Before BIGGS, Chief Judge, and MARIS and KALODNER, Circuit Judges.
These cases involve the deductibility as business expenses in computing the net taxable income of the taxpayers of certain rents and royalties paid by them to the trustee of two trusts created by them for the benefit of their children. They grow out of the following facts:
Taxpayers are husband and wife, residing in Clearfield, Pennsylvania. Their individual tax returns for the calendar year 1944 were filed on the cash receipts and disbursements basis.
Taxpayers were engaged as partners in the general contracting and coal-mining business. In 1943 the business was growing. They owned a large equity in equipment worth about $150,000 and owned several coal properties which were then being operated. In their mining operations they made use of a railroad siding for loading coal, then owned by H. F. Bigler, Jr. The railroad siding consisted of a single track with a ramp or tipple from which coal could be loaded from trucks into railroad cars. The siding connected with the Baltimore & Ohio Railroad and was capable of holding approximately 30 coal cars. Taxpayers paid a wheelage charge of $2.50 a car, regardless of the amount of coal loaded. The amount of coal held by one coal car ranges from 50 to 70 tons.
By deed dated June 7, 1943, taxpayers, as husband and wife, acquired from H. F. Bigler, Jr., and wife, for a consideration of $4,500, title to 8.9 acres of land located just outside the borough limits of Clearfield, Pennsylvania. The railroad siding was one of the improvements on this land.
By deed dated September 29, 1943, taxpayers acquired for $3,000 a 35-acre tract of coal land located about three miles north of Clearfield and known as the Kephart tract. Testings had been made on this tract and evidences of coal discovered. Prior to January 3, 1944, taxpayers had commenced or were about to commence mining operations on this tract.
Sometime prior to January 3, 1944, taxpayers discussed with their attorneys, Harry Boulton and his son, Harold J. Boulton, the matter of the future financial security of their two sons, Robert Earl Brown, born August 10, 1941, and Allan Murray Brown, born July 2, 1943. The creation of a trust was suggested. A plan was agreed upon whereby the title to the 8.9-acre tract upon which the railroad siding was located and to the 35-acre coal land was to be transferred to a trustee, with the understanding that the properties were to be leased to taxpayers, who were, as was always intended, to continue to operate them under their partnership agreement.
On January 3, 1944, taxpayers formally executed two irrevocable trust agreements, under each of which they conveyed to Harold J. Boulton, as trustee, an undivided onehalf interest in the tracts for the benefit of taxpayers' two sons. The trust agreements are identical except as to the names of the beneficiaries. Each trust contained, inter alia, the following provisions:
"1. During the continuance of the Trust, The Trustee shall have the absolute right, in his sole discretion, to operate, manage, sell, convey, transfer, lease, assign and convey any and all, or any part of the said Trust Estate, and to make, execute and deliver good and sufficient deeds, indentures or other written instruments to the purchaser or lessee at whatever price and upon whatever terms may to him seem wise; and the Trustee shall have the right to consent to assignments by lessees and to modify or cancel lease contracts for any part of the trust estate, if power and occasion should be reserved or arise under the terms of the lease agreement or agreements.
"3. The income from the Trust Estate shall be held and accumulated by the Trustee for the duration of the Trust but not exceeding twenty-one years after the death of the survivor of the grantors nor longer than the minority of the beneficiaries; and he shall have the right at all times to pay out of the income at his discretion such sums as he may deem necessary for the support, maintenance and education of any of the beneficiaries who at the time of such payment would be entitled to receive all or part of the Trust Estate as though it were then terminated, and it is specifically authorized that the Trustee may invest any or all of the income, or of the principal if converted into cash, in additional real estate or in leases of additional real estate. The income, after the dates fixed for accumulation thereof shall be paid from time to time to those entitled as though the trust had at the date of such payments been terminated.
"4. The first beneficiary of the Trust Estate hereby created is Allan Murray Brown, a minor child of the Grantors herein, subject to the hereinafter stated terms and conditions of the Trust; but if the said Allan Murray Brown should die before attaining the age of twenty-five years, his surviving children in the first place, or if the said Allan Murray Brown shall not have children to survive him, then his surviving brothers and sisters in the second place, in the order named, are substituted as beneficiaries.
"5. The Trust Estate shall terminate upon the first beneficiary arriving at the age of twenty-five years; if the first beneficiary shall die prior to the date fixed for the termination of the Trust, the duration of the Trust Estate shall, nevertheless, so far as concerns the principal of the Trust Estate, continue until the youngest of the respective substituted beneficiaries shall arrive at the age of twenty-one years, and the Trust shall continue for such substituted term with the same powers as herein set forth. Upon the termination of the Trust Estate, the Trustee shall execute sufficient conveyances and assignments in fee simple as to real estate and absolutely as to personalty, to the beneficiary or beneficiaries of all the corpus of the Trust Estate, including income which may have accumulated."
On January 4, 1944, the day after the trust agreement was executed, taxpayers entered into a written agreement with Harold J. Boulton, as trustee, whereby taxpayers were granted the exclusive right and privilege to occupy and use the railroad siding for a period of 10 years upon the payment of a rental of 7 per ton for each and every ton of coal or clay loaded upon the premises in railroad cars and shipped over the siding. In addition, the lessees (taxpayers) were to keep the railroad siding and equipment in good repair and were to save harmless and indemnify the lessor and the railroad from any loss, damage or expense by reason of injury to persons or property arising from use or occupation of the described premises, including any appurtenant sidewalks or driveways. The ...