the creation of capital, industry and sMll.” Tax Commissioner v. Putnam, 227 Mass. 522, 531, 116 N.E. 904, 910, L.R.A. 1917 F. 806.
*******
⅜ * * If the tax now in question is to be condemned, it must be because of practical consequences and not because purchases and sales by private owners of state and municipal bonds are a part of the State’s action in borrowing money. It would be far-fetched to say that such purchases and sales are instrumentalities of the State. They are not transactions made directly or indirectly in behalf of the State or in the course of the performance of any duty of the State. Sales are merely methods of transferring title to the obligation, that is, the right to receive performance of the promise of the State or municipality. [Emphasis ours.]

A question somewhat similar to that decided in Willcuts v. Bunn, supra, was passed upon by the Court of Claims of the United States in Marland v. United States, 3 Fed. Supp. 611, such question being as follows: Whether the profits derived by the plaintiff from the sale of a number of oil and gas leases of certain school lands entered into between him and the State of Oklahoma were immune from Federal income taxation; and the court in holding such profits taxable said:

The immunity from taxation applies only where the tax would be a real and direct burden upon the State’s exercise of its governmental functions and it is our opinion that under the cases cited the burden upon the State of Oklahoma in leasing its public lands on the best possible terms, because of the tax that may be exacted from the lessee upon the sale by him of his leases from the State, is so indirect and remote as to place it outside the principle that one Government may not levy a tax upon the functions or instrumentalities of another. Although it is shown in this case that a lessee of oil lands from the State of Oklahoma would pay more to the State for a lease in the first instance, if he were assured that profits from the sale of a lease would be exempt from Federal income tax, this was doubtless true in Group No. 1 Oil Corp. v. Bass, supra. [283 U.S. 279.]
* ⅜ * A gain derived by a taxpayer through a sale of property or interest therein acquired from a state, whether acquired in the form of a lease or tty purchase, does not, in our opinion, fall within the implied constitutional prohibition against taxation. “ The immunity does not extend to anything lying outside or beyond governmental functions and tlieir exercise ⅜ ⅜ * .” Indian Motorcycle Co. v. United States, supra. * ⅜ * and it is apparent that not everyone who uses his property or derives a profit, as a result of his dealings with the government, may clothe himself with immunity from taxation. Metcalf & Eddy v. Mitchell, supra. [Emphasis ours.]

In Rice Oil Co. v. United States, — Fed. Supp. — (Sept. 8, 1933), the District Court of the United States for Montana there was presented another somewhat similar question: Whether an assignee of oil and gas leases procured from the State of Montana, lessor, is taxable under Federal income tax law upon income derived in part at least from proceeds of the sale of oil taken from the lands covered by the leases and used in part payment, at least, for the assignment ; and in holding such income taxable the court said:

It appears from the complaint that plaintiff sold its interest in the lands on September 10th, 1926, to the Marine Corporation for $3,000,000.00. $1,000,000.00 was paid in cash and $2,000,000.00 were to be paid out of production of oil from the lands included in the lease. By the terms of the contract governing this transaction title was to pass to the purchaser as of August 11th, 1926. Therefore, can it be said that the income in question was derived by plaintiff as a lessee of the lands or was it in the nature of a profit upon the sale of a capital investment at a price above cost; in view of the facts here, the latter would seem to afford the correct answer under Marland v. United States, 53 F. (2d) 907; and Willcuts v. Bunn, 282 U.S. 216.

As appears from our findings Wanless assigned both state leases to petitioner for one dollar and all of its capital stock of the par value of $50,000. Under the doctrines of the three cases last discussed, can there be any question about the taxability under the Federal income tax laws of profits, if any, made by Wanless on the sale of this stock? While this issue is not before us, we think not. If Wanless is thus taxable, why should not the petitioner be taxable on the income in question here? In reality Wanless bunched the leases in question and sold them for a consideration to petitioner; and if a profit be made by him on his disposition of that consideration, it is taxable. Instead of bunching these leases and selling them to one buyer, petitioner carved out of each leasehold which it bought one or more subleaseholds and sold each for a consideration consisting for the most part in each instance of cash for each ton of ore mined — under one sublease for cash in the amount of 50 cents for each ton of ore mined. The effect in principle is the same as if it made but one sublease to one sublessee. The principal thing which passed to each sublessee under its sublease from petitioner was petitioner’s interest in the ore as conveyed by the subleases; among other things, its right or privilege of mining each ton of ore. The only consideration which actually passed from the sublessee to petitioner was the stipulated amount per ton which it reserved, subject to the qualifications imposed by the sublease, including, among others, the qualification that the state be first paid its royalty of 25 cents per ton, which was protected by its lien. Why should not the profits made by the petitioner on the considerations which it received on its sales or other dispositions to the sublessees be likewise taxable ? We conclude that it should be under the principles of these three cases, without indulging in extended refinements as to the instruments of conveyance or agreements involved there or here.

The nature of these Minnesota mineral leases is shown by what the supreme court of that state said in Marble v. Oliver Mining Co., 215 N.W. 71, as follows:

Mining leases, as a rule, cover a long term of years. They aim at the exhaustion of the ore, the real value of the land. When that has been accomplished, the premises are left in a shape utterly unfit for the ordinary uses of land. The situation of the parties at the time of this letting was that both contemplated that the mining would wholly deplete the ore; that the only returns to the lessor for the supposed great value of the land because of the mineral deposit therein would be the royalty; that the lessee would assume all the burdens and expenses connected with the mining, and realise all the profits which improved methods in mining and advance in price of the product might give over and above the royalty and taxes. For the lessee, the undertaking was a great speculation. [Emphasis ours.]

In Fryberger v. Inland Steel Co., supra, the Minnesota Supreme Court also said:

The lease gave Crosby the right to assign or sublet; that is, it created the right out of the exercise of which (by the assignment to defendant) has sprung the reserved interest, the right to the additional royalty from defendant, which has become the subject of the royalty tax. The lease put in him an estate upon his ownership of which as lessee has been put his additional royalty. It is not a mere excrescence due to any unnatural or unexpected development. [Emphasis ours.]

The position of Wanless is similar to that of Crosby and that of petitioner similar to that of this defendant. But in the instant proceedings petitioner took another step. It sublet to the sublessees, thereby parting with a portion of what it got from Wanless, reserving to itself certain overriding royalties or profits, which as to some tonnage was 50 cents per ton, as heretofore pointed out, which constitute a consideration moving to it for the subleases and which are the subject of the tax sought by the respondent here.

The petitioner claims that by the assignment by Wanless it stepped into the shoes of the assignor and that whatever immunity from taxation, if any, attached to the original lessee must, of course, under the circumstances disclosed, have passed to the petitioner as assignee. It regards itself as the lessee of the lessor state on the assumption that the assignment terminated the relationship between the state and Wanless as lessor and lessee created by the original lease.

After the assignment of the state leases by Wanless to the petitioner, there still remained the privity of contract between the state and Wanless created by the state leases, which was not affected by the assignment. Although made with the assent of the lessor, the lessee still continues liable on his covenants by virtue of this privity of contract. Thompson on Real Property, vol. 2, p. 498; Oswald v. Fratenburgh, 36 Minn. 270; 31 N.W. 173.

While the petitioner, subject to the subleases, is the owner by assignment of such leases, it did not become the owner thereof through the action of the state or in the exercise of its sovereign power. The state was not a party to the assignment or subleases. It was stipulated by the parties that:

The school lands covered by the leases aforesaid from the State of Minnesota have never been sold by the State and the aforesaid leases upon it have ever since their issuance always been and now are in full force and effect.

While the approval of the Land Commissioner of Minnesota is endorsed on the assignment of the state leases to the petitioner, there is no evidence that such approval was other than an approval of form and execution. However, even if such approval may be construed to be a consent of the State of Minnesota to such assignment, it can not be regarded as a new leasing so as to terminate the original leases and to relieve Wanless of his obligations as lessee thereunder. See Keegan v. Heilman Brewing Co., 129 Minn. 496; 152 N.W. 878; and Rees v. Lowry, 57 Minn. 381; 59 N.W. 310, wherein it is held that in no sense is an assignment of a lease and assent thereto to be regarded as a new leasing. In Wilcox v. Hedwell, 239 N.W. 763, wherein a lessor sued his lessee, who had assigned the lease, for arrears of rent and taxes, the court states:

The lease contains no restrictions on assignment of tbe leasehold. Nothing is better settled than that a surrender of a lease, or release of a lessee, is not to be implied from the mere facts that the lessor has assented to an assignment and accepted rent from the assignee. Stern v. Thayer, 56 Minn. 93, 57 N.W. 329; Hilzinger, Jr. v. Novak, 172 Minn. 369, 215 N.W. 515. So it is not enough for defendant that plaintiffs knew of the several assignments and accepted rents from the assignees. ⅜ * * The intention is plain that the defendant might assign, and that, if he did, the normal course would be for the assignee to pay rent directly to the lessors. That was to the defendant’s interest and what he wanted. Not only is there no evidence of an agreement on the part of plaintiffs to surrender, but every consideration of good business was against it because of defendant’s financial responsibility.

The case of Indian Territory Illumination Oil Co. v. Oklahoma, 240 U.S. 522, cited by the petitioner as supporting its contention that as assignee of the state lessee it is immune from Federal taxation, is distinguishable. The Court states the question before it for determination in the following language:

* * ⅜ whether a certain assignment of a lease and rights thereunder made by the Osage Tribe of Indians, ⅜ ⅜ * are subject to a tax assessed under the Laws of Oklahoma as the property of * * * [the oil company] in its capacity of a public service corporation.

While it appears that the original lease was made by Oklahoma with one Foster, and Foster assigned the lease to the oil company, it also appears, as stated by the Court in its opinion, that:

The Act of 1905 recognized the oil company as the owner by assignment of the lease, which assignment was approved by the Secretary of the Interior, and extended the lease for a period of ten years from March 16, 1906, with all the conditions of the original lease except that from and after that date the royalty to be paid on gas should be $100 per annum on each gas well instead of $50, as provided in the lease, and except that the President of the United States should determine the amount of royalty to be paid at all.

From the above it clearly appears that there was in fact a new leasing. Furthermore, in that case the assessment was made upon the leases as objects of taxation having no immunity under Federal law.

Conceding that the state leases are governmental agencies, under the doctrine of Gillespie v. Oklahoma, supra, and Burnet v. Coronado Oil & Gas Co., supra, did Wanless execute the assignment as agent of the state in its behalf and for its benefit? Certainly not. He was acting for himself as principal and for his own benefit. A lessee in no way becomes the agent of the lessor by virtue of a lease agreement. When Wanless assigned the leases he did so at his own risk, for he remained liable on his contract with the state and the state could look to him for the performance of his covenants. While Wanless acquired all of the petitioner’s capital stock, he and the petitioner are two separate and distinct entities. Eisner v. Macomber, 252 U.S. 189; Burnet v. Commonwealth Imp. Co., 287 U.S. 415; and Burnet v. Clark, 287 U.S. 410. Nor was the petitioner acting in behalf of the state or for its benefit when it subleased the premises. When it subleased the premises it likewise did so at its own risk and not as the agent of the state.

The state is not a party to the subleases or the assignments to petitioner, and hence these subleases are not instrumentalities of the state. A state must be a party to its own instrumentalities in a situation of this character. It is a party to the leases and they are its instrumentalities. But assignments followed by subleases, to none of which it is a party, have intervened. The contracts between Wanless and petitioner and between petitioner and the sublessees are different contracts from the one between Wanless and the state, which is the only one to which the state is a party.

From the foregoing discussion it appears that these proceedings do not disclose “ circumstances closely analogous to those which ” are disclosed in Gillespie v. Oklahoma, supra, or Burnet v. Coronado Oil & Gas Co., supra, the doctrine of which we are required by the latter case to “ apply * * * strictly.” In the Coronado case the taxpayer was a party with the state to the lease. As lessee the taxpayer supplied the capital, labor, skill, and other things necessary to extract the oil and gas from the land. The taxpayer and the state shared the oil and gas extracted by the lessee, equally as to some, and in the proportions of one eighth to the state and seven eighths to the taxpayer, as to some. The state received for the lease a consideration in kind from the lessee. (Mid-Northern Oil Co. v. Walker (Mont.), 211 Pac. 353, 356; affirmed in Mid-Northern Oil Co. v. Walker, supra.) This was in the nature of a profit-sharing arrangement. The state supplied the oil and gas in place. The state derived school funds from the sale of its share of the oil and gas extracted by the lessee. The taxpayer likewise derived the income sought to be taxed from its share of such oil and gas. The United States Supreme Court held that this income of the taxpayer was immune from Federal income taxation solely upon the ground that the lease was the instrumentality of the state through which it immediately and directly exercised its sovereign power, adhering strictly to the doctrine of the Gillespie case. The circumstances disclosed in that case are closely analogous to those of the Coronado case. It is plain from an examination of those cases and more recent cases of the United States Supreme Court heretofore pointed out (Fox Film Corp. v. Doyal, supra, and Burnet v. Jergins Trust, supra), that to carry this doctrine of implied immunity beyond the requirements of those cases as contended for by petitioner in these proceedings would be contrary to those cases.

It follows, therefore, that since the petitioner is not an agency through which the state immediately and directly exercised its sovereign powers, since petitioner is not intimately connected with the necessary functions of the state, since the subleases and not the state leases are the source of the petitioner’s income here involved, since no direct and substantial burden is laid upon the power of the state to lease its school lands, since the effect of the imposition of Federal taxation on the petitioner’s income herein on the state or its revenue is remote and at best merely conjectural, and since the granting of the immunity sought would unduly impair the taxing power of the Federal Government, the determination of the respondent that such income is subject to Federal income tax is approved.

The respondent contends also that the right of the petitioner to the receipts of royalty from its sublessees, or so-called overriding royalties constituting its income involved herein, was valued by the respondent, which value was determined to be the value of petitioner’s interest as of March 1, 1913; that in arriving at this value the entire amounts of the expected future receipts from the sublessees under the contracts were discounted to reach the value on the basic date and represent exactly what a willing buyer would have then paid a willing seller for the right to receive the entire future royalties; that this gross value of the petitioner’s interest was in fact the gross gain from the contracts; that the statutory depletion deduction spreads this gross value of petitioner’s expected future receipts over the number of tons of ore actually mined; and that therefore this deduction for depletion in fact exempts from tax the entire value of the consideration provided in the contracts to be paid to the petitioner by its sublessees. In view of our conclusion as to respondent’s first contention, hereinbefore stated, it is not necessary to discuss this second contention of the respondent.

Reviewed by the Board.

Decision will he entered for the respondent.

SteRnhagen, Murdock, and Matthews concur in the result.

Lansdon dissents.


author: Smith :

text:
    Hobart Iron Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 33413.
    Promulgated January 23, 1934.

      Ellsworth G. Ahvord, Esq., John B. Putnam,, Esq., and Ralston R. Irvine, Esq., for the petitioner.

      J. K. Polk, Esq., and Harold F. Noneman, Esq., for the respondent.
   OPINION.

Smith :

This is a proceeding for the redetermination of a deficiency in income tax for 1923 of $652.69. The petitioner claims that there is no deficiency but that the tax has already been overpaid and that it is entitled to a refund. The petition alleges that the respondent erred in failing “to exclude from net income in the year 1923 the amount of net income derived by the taxpayer from the operation of its mine, which property is owned in fee by the State of Minnesota.”

The petitioner is a corporation organized and existing under the laws of the State of Minnesota, with its principal office in Duluth.

Upon its admission into the Union the State of Minnesota acquired title to certain lands, the income from which was to go to the support of a university. Some of the lands thus acquired were mineralized and the state leased these lands to certain individuals who, under the terms of the lease, were required to pay royalties upon the production of ores to the state. On January 1,1902, the state issued to Francis W. Sullivan and James T. Hale a mineral lease, described as “ Contract #456 ” upon certain land upon which later the Majorca Mine was located. The lease ran for a period of 50 years from January 1, 1902, and was in the statutory form provided.by section 4079 of chapter 38 of the Minnesota Statutes of 1894. By the terms of the lease the lessees agreed to pay a royalty to the state of 25 cents on each ton of ore mined and taken away. For the first five years of the term of this lease the lessees agreed to pay a minimum royalty of $100 per year and thereafter a minimum royalty of $1,250 per year. As provided by the Minnesota statute, the lease contained the following provision:

The covenants, terms and conditions of this lease shall run with the land and be in all respects binding and operative upon all sublessees and guarantees Lgrantees] under the parties of second part.

On May 1, 1907, Sullivan and Hale entered into a contract with the petitioner whereby they leased to the petitioner for a term of 44 years commencing May 1, 1907, the land covered by “ Contract #456.” This lease was also prepared in statutory form in so far as applicable. Under the terms of this agreement the petitioner agreed to pay to Sullivan and Hale a royalty of 10 cents on each ton of iron ore mined and taken away and also to pay to the State of Minnesota such royalty and other payments as were provided in “ Contract #456.”

The agreement between Sullivan and Hale and the petitioner contained the following provision:

The Iron Company expressly admits that it accepts this lease subject to the terms and conditions of said state mineral contract [Contract #456].

Since May 1907 the State of Minnesota has at all times treated the petitioner as being directly responsible to it and in this capacity petitioner has dealt directly with the State of Minnesota as the lessor.

In 1923 the petitioner sold 151,743 tons of iron ore from the Majorca Mine and sustained deductible depletion on that mine of $52,184.42.

In addition to the Majorca Mine the petitioner operated another mine on the Masaba Range, known as the Elba Mine, which was located approximately 25 miles from the Majorca Mine. The Majorca Mine is an open-pit operation, while the Elba Mine is an underground operation. The two mines required separate local management, but they have had a common local and district agent management. In respect to the Elba Mine there was an ore reserve on March 1, 1913, of 1,190,591 tons having a then present value to the petitioner of $122,454.33. From the Elba Mine the petitioner sold 18,440 tons of ore in 1923 and sustained depletion on that mine of $30,184.91.

The petitioner had a net income for 1923, as determined by the respondent, of $231,402.14 of which it is stipulated that $184,380.90 was derived from the operation of the Majorca Mine and $41,021.24 from the operation of the Elba Mine.

The petitioner contends that its net income from the operation of the Majorca Mine in 1923 in the amount of $184,380.90 is exempt from income tax and that its only taxable net income is the $41,021.24 derived from the operation of the Elba Mine. This claim is made under the decision of the Supreme Court in Burnet v. Coronado Oil & Gas Co., 285 U.S. 393, in which the Supreme Court held that a lessee’s income from the sale of oil and gas produced under lease of school lands belonging to the State of Oklahoma was not taxable by the Federal Government, since the lease constituted a governmental instrumentality of the state. The petitioner argues that the facts in that case are almost identical with those which obtain in the proceeding at bar and that a like conclusion must be reached herein. Its contention is that the lease granted by the State of Minnesota to Sullivan and Hale was an instrumentality of the state for the purpose of realizing income from its state school lands; that the contract entered into between Sullivan and Hale and the petitioner on May 1, 1907, if not an assignment of the lease owned by Sullivan and Hale, in legal effect made the petitioner the lessee of the state lands and consequently that that contract was an instrumentality of the State of Minnesota for the purpose of deriving income from its school lands.

The respondent denies that the petitioner in 1923 occupied the same relationship to the State of Minnesota that Sullivan and Hale would have occupied if they had operated the mine in 1923. He contends that the contract of May 1, 1907, was not in legal effect an assignment of the lease and that there was no privity between the petitioner and the State of Minnesota with respect to the lands demised by the state to Sullivan and Hale; that the petitioner was merely a sublessee of Sullivan and Hale; and that it is liable to income tax in respect of its entire net income for the year 1923.

It will be noted from our findings that whereas Sullivan and Hale held the lease upon the demised premises for 50 years from January 1, 1902, or from that date to January 1, 1952, the contract between Sullivan and Hale and the petitioner was for a period of 44 years from May 1, 1907, or from that date to May 1, 1951. There was, therefore, a period from May 2, 1951, to January 1, 1952, for which petitioner had no lease upon the demised properties. In other words, there was a reversion in Sullivan and Hale for such period.

In the light of these facts we think it clear that the petitioner operated the demised properties during the taxable year as the sub-lessee of Sullivan and Hale. Cf. Craig v. Summers, 47 Minn. 189; 49 N.W. 742; Cameron Tobin Baking Co. v. Tobin, 104 Minn. 336; 116 N.W. 639; Davidson v. Minnesota Loan & Trust Co., 158 Minn. 411; 197 N.W. 833; and Thompson on Real Property, vol. 2, § 1372.

The petitioner contends that the State of Minnesota dealt with it during the taxable years in question as the lessee of its lands. It calls attention to the decision of the Supreme Court of Minnesota in State v. Hobart Iron Co. (1919), 143 Minn. 457; 172 N.W. 899, in which it appears that the state sued the petitioner to recover a balance of $1,401.75 royalty due under Contract #456.” Both of the agreements involved in this proceeding were before the court. The Supreme Court of the State of Minnesota held that the petitioner was responsible directly to the state under “ Contract #456.” In the course of its opinion the court stated:

The defendant operates the Majorca Mine under a lease from the state. The lease was granted to its assignors in 1902, and is in statutory form. Laws 1895, e. 105, § 4; (G.S. 1913, § 5315). It recites that the premises are leased, “for the purpose of exploring for, mining, taking out and removing therefrom, the merchantable shipping iron ore, which is, or which hereafter may be found,” etc. The lessee agrees to pay “ for all the iron ore mined and removed ⅜ * * at the rate of 25 cents per ton for all iron ore so taken out, mined and carried away.” * * *

We are of the opinion that this determination of the Supreme Court of the State of Minnesota is not determinative of the issue before us. As a sublessee the petitioner could be held liable for the payment of royalty to the State of Minnesota without there having been any privity of contract between the state and the petitioner. This fact is recognized in Thompson on Real Property, vol. 2, pp. 492-493, where it is stated:

It is well settled that the common law gives the lessor no right of action on any of the covenants of the original lease against the sub-tenant or under-lessee, because there is no privity of contract between the lessor and the sub-lessee and because there is no privity of estate. There is no privity between the landlord and sub-tenant, arising merely -from that relation as will subject the sub-tenant to liability for the debt of the tenant for rent. * * * [Italics supplied.]

However, where the sublessee assumes the covenants of the lease the lessor acquires a right of action against the sublessee. This was held in In re Assignment of Dickinson Co., 72 Minn. 483; 75 N.W. 731, in which the Supreme Court of the State held:

* * We Rave now before us the agreement between Dickinson and Cunnington and the Dickinson Company, by the terms of which the latter assumed and agreed to perform all the covenants of the lease, including- the payment of rent to the end of the term. Under the reported decisions of this court, Fitterling, to whom the rent was due and payable, could maintain an action on this covenant in his own name, and for his own benefit. This is decisive of the case, without considering the question of whether the Diclcm-son Company was assignee of the lease, or an undertenant. [Italics supplied.]

In Burnet v. Coronado Oil & Gas Co., supra, the Supreme Court stated:

When Oklahoma undertook to lease her public lands for the benefit of the public schools she exercised a function strictly governmental in character. * * *
Here the lease to the respondent was an instrumentality of the state for the purpose of carrying out her duty in respect of public schools. To tax the income of the lessee arising therefrom would amount to an imposition upon the lease itself.

If the petitioner conducted mining operations under a lease directly from the State of Minnesota its claim that it was immune from Federal income taxation would appear to be ruled by the decision in Burnet v. Coronado Oil & Gas Co., supra. It should be borne in mind, however, that the doctrine of implied immunity from Federal taxation has its “ inherent limitations.” Fox Film Corp. v. Doyal, 286 U.S. 123. The application of such doctrine is limited to those agencies “ through which either government immediately and directly exercises its sovereign powers.” Metcalf & Eddy v. Mitchell, 269 U.S. 514. In Burnet v. Jergins Trust, 288 U.S. 508, the Supreme Court had before it the question of the tax-ability of income derived by a lessee from an oil and gas lease on lands owned by a political subdivision of the State of California. The Court, referring to Burnet v. Coronado Oil & Gas Co., supra, and to Gillespie v. Oklahoma, 257 U.S. 501, stated:

* * * in both of those eases the sovereign was actiDg as the trustee of an express trust with regard to the lands leased. In both the burden upon the public use was more definite and direct than in the present case. As said in the Coronado case, the doctrine of Gillespie v. Oklahoma is to be applied strictly and only in circumstances closely analogous to those which it disclosed. The decisions relied on cannot be held to be authority upon the facts presented by this record.

In the light of what has been said we are of the opinion that the agreement between Sullivan and Hale and the petitioner by which it operated the Majorca Mine in 1923 was not an instrumentality of the

State of Minnesota and, consequently, that the petitioner is not exempt from income tax in respect of income derived from the operation of that mine. Wanless Iron Co., 29 B.T.A. 834. Cf. Atlas Life Ins. Co., 29 B.T.A. 750.

Reviewed by the Board.

Judgment will be entered under Rule 50.

Sternhagen, ARUNDELL, Murdock, and Goodrich concur in the result.