Magruder v. Hospelhorn

Mitchell, J., delivered the opinion of the Court. This appeal is from an order of the Circuit Court ⁶⁴ No. 2 of Baltimore City, sustaining the objections of the receiver of the Baltimore Trust Company to a claim for income taxes for the years 1930, 1931, and 1932, alleged to be due the United States, and disallowing said claim. The material facts in the case are not in dispute, as by a stipulation filed therein they are substantially agreed upon, and hence the solution of the questions presented depends upon the legal consequences flowing from the facts. They are as follows: The Gould Coupler Company, hereinafter designated as lessor, on August 1st, 1930, was the owner of certain real property located in Erie County, in the State of New York; the same being subject to the lien of a first mortgage and deed of trust to the Chase National Bank of the City of New York in the sum of $4,000,000.

On said date the company entered into an indenture with the Gould Storage Battery Corporation, an independent body corporate, hereinafter designated as lessee, under the terms of which the lessor leased to the lessee a part of its entire property, for the' period of ten years, accounting from the date of the indenture, at an annual rental of $50,000. The indenture further providing that, in addition to said rental, the lessee would pay to the lessor a sum equal to fifty per cent, of the former’s annual net profits, if any, to the extent of $250,000, during the period of the lease. Among the more important provisions of the indenture, bearing upon the case now before us, it was agreed: (a) That the lessor from time to time would pay and discharge, or cause to be paid and discharged, all taxes, assessments, and governmental charges which might be lawfully imposed upon it or upon the leased premises; (b) that the lessor would at all times insure or cause to be insured all of the improvements upon the leased premises against loss or damage by fire and other usual hazards, in such manner and to the extent necessary to adequately protect the premises, in accordance with the provisions of the first mortgage and deed of trust of the lessor; all policies of insurance on the leased prem ⁶⁵ ises being made payable to the trustee under the first mortgage and deed of trust / and the lessor, as their interests might appear, and the application of such insurance as might be collected from losses to be made as set forth in the indenture; (c) that, if the rental fixed or otherwise reserved, or any part thereof, at any time remained unpaid for a period of sixty days after the same became due, the lessor could distrain therefor; (d) that, if the rental, or any part thereof, remained due and unpaid for a period of ninety days, or if the lessee violated any of the covenants contained in the lease and continued in default in respect thereof for a like period of ninety days after being notified of such default by the lessor, then and in said event, the lessee, at the option of the lessor, could be regarded as a tenant at will, and the lessor thereby have the right to re-enter upon the demised premises, whereupon the lease would become null and void and all payments of rental, fixed or otherwise, then made by the lessee and held in trust under the trust agreement to which reference is hereinafter made, be forthwith paid by the trustee, under said latter agreement, to the lessor; (e) the alternative contingency being that should the lessor fail, upon full performance by the lessee of all obligations on its part, to procure the release from the lien of said first mortgage and deed of trust, and convey to the lessee the leased premises, or such part thereof, as the lessee under its option therein elected to purchase, all funds in the custody of the trustee would then become payable to the lessee, whereupon the lease would likewise become null and void; (f) that the lessee should have the option, upon its full compliance with the terms of the lease, to purchase the leased premises, or a part thereof, upon the termination of the lease,- at a fixed purchase price; the lessee, in event of such purchase, to be then credited on account of the purchase price with the fifty per cent, net profits, if any, in the custody of the trustee. On the same day upon which the lease was executed, a trust agreement, by and between the lessor, the lessee, ⁶⁶ and the Baltimore Trust Company, was entered into.

The provisions of the latter agreement which more particularly concern the solution of the instant case are: (1) That all payments of rentals, fixed or otherwise, including payments on account of the option, be paid to the Baltimore Trust Company, Trustee, and credited by it to a capital account as principal, and, together with all income therefrom, be invested, from time to time, by the trustee, at the direction of the lessor; (2) subject to restrictions as to the character of investments made by the Trustee of all funds which it might receive, the manner of the investment and reinvestment of the trust funds to be committed to the “sole and absolute discretion and control” of the lessor and the Trustee; (3.) all funds received by the Trustee, including all income accruing from investments thereof, to be held by the Trustee in trust for ultimate distribution in accordance with the terms of the lease agreement. ‘ It is obvious, from the aforegoing synopsis of both the lease and trust agreements, that the trust was created for the sole purpose of carrying out the terms of the lease agreement, embracing, as it did, the option to purchase the leased premises; and more especially to insure to the lessee, in event of its exercise of said option, a title for the leased property, or so much thereof as it might elect to purchase, free and clear of the lien of the first mortgage. In other words, as set forth in the trust agreement: “This trust is established in order to carry out the terms of said lease with respect to rentals, fixed or otherwise, and the purchase price provided therein to be paid in trust, and shall terminate upon the expiration or cancellation of the lease and the application of all of the deposited funds, and the investments thereof pursuant to the terms of said lease. The rights of the parties to said funds and the investments thereof shall be as provided in said lease upon the contingencies therein mentioned.” It may be here stated that, in accordance with the ⁶⁷ terms of the lease and trust agreements, the trustee assumed the trust and collected the following sums as rentals: 1930 $20,833.35 1931 50,000.00 1932 41,666.66 On November 1st, 1932, following the appointment of receivers for the lessor, the lease was terminated in accordance with its provisions, and thereupon the lessee became entitled to the return of the rentals paid the trustee. By agreement dated November 1st, 1932, between the Gould Storage Battery Corporation, the lessee, and Depew Securities > Company, Inc., it is shown that the latter company succeeded to the rights of the lessee in and to the trust estate.

The record further shows that the greater part of the rentals received by the trustee were invested, under the direction of the lessor, in bonds of the lessor company, as permitted by the trust agreement. It appears that no income was derived from these investments in 1930, but thereafter the trustee received net income from such investments for the years 1931 and 1932, of $2,230, and $2,589.66, respectively. Upon these sums the trustee filed returns reporting taxable income thereon, and paid taxes thereon. It is conceded that the trustee did not report as income the rentals paid to it by the lessee, and by the testimony of R. E. Frederickson, treasurer of the lessor, it is shown that rentals, in the exact amount received by the trustee, were reported as income in the tax returns of the Gould Coupler Company for the years in question; it being further conceded that the latter company did not pay any tax for the years involved, for the reason that, notwithstanding the computation of the rentals in its income returns, there was no taxable income shown therein to be payable to the government.

In 1935 the Commissioner of Internal Revenue assessed deficiency taxes against the trustee in the aggregate ⁶⁸ amount of $13,568.55, plus interest thereon amounting to $2,612.32, and it is agreed, under stipulations found in the record, that such assessment is based entirely upon the treatment of the rentals as income to the trustee, and that no other items of income or deductions are involved. Under the aforegoing state of facts, two questions are presented. The first of these is raised by the objection of the appellee to the admissibility of the testimony of the witness R. E. Frederickson, as hereinbefore set forth. The basis of the objection was that such testimony was immaterial and' irrelevant, and an exception was reserved by the government; the appellee, to an adverse ruling of the lower court.

In the view we take with reference to the computation of the rentals as income in the hands of the trustee, it.becomes unnecessary to pass upon the first question. As has been shown, the appellee’s claim involves income taxes for the years 1930,