Docket Nos. 4430 6358.
Preston B. Kavanagh, Esq., and Lamar Williamson, Esq., for the petitioner. J. Marvin Kelly, Esq., for the respondent.
Held, on the facts, petitioner is not an association taxable as a corporation. Preston B. Kavanagh, Esq., and Lamar Williamson, Esq., for the petitioner. J. Marvin Kelly, Esq., for the respondent.
In these consolidated proceedings respondent determined that the J. A. Riggs Tractor Co. is an association taxable as a corporation and proposed tax deficiencies as follows:
+-------------------------------------------------------------------+ ¦ ¦ ¦ ¦Declared value¦ +--------------------------+----------+--------------+--------------¦ ¦Fiscal year ended Oct. 31-¦Income tax¦Excess profits¦excess profits¦ +--------------------------+----------+--------------+--------------¦ ¦ ¦ ¦tax ¦tax ¦ +--------------------------+----------+--------------+--------------¦ ¦1940 ¦$22,554.37¦ ¦$16,766.12 ¦ +--------------------------+----------+--------------+--------------¦ ¦1941 ¦53,617.94 ¦$22,951.42 ¦33,974.50 ¦ +--------------------------+----------+--------------+--------------¦ ¦1942 ¦75,181.55 ¦227,211.03 ¦71,719.73 ¦ +-------------------------------------------------------------------+
The only issue before us is whether J. A. Riggs Tractor Co. is an association taxable as a corporation, as determined by respondent, or a partnership, as contended by petitioner.
The petitions herein were filed in the name of J. A. Riggs Tractor Co. and signed by the partners. Inasmuch as the respondent addressed the notices of deficiency to J. A. Riggs Tractor Co. it is the proper petitioner and our use of the term petitioner herein is not intended to suggest that we agree with respondent.
The case was submitted on a stipulation of facts, which is herewith adopted as part of the findings of fact by reference, and evidence adduced at the hearing.
FINDINGS OF FACT.
During the taxable years involved J. A. Riggs Tractor Co. was engaged in business in Arkansas, with its principal place of business at Little Rock. Its books of account and tax returns were kept and filed on the basis of a fiscal year ending October 31. For the fiscal years ended October 31, 1940, 1941, and 1942, partnership returns of income were filed with the collector of internal revenue at Little Rock, Arkansas. Each partner of the firm reported on his individual return his distributive share of the net income.
The business of petitioner consists of the sale and servicing of roadbuilding and dirt-moving machinery to contractors and local governmental units. Approximately 80 percent of the sales were made on the deferred payment plan, credit being extended in some cases for as long as 2 years. The remaining sales were made for cash. The firm maintains a service department and a parts department, and it engages in the business of buying, rebuilding, and selling secondhand machinery. The business is built around a franchise from the Caterpillar Tractor Co. of Peoria, Illinois, which gives petitioner an exclusive distributorship of Caterpillar products in 56 counties in the State of Arkansas. This franchise may be canceled at will.
Prior to November 1, 1937, this business was conducted as a corporation known as Arkansas Tractor & Equipment Co. in which John A. Riggs, Sr., and his son, John A. Riggs, Jr., were the controlling stockholders. Because the minority stockholders were continually pressing for dividends at a time when the business, because of limited capital, had to bolster its credit through the personal guarantee of Riggs, Sr., on its borrowings, Riggs, Sr., and his son determined to purchase the minority interest, dissolve the corporation, and form a partnership in which they would be the sole owners. This was done and the corporation was formally dissolved November 1, 1937, and its assets transferred to J. A. Riggs Tractor Co., a partnership, with Riggs and his son as the only partners. There were several changes in the business procedure of the new organization. For example, whereas the corporation had kept its books on a calendar year basis, the new firm adopted a fiscal year of accounting and changed the method of handling deferred payment sales.
On December 24, 1938, Riggs, Sr., created six trusts by transferring to himself, his son and the Union National Bank of Little Rock, as trustees, six one-twentieth interests in the business of J. A. Riggs Tractor Co. The corpus of each trust consisted of a 5 percent interest in the business. These trusts were for the benefit of Mrs. Riggs, Sr., Mrs. Riggs, Jr., and the four children of Riggs, Jr. Riggs, Sr., filed a gift tax return for the year 1938, reporting gifts to the trusts at a value of $10,000 each.
Each trust instrument referred to the creation of the other trusts and gave the trustees power to enter into the partnership of J. A. Riggs Tractor Co. Riggs, Sr., and Riggs, Jr., and the survivor of them, were given paramount authority in all matters affecting the interests of the partnership. The duties of the bank in connection with the partnership business matters were limited to liquidating the business in the event of the death of Riggs, Sr., or Riggs, Jr. In all other matters the trustees had equal powers. Riggs, Jr., gave his written consent to these assignments of interest in the business.
On the same day, December 24, 1938, Riggs, Sr., and Riggs, Jr., as individuals and as trustees for the various trusts, executed an agreement for the conduct of the business of J. A. Riggs Tractor Co. as follows:
1. WHEREAS, J. A. Riggs Tractor Company, of 424 East Third Street, Little Rock, Arkansas, engaged in the business of buying, handling, selling and distributing Diesel tractors, power units, road building and maintenance machinery, and similar equipment, has heretofore been a partnership composed of John A. Riggs, Sr. (owning an undivided 60% interest in the business), and John A. Riggs, Jr., (owning an undivided 40% interest); and
2. WHEREAS, said John A. Riggs, Sr. has, with the assent of John A. Riggs, Jr., sold and assigned an undivided one-twentieth (5%) interest in said business to each of six Trusts, for the use and benefit of Mrs. Lela Wilson Riggs, Martha Williamson Riggs, and the four children of John A. Riggs, Jr., respectively, of each of which trusts said John A. Riggs, Sr., John A. Riggs, Jr., and Union National Bank of Little Rock, a corporation, of Little Rock, Arkansas, are Trustees, with authority vested exclusively in said John A. Riggs, Sr., and John A. Riggs, Jr., as Trustees (and John A. Riggs III, if and when he becomes a Trustee), to represent each of said Trusts in the management of its interest in said partnership business:
3. NOW THEREFORE, it is agreed that the undersigned
(1) John A. Riggs, Sr., owning an undivided thirty percent (30%) interest,
(2) John A. Riggs, Jr., owning an undivided forty percent (40%) interest,
(3) John A. Riggs, Sr., and John A. Riggs, Jr., as Trustees of the John A. Riggs, Sr., Trust No. One, established for the use and benefit of Mrs. Lela Wilson Riggs, with possible remainder beneficial interests in Martha Williamson Riggs and the children of John A. Riggs, Jr., owning an undivided five percent (5%) interest,
(4) John A. Riggs, Sr., and John A. Riggs, Jr., as Trustees of the John A. Riggs, Sr., Trust No. Two, established for the use and benefit of Martha Williamson Riggs, owning an undivided five percent (5%) interest.
(5) John A. Riggs, Sr. and John A. Riggs, Jr., as Trustees of the John A. Riggs, Sr. Trust No. Three, established for the use and benefit of John A. Riggs, III, owning an undivided five percent (5%) interest.
(6) John A. Riggs, Sr. and John A. Riggs, Jr., as Trustees of the John A. Riggs, Sr., Trust No. Four, established for the use and benefit of Lelia Riggs, owning an undivided five percent (5%) interest.
(7) John A. Riggs, Sr. and John A. Riggs, Jr., as Trustees of the John A. Riggs, Sr., Trust No. Five established for the use and benefit of Lillian Riggs, owning an undivided five percent (5%) interest, and
(8) John A. Riggs, Sr. and John A. Riggs, Jr., as Trustees of the John A. Riggs, Sr. Trust No. Six, established for the use and benefit of the unborn child of said John A. Riggs, Jr., and his wife, Martha Williamson Riggs, owning an undivided five percent (5%) interest.
be associated, and do hereby associate themselves as partners, to continue the ownership and conduct of the business hereinabove referred to, under the partnership and business name of J. A. Riggs Tractor Company, each of the eight partners hereinabove indicated owning the share and interest in the partnership business, assets, and distributable interests hereinabove stated; subject to the following terms and agreements, to-wit:
4. Nature of the Business. The nature of said business, until otherwise agreed between the partners, shall be the same as has heretofore been conducted by said J. A. Riggs Tractor Company, as heretofore constituted, i.e., acting as distributor and retail sales agency of the products of Caterpillar Tractor Company, of Peoria, Illinois, buying, handling, selling and exchanging tractors, power units, road construction and maintenance machinery and similar equipment; selling road construction and maintenance machinery and similar equipment; selling such equipment for cash or in whole or in part on credit, taking county warrants, city warrants, bonds and various types of negotiable and non-negotiable securities in payment therefor; maintaining an office, warehouse and display rooms in Little Rock, Arkansas, and elsewhere in the State of Arkansas; owning, maintaining and operating office equipment, automobile and trucks and other equipment useful in the conduct of said business; employing salesmen, demonstrators, office help and other employees necessary or useful in the conduct of said business, and doing all such things and engaging in all such transactions as are reasonably incident to or useful in connection with the conduct of said principal business.
5. Participation in Profits and Losses. Each partner will participate in the net earnings of the partnership and contribute to its losses, and, as between themselves, will be responsible for its obligations, pro rata, to the extent of the interest of each such partner in the total assets of the partnership, as hereinabove set forth.
6. Management. The authority for the management of said business, in all of its aspects and details, shall be vested exclusively in John A. Riggs, Sr. and John A. Riggs, Jr. in their respective individual capacities and as Trustees, so long as each or either retains an interest in the business, individually or as Trustees, and in John A. Riggs, III, if, when and after he reaches maturity and while he is a Trustee or in his individual capacity retains an interest in the business; provided that in the event of a disagreement or difference in opinion between the partners as to any matter of policy or any action to be taken or omitted in the conduct of the partnership business, the judgment of John A. Riggs, Sr., so long as he lives and either in his individual capacity or as Trustee retains an interest in the business, and after his death or retirement the judgment of John A. Riggs, Jr., so long as he lives and either in his individual capacity or as Trustee retains an interest in the business, shall be controlling, and shall determine the policy to be adopted and the action to be taken or omitted. It is recognized that as between the partnership and third persons, either of the partners will be authorized to bind or obligate the partnership by any act, omission or contract reasonably incident to the normal conduct of the business: But as between the partners the foregoing provision shall be binding, and neither partner will in behalf of the partnership enter into any contract or assume an obligation or voluntarily incur a liability, other than in the normal course of the routine conduct of said business, without first consulting the other partners.
7. Application of Earnings. The earnings of said partnership shall be applied first to defray the costs and expenses incident to the operation of the business, including investments which are necessary or advisable for the successful conduct of the business, and to the payment of all debts and obligations of the partnership; and the payment of taxes and other charges against the assets of the business. Out of the remaining net earnings there shall be monthly, or at such other periods as may be agreed upon between the partners, distributed to the respective partners, pro rata in accordance with their respective interests in the partnership business as hereinabove stated; and in the event of the dissolution of the partnership and liquidation of the partnership business, the net proceeds of such liquidation shall be in like manner distributed.
8. Continuation of Partnership in Event of Death of a Partner, Etc. In the event of the death of said John A. Riggs, Sr. or John A. Riggs, Jr., or in the event of the termination of either of said trusts, or the voluntary or involuntary withdrawal from the business and partnership by either of said partners, it is hereby irrevocably agreed that the partnership business need not be and will not on that account be liquidated, but will be continued under the management and control of the surviving or remaining partners, and said John A. Riggs, Sr., and John A. Riggs, Jr. (and John A. Riggs III if and after he becomes and while he remains a member of the partnership, either as Trustee or in his individual capacity), or the survivor of them, will as Trustees, or Trustee, for the use and benefit of the estate, heirs or personal representatives of the deceased partner, or for the use and benefit of the partner who has withdrawn, his heirs, successors, assigns and personal representatives, hold title to the share and interest of such deceased or withdrawn partner, in the partnership business, and represent the estate of such deceased partner, or the interests of such withdrawn partner, in the management of said business, until such time as settlement can be made with the estate of the deceased partner, or with the withdrawn partner, for the value of such deceased or withdrawn partner's interest in the partnership assets, and, until such settlement be made, the share of such deceased or withdrawn partner in the net earnings, if any, of the partnership, shall be received for and distributed to the owner thereof by said John A. Riggs, Sr., and John A. Riggs, Jr., (and John A. Riggs III, after he becomes qualified), or the survivors or survivor of the, as Trustees as aforesaid. And each of the undersigned partners does hereby irrevocably agree that in the event of the death of said John A. Riggs, Sr. or John A. Riggs, Jr., or the termination of either of said Trusts, or in the event either of said partners be adjudicated bankrupt or insolvent, or in the event either of said partners for any reason withdraws from the partnership, the surviving or remaining partners may, within a reasonable time, not less than ninety (90) days after the death, adjudication in bankruptcy or insolvency, or withdrawal of such deceased, bankrupt, insolvent or withdrawn partner, purchase the interest of such partner in the partnership business, by paying therefor the net book value thereof; and the value of the interest of such deceased, bankrupt, insolvent or withdrawn partner, in the partnership business, shall be the percentage of the net book value of the assets of the partnership, corresponding with the percentage of the partnership assets owned by such deceased, bankrupt, insolvent, or withdrawn partner. In arriving at such book value there shall be included and taken into consideration only the real and tangible personal property, bonds, warrants, stocks and other evidences of indebtedness or of valuable rights and interests, the notes and accounts receivable, and choses in action of the partnership, that is to say, actual tangible property, securities, notes, bills and accounts receivable, and rights of action, excluding any real or hypothetical value of business good will or any valuation based on a capitalization of normal earnings of the partnership, it being hereby irrevocably agreed between the partners, that the nature of the partnership business is such as to have no salable or assignable business good will.
9. Restrictions on Sale of Partnership Interest; and Option to Trustees of John A. Riggs Trust No. Three. It is mutually and irrevocably agreed that neither partner shall have the power or right to sell, and that neither will ever undertake to sell, his or its interest in the partnership business hereby established, to any purchaser other than one or more members of the partnership as composed at the time of the proposed sale, except by and with the express consent of all the remaining partners first obtained.
The Trustees of the John A. Riggs Trusts Nos. One, Two, Four, Five, and Six, herein represented by the undersigned Trustees of said respective Trust Estates, who are hereunto duly authorized, do hereby irrevocably grant unto the Trustees of the John A. Riggs Trust No. Three (established for the use and benefit of John A. Riggs III), and unto their successors, at any time during the life of said John A. Riggs III, an option to purchase the interest of each, either, or any of said other Trust Estates in the partnership and partnership business hereby established, by paying therefor the book value thereof, as hereinabove defined.
10. Each and all of the provisions of this partnership agreement shall be binding upon each of the undersigned partners, and upon his or its heirs, assigns, successors and personal representatives.
IN WITNESS WHEREOF the undersigned partners have executed and delivered this instrument in triplicate, on this 24th day of December, 1938, to be effective as of the beginning of business on the 26th day of December, 1938.
(Signed) John A. Riggs, Sr. JOHN A. RIGGS, SR. John A. Riggs, Jr. JOHN A. RIGGS, JR. John A. Riggs, Sr. JOHN A. RIGGS, SR. and John A. Riggs, Jr. JOHN A. RIGGS, JR. As Trustees of each of the John A. Riggs, Sr. Trusts hereinabove mentioned, Nos. 1 to 6, inclusive.
When this partnership agreement was executed no new capital was added to the business. The investment account of Riggs, Sr., was reduced by transferring $10,000 on the partnership books to the investment account for each of the six trusts.
When the trusts were admitted to the partnership, J. A. Riggs Tractor Co. gave notice of that fact to the manufacturers with which it did business, the banks, commercial agencies, and its customers. The bank in which the firm kept its funds used ordinary partnership signature cards. Formerly it had required a corporate resolution and used a corporate signature card. A certificate of partnership agreement showing the members of the partnership was filed on January 6, 1944, pursuant to an Arkansas statute adopted in 1943.
Riggs, Sr., and his son occupied adjoining offices and shared jointly in the making and carrying out of all decisions affecting the business. These decisions were reached after consultation between father and son, and no major project was undertaken which did not have joint approval. There were no regular meetings of the partners; simplicity and informality were the keynotes of petitioner's operations.
When Riggs, Jr., entered the Army, he executed a power of attorney authorizing his father to act for him and on his behalf in all matters pertaining to the business. Prior to the time that Riggs, Jr., entered the Army, the Union National Bank took no active part in the management or conduct of the business. After the induction of Riggs, Jr., into the Army, having the possible liquidation of the business in mind, the trust officer of the bank frequently conferred with Riggs, Sr., on business matters pertaining to policy, and Riggs, Sr., relied to a considerable extent on his advice.
In 1943 the Caterpillar Tractor Co. was insisting that petitioner establish branches throughout the state in order to handle more effectively the business of distributing and servicing machinery. Such expansion would have required considerable capital. Riggs, Sr., felt that the wishes of Caterpillar in this respect must be carried out, otherwise the franchise might be canceled. The bank did not wish the trusts to increase their investments in the business or to assume liability for borrowed capital to finance such a program. It was therefore agreed that the trusts would withdraw from the partnership and dispose of their interests.
It was arranged that four of the employees of petitioner were to become members of the firm by purchasing the interests of the trusts. The sale was consummated November 1, 1944, and the trusts withdrew from the firm. The new partners signed a new partnership agreement which provided for the carrying on of the business in the same manner as formerly. The trusts are still in existence and the trust instruments have not been amended.
After the notices of deficiencies were issued, but prior to the filing of the petitions in these cases, the petitioner filed capital stock tax returns for the fiscal years ended June 30, 1940, 1941, and 1942. These returns contained a statement that the petitioner was a partnership and not subject to tax and returns were being filed in order to protect the petitioner in the event that it should be held an association taxable as a corporation.
At all times since November 1, 1937, the partnership books have been kept in strict accordance with recognized rules of partnership accounting. There was no capital stock account, no surplus account, and no dividend account. On the admission of the six trusts as partners in December 1938 the books were correctly adjusted to show the new interest, and at all times the books correctly reflected the interests of the partners in accordance with the partnership agreement. No salary was paid during these years to any partner. No dividend or interest was paid to any partner by virtue of his investment. No part of the profit of the business was paid or credited to any one other than a partner.
The partnership never issued any stock certificates, certificates of beneficial interest, or ownership certificates of any kind. Evidence of ownership was to be found only in the partnership agreement, in the partnership investment accounts, and in the certificate filed with the state. The partners intended to operate the business as an ordinary partnership at all times, and to that end they sought and obtained legal and accounting advice in the organization and operation of the business.
During the fiscal years ended October 31, 1940, 1941, and 1942, J. A. Riggs Tractor Co. was operated as a partnership and did not, either in form of organization or form of operation, bear such a resemblance to corporate form of organization or operation as to require it to be treated as an association for Federal tax purposes.
The only issue in this proceeding is whether the respondent has correctly determined that J. A. Riggs Tractor Co. was operated in such form and manner during the taxable years as to constitute it an association taxable as a corporation within the meaning of section 3797 of the Internal Revenue Code. Both parties concede that the tests for determining whether or not petitioner is so taxable are to be found in the Supreme Court decision in Morrissey v. Commissioner, 296 U.S. 344, and the companion cases decided the same day. The problem is to determine whether or not the criteria therein enunciated are present under the facts here. The answer must be found in an examination of all material facts.
Respondent insists that petitioner comes within the ambit of the Morrissey case. Petitioner contends contra.
Respondent points to several features in connection with the petitioner's methods of operation and form of organization which he says bring petitioner within his regulations defining associations. He claims that the trustees of the various trusts created by Riggs, Sr., are a continuing body and that under paragraph 6 of the partnership agreement there is centralized management. He further contends that the only reasonable construction of paragraph 8 of the partnership agreement would indicate that the parties intended to provide for a continuing of the partnership as an entity in the event of the death or withdrawal of a partner. He argues that the restriction on the transfer of a partnership interest is similar to the restrictive agreements covering corporate stock in small closely held corporations and is in no way indicative of partnership intent. Likewise he points to paragraph 5 as evidencing the intention of the parties to confine their liability for business losses to the extent of their interests in the business. Petitioner contends that in all respects it is a valid partnership and that the respondent has drawn unreasonable inferences from the foregoing provisions of the partnership agreement, which it contends are ordinary and customary in partnership arrangements. Petitioner insists that each of them may be found in parallel cases where the respondent's determination of association status has been reversed, citing Chilhowee Mills, 47 B.T.A. 682; George Bros. & Co., 41 B.T.A. 287; Glensder Textile Co., 46 B.T.A. 176, and other cases.
Secs. 19.3797-1, 19.3797-2, and 19.3797-4, Regulations 103.
As we understand the argument of the respondent, his chief concern seems to be over the fact that the partnership agreement provides that the management of the business shall be vested in Riggs, Sr., and Riggs, Jr., and in the event of a conflict over decisions to be made or business policy to be adopted, the decision of Riggs, Sr., shall control. His second major contention is based upon paragraph 8 of the partnership agreement, providing that business shall be continued in the event of the death or withdrawal of a partner. Because Riggs, Jr., was absent in military service, his father was the only partner to testify. His statements, which were not contradicted, were to the effect that at all times he and his son intended to form a partnership. Their business arrangements at the time the organization commenced operations in 1937 and when the new firm was organized in 1938 appear to be in keeping with this intention. No certificates of ownership or beneficial interest were issued. The only written evidences of ownership were to be found in the partnership agreement, in the partnership books, and in the certificate subsequently filed with the Secretary of State of Arkansas. Petitioner's books were prepared and kept in accordance with recognized rules of partnership accounting. They had none of the accounts peculiar to corporation accounting methods. Customers and all other business connections, including the bank in which petitioner kept its funds, regarded petitioner as a partnership. The signature cards used when the bank account was opened were those used for partnerships and individuals. The bank required corporate resolutions authorizing the withdrawal of corporate funds, but no such requirement was here imposed. The evidence here shows that the partners took an active part in the conduct of the business; that they had an equal voice in its management and operations. Their voice in the management was not computed according to the size of their respective partnership interests. The fact that Riggs, Sr., was given a controlling vote in the event of a disagreement between the partners or a difference in opinion as to a policy to be adopted does not alter the case. It is not uncommon for a partnership to have a managing partner. Cf. George Bros. & Co., supra. Certainly, that part of the partnership agreement giving Riggs, Sr., this veto power is not so rare a provision in partnership agreements as to require our holding that this enterprise was more than an ordinary partnership. It is not an uncommon feature in partnership agreements. We are unable to discern any real distinction between the management and control of petitioner's business and the management and control of the business of ordinary partnerships. We are satisfied that the operations and business conduct of petitioner more closely resemble the operations of an ordinary partnership than the operations of a corporation.
Nor are we convinced by respondent's argument concerning the pledge contained in paragraph 8 of the partnership agreement that the business would be continued in the event of the death or withdrawal of a partner. As we read that paragraph, it merely provides that in such event the business will not be liquidated, but will be continued under the management and control of the surviving or remaining partners. It was stipulated that one of the surviving partners would be appointed to represent the interests of the deceased or withdrawn partner until such time as a settlement of that partner's interest could be arranged. That feature is not a rarity in partnership arrangements. See, Glensder Textile Co., supra., at page 185. We are not convinced that that provision of the partnership agreement calls for that continuity of an enterprise which is one of the essentials to our holding that petitioner is an association taxable as a corporation.
We think another important factor is the effort on the part of the parties to select their business associates as evidenced by the restraint of the sale or disposition of the partners' interests. New partners could enter the firm only with the consent of all of the other partners. In view of the agency relationship existing between the partners, both by virtue of the partnership agreement and the law of the state, that element is persuasive and tends to substantiate the claim of the partners that they intended to form an ordinary partnership for the conduct of its business.
The contention of the respondent that paragraph 5 of the partnership agreement is an attempt to limit the liability of the partners for business losses must likewise be rejected. We can not see any real distinction between that provision and the provision found in the partnership agreement construed in George Bros. & Co., supra, where we held that organization to be a bona fide partnership. Such a provision merely determines how the liabilities, profits, and losses shall be divided among the partners. Obviously, it could have no effect on third persons not a party to the agreement.
From an examination of the entire record, we are satisfied that the instant case is indistinguishable from George Bros. & Co., supra. If anything, petitioner's case is the stronger. We have found that the operations of petitioner more closely resemble the operations of a partnership than an association or corporation. It follows that respondent erred in determining that petitioner was an association taxable as a corporation.
Reviewed by the Court.
Decision will be entered for the petitioner.