James D. BALLOU and Sarah L. Ballou, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee, 370 F.2d 659

HARRY PHILLIPS, Circuit Judge. This is an income tax case, involving the bona fides of a family partnership operated under the name “Ballou Services” and engaged in the business of providing office services to the public. The taxpayers, a husband and wife, attempted to create a new partnership to carry on their office service business, which they had conducted previously as equal partners. The new partnership was to consist of the taxpayers individually, and the husband as trustee of separate trusts for each of their three minor children, whose ages were seven years, five years and eight months respectively.

In pursuance of this plan, the taxpayers executed instruments conveying to the husband as trustee for each child a capital interest of fifteen per cent in the partnership. A formal partnership agreement thereupon was executed by the husband and wife and the husband in his capacity as trustee for the three minor children. The Internal Revenue Service refused to recognize the trusts as valid partners and taxed the income of the partnership to the husband and wife for the years 1956,1957 and 1958. The taxpayers paid the difference plus interest totaling $32,-217.05, and filed suit for refund, demanding a jury trial.

The jury returned a general verdict in favor of the United States and also answered in the negative the following interrogatory submitted by the district judge: “Have the plaintiffs proven by a preponderance of the evidence that each of the three trusts which they created for their children genuinely owned a fifteen per cent capital interest in Ballou Services?” The motion of the taxpayers for a new trial was overruled and this appeal followed. The issue on appeal is whether there is evidence to support the verdict of the jury.

The facts are set forth more fully in the comprehensive dissenting opinion of Judge McAllister, to which reference is made. The present statutory provisions relating to family partnerships originated with the Revenue Act of 1951, effective for taxable years beginning after December 31, 1950, and were codified without substantial change in

Section 704(

e) of the Internal Revenue Code of 1954. The reports of the House and Senate Committees contain the following comments : “The amendment leaves the Commissioner and the courts free to inquire in any case whether the donee or purchaser actually owns the interest in the partnership which the transferor purports to have given or sold him. Cases will arise where the gift or sale is a mere sham.

Other cases will arise where the transferor retains so many of the incidents of ownership that he will continue to be recognized as a substantial owner of the interest which he purports to have given away, as was held by the Supreme Court in an analogous trust situation involved in the case of Helvering v. Clifford (309 U.S. 351). The same standards apply in determining the bona fides of alleged family partnerships as in determining the bona fides of other transactions between family members.

Transactions between persons in a close family group, whether or not involving partnership interest, afford much opportunity for deception and should be subject to close scrutiny. All the facts and circumstances at the time of the purported gift and during the periods preceding and following it may be taken into consideration in determining the bona fides or lack of bona fides of a purported gift or sale.” U. S. Code Congressional and Administrative Service, 82d Cong., 1st Sess. pp. 1814-1815, 2009.

Mertens summarizes as follows the tests to apply to a family partnership such as the one here involved: “The most difficult problem in the case of partnership capital interests acquired by gift or purchase from a member of the family is the determination of whether the purported transfer vested in the transferee such dominion and control over the interest that he might be considered its true owner.

This determination requires a close scrutiny of all the circumstances before, during and after the purported transfer. “The bona fides of a donee’s ownership of the capital interest attributed to him is not determined exclusively by the fact that legally sufficient documents of transfer have been executed nor by any other mechanical or formal test. * * * “More important than formal or mechanical tests is the extent to which substantial controls over the purportedly transferred partnership interest are retained by the transferor.

Among the ‘retained controls’ which may be considered significant as an indication of a lack of real ownership in the transferee are the following: “1. Retention of control of the distribution of amounts of income or restrictions on the distributions of amounts of income to the donee partner. Such restrictions are clearly present when the donee has no voice in the determination of when and in what amounts such distributions are to be made, these decisions resting in the uncontrolled discretion of the donor and other partners.

On the other hand, when a donee either receives or has the right to receive upon demand his distributive share of partnership income for his sole benefit and use, without interference from the donor, this evidences the reality of his partnership interest. “2. Restrictions on the right of the donee to sell or liquidate his interest without financial detriment.

Thus, while an agreement by a donee partner not to dispose of the acquired interest to anyone except the donor may not render the partnership invalid, even if the donor has an option to acquire such interest at will, the reservation by the donor of a right to repurchase at book value may lead to a contrary result. Although the donee may be technically free to liquidate his interest, his dependence on the donor and a lack of maturity and understanding of his rights may indicate a lack of freedom, in fact. This is particularly true in the case of minors. “3.

Retention of control by the donor over the assets essential to the partnership business (as for example, through retention of assets leased to the alleged partnership) and retention by him of management powers beyond those common in ordinary business relationships. Such powers retained by the donor, however, are not necessarily fatal to the existence of a valid partnership where a bona fide transfer of a partnership interest otherwise indicated ; partnership affairs are frequently conducted by a managing partner.

The participation by the donee, however, in an executive or management capacity in the conduct of the business affairs of the partnership is a good indication of the bona fides of his interest.” Mertens, Law of Federal Income Taxation, Vol. 6, § 35.10. A partnership may consist of members of a family and may be recognized for tax purposes, both under the statute (Footnote 1) and under decisions announced prior to the enactment of the statute. Commissioner of Internal Revenue v. Culbertson, 337 U.S. 733, 69 S.Ct. 1210, 93 L.Ed. 1659; Miller v. Commissioner of Internal Revenue, 203 F.2d 350 (C.A. 6); Miller v.

Commissioner of Internal Revenue, 183 F.2d 246 (C.A. 6); Kent v. Commissioner of Internal Revenue, 170 F.2d 131 (C.A. 6). The bona fides of a family partnership, particularly one involving minor children who contribute no services, is subject to close scrutiny and is a question of fact to be determined under the particular circumstances of each case. It has been said that this statute (Footnote 1) does “not legitimatize all family partnerships.” Kuney v. Frank, 308 F.2d 719, 720 (C.A. 9).

Thus, a question of fact is presented as to whether a capital interest in Ballou Services is genuinely owned by the three trusts created by the taxpayers for their minor children. The jury, as trier of the facts, determined this issue against the taxpayers and in favor of the Government. In family partnership eases, as in other cases, the findings of the trier of the facts will not be disturbed on appeal, if supported by substantial evidence and not clearly erroneous. Dulworth v. United States, 302 F.2d 266 (C.A. 6); Acuff v. Commissioner of Internal Revenue, 296 F.2d 725 (C.A. 6); MacDonald v.

Commissioner of Internal Revenue, 165 F.2d 213 (C.A. 6); De Korse v. Commissioner of Internal Revenue, 158 F.2d 801 (C.A. 6). Under the record in the present case, we cannot say that there is no evidence from which the jury, as triers of the facts, could not have reached its verdict against the taxpayers and in favor of the Government. Under the provisions of the partnership agreement and trust instruments, the husband and father retained the same control of the management of the new partnership as he had previously exercised over the old partnership.

Neither the minor children nor their father in his capacity as trustee contributed any services to the partnership or participated in the daily operation of the business. Under an express provision of the partnership agreement, the father in his capacity as trustee was prohibited from performing any service for the partnership. The forty-five per cent share of the partnership assets held in trust for the minor children could not be sold or reinvested except with the consent of the father and mother as owners of the remaining fifty-five per cent interest.

No single factor discussed either in this opinion or in the dissenting opinion is conclusive in and of itself as to the validity of the partnership for tax purposes, but any or all these factors could be considered by jurors in making their factual determination as to the bona fides of the partnership. As pointed out by Judge McAllister in his able dissenting opinion, this court has recognized the validity of a family partnership involving minor children in Miller v. Commissioner of Internal Revenue, supra, 203 F.2d 350 and 183 F.2d 246.

We held in Miller that the findings of the tax court were not supported by substantial evidence. The Miller case was decided upon its own facts, involving the operation of drug stores by a family partnership. Although there is factual similarity between the Miller case and the present case, a distinguishing factor was the following: “Prior to the making of the above named trusts, Sam H. Miller and Florence R. Miller, his wife, as copartners, owned equal interests of $60,000 each in a drug store business.

During the year 1940, the Millers had lost a prominent location for one of their stores in Butler, Pennsylvania, when a large chain store corporation had acquired the lease. At that time, they felt it was necessary to secure another location in that city, and in making arrangements to purchase a drug store, they called on Mr. Miller’s father, W. R. Miller, for financial assistance. Thereafter, during the fall of 1940, Mr. and Mrs. Miller had many talks with W. R.

Miller, on the subject, and it was finally agreed among all of them that the elder Miller would invest $15,000 in the business in order to purchase the drug store in question, subject to certain conditions. In the first place, this sum of $15,000 was to be used to secure interests of $5,000 to each of the three children of Sam H. Miller and Florence Miller. At that time, these children were William, aged eleven, Samuel, aged ten, and Barbara, aged eight. Mrs. Miller was also the mother of a boy, John Siebert, aged sixteen, by a prior marriage.

In addition to securing interests for the three children, as above mentioned, the elder Miller was concerned about what might happen to them in the case of the death or remarriage of either of their parents. His purpose was to insure the most substantial provision for the children, in so far as he was able. After many consultations, the elder Miller required, in addition to providing three trust interests in the partnership for the children in the amount of $5,000 each, that Sam H.

Miller and Florence Miller set up trusts for the children out of their own interests in the business in such a way that each of the children would have an interest of 20% in the partnership business, with the result that each of the children and their parents would each be the owners of a one-fifth interest in the business. Mr. and Mrs. Miller agreed to this proposition.” In the present case no capital was contributed by the children or by any other person on their behalf except the shares of the partnership set aside in trust by their parents.

The taxpayers argue that they were the only witnesses at the trial and that their bona fides in creating the trusts stands uncontroverted under their own testimony. It is not surprising that the taxpayers were the only witnesses, since they were the only persons familiar with the daily operations of the business. The jury was under no obligation, however, to accept their testimony without careful scrutiny. Kuney v. Frank, supra, 308 F.2d 719, 721 (C.A. 9); Anderson v. Commissioner of Internal Revenue, 250 F.2d 242, 247 (C.A. 5), cert. denied, 356 U.S. 950, 78 S.Ct. 915, 2 L.Ed.2d 844; Chesbro v.

Commissioner of Internal Revenue, 225 F.2d 674 (C.A. 2), cert. denied, 350 U.S. 995, 76 S.Ct. 544, 100 L.Ed. 860; Gloyd v. Commissioner of Internal Revenue, 63 F.2d 649 (C.A. 8), cert. denied, 290 U.S. 633, 54 S.Ct. 52, 78 L.Ed. 551. The father particularly was subjected to lengthy and thorough cross-examination. The manner and demeanor of the father and mother as witnesses were relevant factors to be considered by the jury in determining the weight to be accorded to their testimony. Stephan v.

United States, 133 F.2d 87, 95 (C.A. 6), cert. denied, 318 U.S. 781, 63 S.Ct. 858, 87 L.Ed. 1148, rehearing denied, 319 U.S. 783, 63 S.Ct. 1172, 87 L.Ed. 1727. The taxpayers rely upon the phraseology of the partnership agreement and trust instruments, all of which were skillfully drafted by able attorneys. Income taxes cannot be avoided by “the simple expedient of drawing up papers”. Commissioner of Internal Revenue v. Tower, 327 U.S. 280, 291, 66 S.Ct. 532, 538, 90 L.Ed. 670. The provisions of these instruments are not necessarily determinative of the bona fides of the family partnership. Kuney v.

Frank, supra, 308 F.2d 719, 720 (C.A. 9). We hold that under the record in the present case there is evidence supporting the verdict of the jury that no bona fide partnership was created between the taxpayers and the trusts. The taxpayers further contend that the district judge committed prejudicial and reversible error in his charge to the jury. We find that the charge, considered as a whole, contained a correct statement of the law of income taxation relating to family partnerships. Affirmed. . 26 U.S.C. § 704(e): “(

e) Family partnerships.— “

(1) Recognition of interest created by purchase or gift. — A person shall be recognized as a partner for purposes of this subtitle if he owns a capital interest in a partnership in which capital is a material income-producing factor, whether or not such interest was derived by purchase or gift from any other person. “

(2) Distributive share of donee includible in gross income. — In the case of any partnership interest created by gift, the distributive share of the donee under the partnership agreement shall be includible in his gross income, except to the extent that such share is determined without allowance of reasonable compensation for services rendered to the partnership by the donor, and except to the extent that the portion of such share attributable to donated capital is proportionately greater than the share of the donor attributable to the donor’s capital. The distributive share of a partner in the earnings of the partnership shall not be diminished because of absence due to military service. “

(3) Purchase of interest by member of family. — For purposes of this section, an interest purchased by one member of a family from another shall be considered to be created by gift from the seller, and the fair market value of the purchased interest shall be considered to be donated capital. The ‘family’ of any individual shall include only his spouse, ancestors, and lineal descendants, and any trusts for the primary benefit of such persons.” . H.Rep.No. 586, p. 33, S.Rep.No. 781, pp. 39-40, 82d Cong. 1st Sess. (1951-2 Ou. Bull. pp. 357, 381, 458, 486).