The trustee was given authority (with respect to the properties so conveyed to it) to collect or sell notes; to sell and dispose of real estate, including oil and mineral interests; and, pending such disposition, to manage and control the property. Article VII of the trust instrument provided: The Trustee hereunder shall never have or acquire the power or authority on behalf of this Trust: (a) To invest any funds coming to it hereunder as such Trustee, or to acquire additional property. (b) To engage, except as landlord or lessor, in farming, ranching or producing oil or gas. (c) To make any obligation, contract or agreement which will create or give rise to a personal obligation upon the part of any beneficiary hereunder, or which can be satisfied out of any property of any beneficiary hereunder, save and except such beneficiary's share of the trust property. The power to sell real estate (including mineral or royalty interests) was limited by a provision that each such sale had to be approved by the majority of an advisory committee of three. The original committee consisted of C. E. McCutchen, W. M. McGregor, and Carter McGregor. Vacancies in the committee were to be filled by the remaining members. (e) The trustee was required to distribute periodically, and at least once each three months "all of the receipts from its operations and transactions hereunder, after deducting from such receipts all taxes and expenses then due or accrued, and its compensation as such Trustee." All such receipts were to be distributed "without any distinction being made as to whether they represent capital or income." At the termination of the trust the trustee was to convey, ratably, to the beneficiaries all property and funds then on hand and to make a final accounting. (f) As to the transfer of beneficial interests, article X of the trust instrument provided: The whole, or any part, of the beneficial interest in the trust property held by any receipt holder hereunder may be transferred in the following way, and in that way only. The receipts issued hereunder evidencing the ownership of the interest to be conveyed, shall be surrendered to the Trustee, and with it there shall be delivered to the Trustee appropriate instruments of conveyance and transfer, and appropriate evidence of the validity of such instruments. The Trustee shall keep and retain such receipt and the other instruments and shall, thereupon, execute and deliver new receipts in accordance with said instruments. Thereafter, those designated in the new receipts shall be, for all purposes hereafter, substituted as beneficiaries hereunder in lieu and in place of those designated in the receipt so surrendered. The one desiring such a transfer shall defray all of the reasonable costs and expenses incurred by the Trustee in examining into the validity and appropriateness of the instruments tendered, including all attorneys' fees incurred in this connection. (g) The trust instrument contained the other provisions customarily found in instruments of this character, including a provision for compensation to the trustee and indemnification out of trust property against liabilities properly incurred. All of the shareholders in the company duly surrendered their stock certificates in the company and accepted receipts issued by the bank as trustee in accordance with the trust agreement. This receipt merely recited that the holder was the beneficial owner of a specified undivided interest in all of the property held by the bank as trustee under the aforesaid deed of trust; that it was the sole and only evidence of such ownership and could be transferred, assigned, or encumbered only in the manner specified in the trust deed; and that, by accepting it, the holder agreed to all of the terms and provisions contained in the trust deed. Between the date it accepted the trusteeship and the date of the hearing of these causes, the activities of the First National Bank of Wichita Falls as trustee consisted of the following: The collection of the amounts due for royalty oil produced from the K M A property; the collection of the oil payments on hand at February 7, 1938 (all but one of these having been collected in full); the collection of the notes conveyed to the trustee (all but one of these having been collected in full); the sale of four parcels of land (three of these being partially upon credit); the renting of the surface of the K MA lands for farming by tenants on shares; sales of right of ways; and the distribution of receipts to the beneficiaries after payment of expenses and charges. The trustee of Trust No. 2 distributed $137,500 in 1938 and $50,000 in 1939. The trustee made no advances to the agricultural tenants. These tenants financed themselves. The trustee made no new oil and gas leases and did not in anywise modify any of the oil and gas leases which were outstandinging at the date the property was conveyed to it. When the company was dissolved its bank account was closed and another was opened up for the trust. In 1938 there was paid from the funds of Trust No. 2, in four installments, the income tax for 1937 of the company, and on March 14, 1939, there was paid from the funds of Trust No. 2 $6,189.70 as representing the corporate income and excess profits taxes due by the company for the period January 1 to February 7, 1938. In 1939 there were also paid from the funds of Trust No. 2 ad valorem taxes due various taxing bodies with respect to the K M A lands, a substantial amount of these payments being taxes for 1938. The First National Bank of Wichita Falls, as trustee of Trust No. 2, has made no investments whatsoever. There have been but two or three transfers of "Receipt" certificates of beneficial interest. These arose in connection with the distribution of estates. The two notes executed by McGregor, McCutchen, and McGregor, as trustees of Trust No. 1, in renewal of indebtedness which the company had owed in 1935 were paid in full from the funds of Trust No. 1 on February 16 and July 14, 1938, respectively. In 1942, after the controversies here involved arose, the bank, as trustee of Trust No. 2, filed capital stock tax returns for the years ended June 30, 1938, and June 30, 1939, declaring capital stock values of $750,000 and $725,658.21, respectively, and paid the capital stock tax, interest, and penalties disclosed by these returns. Each return contained a recitation that it was filed without admitting that the trust was taxable as a corporation, but expressly denying it, and solely for the purpose of protecting the trust against the excess profits tax liabilities then being asserted. For the period February 7 to December 31, 1938, the bank, as trustee of Trust No. 2, filed a fiduciary return on Form 1041, showing a net income of $43,628.57 before distributions to beneficiaries of $137,500, and no tax due by the trust. This return disclosed the following receipts: Interest Proceeds from sale of right of ways. Collections from oil payments- Collections from oil royalties-- $817.08 2,000.00 23,723. 12 72, 490.97 1,085. 71 All of the receipts from oil payments were applied against the value of these payments on February 7, 1938, and no income was reported from this source. The return claimed a deduction for depletion upon oil royalties in the amount of $30,938.70, upon the following basis: "Cost depletion at 50¢ per barrel on 61,938.70 barrels-value at which received upon liquidation of First National Co. on Feb. 7, 1938," and depreciation upon farm and ranch buildings in the amount of $452.61. The other deductions consisted of a trustee's fee of $1,000, a storm loss of $179.76, and office supplies and miscellaneous expenses amounting to $194.12. For the year 1939 the bank, as trustee of Trust No. 2, filed a fiduciary return on Form 1041, disclosing a net income of $33,658.21 before distributions to beneficiaries of $50,000, and no tax liability. The item of $33,658.21 is made up of the following: On March 15, 1939, the company filed a corporation income and excess profits tax return for the period January 1 to February 7, 1938, and reported therein a net income of $27,894.50 and a resulting tax liability of $6,189.70. In this return there were also reported "Distributions in Liquidation-February 7, 1938" in amounts summarized as follows: e royalty and mineral rights in blocks 26, 27, 28, 29, and 44, Kemp's Wichita Valley Farm Lands, Wichita County, Texas. An undivided interest in the fee title less mineral rights to the above Obligations payable out of oil given in part payment for leases sold. Improvements. Accounts receivable. Total assets.. Liabilities: $1,097. 39 39, 198. 06 92, 689. 21 $1,047. 67 46, 883. 26 290,000.00 8,025. 00 51,409.96 1, 975.00 40.00 399, 380. 89 Under date of November 1, 1939, the respondent caused an examination to be made of the 1938 return filed by W. M. McGregor and wife, who had reported a gain of $21,743.96 upon the complete liquidation of the company. McGregor was the largest stockholder in the company at the date of its dissolution. In this examination it was determined that the net assets distributed to Trust No. 1 and Trust No. 2 were $80,155.30 and $497,283.85, respectively. The increase of $110,000 in the net assets distributed to Trust No. 2 over that reported by the company in its return for the period January 1 to February 7, 1938, was due to the determination that the value of the one-sixteenth royalty and mineral rights on February 7, 1938, was $400,000, instead of $290,000 as reported by the company. In this examination it was also determined that the cost of McGregor's stock in the company and units of interest in Trust No. 1 was $37,110.02. Based upon these two determinations, McGregor's taxable gain upon the complete liquidation of the company was determined to be $37,151.67, computed as follows: Value of dividend: 96 shares of stock times $994.5677 ($497,283.85 divided by 500 equals $994.5677)1_ $95, 478. 50 397% units of interest times $40.07765 ($80,155.30 divided by 2,000) 15, 934. 87 111, 413. 37 37, 110. 02 Total value of dividend___ Cost of stock and units of interest.. Gain realized on complete liquidation of the company. Gain taxable (stock held over two years-50%) - 74, 303. 35 37, 151. 67 This adjustment and two other minor adjustments resulted in deficiencies totaling $4,109 against McGregor and his wife for the year 1938, which were agreed to by these two individuals. Under date of October 25, 1939, the respondent caused an examination to be made of the fiduciary return filed by the bank as trustee of Trust No. 2 for the period February 7 to December 31, 1938. In this examination the theories that the company had been completely liquidated on February 7, 1938, and that Trust No. 2 was a liquidating trust were not disturbed. The value of the one-sixteenth royalty and mineral rights on February 7, 1938, was increased from $290,000, as claimed by the trust, to $400,000. The adjustments made as a result of this examination were agreed to by the trustee. Under date of November 23, 1940, the respondent caused a reexamination to be made of the fiduciary return filed by the bank as trustee of Trust No. 2 for the period February 7 to December 31, 1938, and of the corporation return filed by the company for the period January 1 to February 7, 1938. In a preliminary statement attached to this report the examining officer stated in part as follows: Principal causes of additional tax: Conclusion that the income reported by the Corporation and by Trustees of the Trust No. 1 and Trust No. 2 should be combined and taxed as the income of one entity; disallowance of excessive depletion and depreciation and the addition to income of amount received for grant of right of ways. All changes were discussed with Mr. W. M. McGregor, one of the Trustees, who does not agree to the adjustments. 1At the time the company reduced its capital stock from $250,000 to $50,000, McGregor owned 497 shares, which he surrendered in return for 99% new shares in the company and 397% units of interest in Trust No. 1, and in 1937 he sold 3% shares in the company, which left him 96 shares at the time of dissolution. |