decided: November 15, 1966.
Appeal from decree of Orphans' Court of Schuylkill County, Sept. T., 1963, No. 10, in re estate of Thomas J. Anthony, deceased.
John T. Pfeiffer, III, with him John B. McGurl and Ronald J. Ulmer, for appellant.
Robert M. Zimmerman, with him Guy E. Waltman and E. Mac Troutman, for appellees.
Paul Maloney and Ernest Scott, and Pepper, Hamilton & Scheetz, filed a brief under Rule 65.
Thomas N. Griggs, and Griggs, Moreland, Blair & Douglass, filed a brief under Rule 65.
Bell, C.j., Musmanno, Jones, Cohen, Eagen, O'Brien and Roberts, JJ. Opinion by Mr. Justice Roberts. Concurring Opinion by Mr. Justice Cohen.
[ 423 Pa. Page 402]
The single question presented on this appeal is whether 900 shares of General Motors common stock
[ 423 Pa. Page 403]
distributed by E. I. duPont deNemours and Company pursuant to an anti-trust divestiture decree shall be allocated by the trustees of a testamentary trust to corpus or income. The court below, relying on § 5(3) of the Principal and Income Act of 1947,*fn1 entered a decree nisi confirming an allocation of the shares to principal. Exceptions taken by the life tenant were dismissed and a final decree entered.*fn2 This appeal followed.
Thomas J. Anthony, a resident and domiciliary of this Commonwealth, died testate on February 26, 1934. In his will, testator devised and bequeathed the whole of his residuary estate in trust, directing that the income be paid to his wife, Sadie Rohrer Anthony, for life, and the principal, at her death, to certain named beneficiaries. Included within decedent's residuary estate, and, subsequently conveyed into trust, were 450 shares of common stock of E. I. duPont deNemours and
[ 423 Pa. Page 404]
Company, which shares, as the result of a stock split have increased to 1800. On the basis of these holdings, the trust received, on July 9, 1962, the distribution here in dispute.
The background and circumstances of the duPont-General Motors distribution are sufficiently known to make a detailed review of those events unnecessary.*fn3 It suffices for present purposes to note that as a result of the successful prosecution of an anti-trust action instituted against duPont, on March 1, 1962, 63,000,000 shares of General Motors, acquired over a period dating back to 1917, and constituting almost 25% of the assets of duPont, were ordered divested. United States v. E. I. duPont deNemours & Co., 366 U.S. 316, 81 S. Ct. 1243 (1961). In accordance with the options permitted duPont, compliance with the divestiture decree was had through the distribution of the shares to duPont shareholders.*fn4 Although only 900 shares are here in issue, the Anthony trust ultimately received, as its pro rata share of the distribution, 2448 shares of General Motors.*fn5
Both parties concede that the allocation of the distribution, whether to the income cestui or to corpus,
[ 423 Pa. Page 405]
is to be controlled by the Principal and Income Act of 1947;*fn6 they differ only as to the applicable provision.*fn7 Appellant, the life tenant, contends that the distribution constituted a dividend payable in shares of a corporation other than the distributing corporation and is thus allocable under § 5(1) to income.*fn8 Appellees, the remaindermen, dispute the characterization of the distribution as a dividend, and, a fortiori, the applicability of the provision upon which appellant relies. Moreover, they urge that the distribution was designated by duPont as a "return of capital," and, as a result, is allocable under § 5(3) to principal.*fn9 Alternatively, they ask that we construe that provision of § 5(3) which directs the allocation of corporate assets distributed in partial liquidation to principal*fn10 to include, given the magnitude and circumstances of General Motors distribution, the instant transaction. In
[ 423 Pa. Page 406]
either case, they urge, assuming arguendo the correctness of appellant's characterization of the distribution, § 5(3) would nevertheless be controlling.
At the outset, it should be noted that the Principal and Income Act of 1947 does not explicitly provide for corporate distributions in compliance with divestiture decrees. While such distributions may fairly be described as extraordinary, they are not, as the celebrated 1911 Standard Oil divestiture establishes, unprecedented.*fn11 Yet, the Uniform Principal and Income Act,*fn12 upon which the Principal and Income Act of 1947, and its predecessor, the Principal and Income Act of 1945,*fn13 were based, did not as originally adopted, anticipate or deal with the allocation problem presented under such circumstances. Subsequently, the Uniform Act was amended and in its revised form
[ 423 Pa. Page 407]
provides specific treatment for divestiture distributions.*fn14 Our Act, however, remains silent on the subject.
Yet, in the face of the clear language of § 2 that the Act was intended "[to] govern the ascertainment of income and principal and the apportionment of receipts and expenses between tenants and remaindermen in all cases where a principal has been established with, or, unless otherwise stated hereinafter, without the interposition of a trust," Act of July 3, 1947, P.L. 1283, 20 P.S. § 3470.2, we would be reluctant to conclude that resort to a non-statutory rule is here required. Especially is this the case where the background and history of the legislation makes abundantly clear the Legislature's intent to displace our former rules of apportionment. While designed to insure equitable treatment of the various interests in a trust corpus, experience has demonstrated how easily the purpose of those rules was confounded by the complexity of modern corporate finance and accounting. See Catherwood Trust, 405 Pa. 61, 173 A.2d 86 (1961); Norvell Estate, 415 Pa. 427 203 A.2d 538 (1964);
[ 423 Pa. Page 408]
finds little support. To the contrary, that background suggests the thesis that the draftsmen of the Uniform Act, rejecting the view that undistributed earned surplus be equated with "income" for trust purposes, adopted the policy that nothing be deemed income which is not the result of a decision by management, freely arrived at, to distribute the "earnings" of the corporation.*fn16 Thus, they sought to restate, by generalizing as to traditional corporate practices, those distributions which are presumptively the result of such a decision. These distributions are allocated to the income cestui. All other distributions, including those designated by the directorate as "a return of capital or a division of corporate property," are allocated to principal. Our statute, following the Uniform Act, reflects the same basic design.*fn17
[ 423 Pa. Page 410]
In the face of the underlying policy of our Act, we are unable to conclude that a distribution of almost 25% of the assets of duPont, dictated by external circumstances rather than by a decision of duPont's directorate, constitutes a dividend allocable to income. Moreover, even were we to concede the correctness of appellant's characterization of the distribution as a dividend, we would not dispose of the claims of the remaindermen to the distribution, since the provision of § 5(1) upon which appellant relies is expressly made subject to displacement by § 5(3),*fn18 when applicable, which operates to allocate the shares to corpus. It is necessary, therefore, that we turn to a consideration of § 5(3).
While we are of the view that § 5(3) of the Act compels the allocation of the General Motors shares to principal, we do not base our conclusion on the ground advanced by appellees that the distribution has been designated by duPont as "a return of capital" within the meaning of the Act. As we view the documents upon which appellees rely,*fn19 they are concerned
[ 423 Pa. Page 411]
exclusively with matters of federal taxation, intended merely to advise duPont shareholders of the tax consequences of the distribution. Nothing contained in these documents is expressive of duPont corporate policy with regard to the distribution, and, thus, the communications do not suffice to control the instant allocation. However, appellees' alternative argument, treating the distribution as one made in partial liquidation within the meaning of § 5(3), corresponds to our view of the transaction and represents the position which we adopt.
In reaching this conclusion, we are not unmindful of the fact that duPont, both prior and subsequent to the distribution, was and continues to be a thriving business. Moreover, we are cognizant of the fact that no liquidation was technically effected under Delaware law, the state of duPont's incorporation. Nevertheless, as pointed out by the court in Steel Estate, 32 Pa. D. & C. 2d 553 (Orphans' Ct. Phila. Co. 1964), the fact remains that duPont has distributed a substantial percentage of its assets and "thereby . . . 'liquidated' a major portion of its business as a holding company." Id. at 567-68. As a result, neither the dividends derived from its General Motors holdings nor the capital represented by its investment in those shares will be available to duPont to supplement its earnings from its own sources. See ibid. And, where sums of the magnitude of those here distributed are involved, a characterization of the distribution as one made in partial liquidation is strongly suggested, if not compelled.
Although not dispositive of our Act, it is instructive to note that the comment to § 236(e) of the Restatement 2d, Trusts, which allocates all distributions made in total or partial liquidation other than "amounts paid as cash dividends declared before such liquidation occurred or as arrears of preferred or guaranteed dividends"
[ 423 Pa. Page 412]
to principal, adopts the view that the distribution of shares of a subsidiary corporation, directed by a public authority, "may be in the nature of a partial liquidation and allocable to principal." This is the position taken by Scott in his treatise on trusts. 3 Scott, Trusts § 236.5 (Supp. 1966). While General Motors was not a subsidiary of duPont, the rationale and policy of the rule advanced by the Restatement and Scott would appear, nevertheless, to apply. Fiduciary Review, Principal and Income -- duPont Distribution of General Motors Shares 4 (August 1962). Moreover, by recent legislation, several other jurisdictions have required the allocation of a distribution made under such circumstances to corpus.*fn20
Given the fact that the Revised Uniform Act and the Restatement reflect the considered judgment of scholars and practitioners knowledgeable in this area of the law, their treatment and allocation of judicially dictated distributions to principal is entitled to great weight. While not dispositive of the intent of our Legislature in enacting the Act of 1947, the positions taken by the Restatement and Revised Uniform Act do support the conclusion that a characterization of the duPont distribution as one made in partial liquidation
[ 423 Pa. Page 413]
does not violate accepted convention. Moreover, such views confirm our conclusion that the duPont-General Motors distribution sufficiently approximates in economic effect a distribution in partial liquidation to justify its inclusion in that category of our Act and its allocation to principal.
We think it worth noting, that a contrary conclusion would have particularly untoward effects on the corpus of trusts receiving the duPont distribution. Beyond the depreciation in the value of the duPont holdings,*fn21 extreme because of the magnitude of the distribution, the tax consequences would be particularly exacerbating. As a result of special legislation, the General Motors shares distributed are entitled to be treated by non-corporate shareholders as a return of capital for federal income tax purposes. Int. Rev. Code of 1954, § 1111; see 5 CCH 1966 Stand. Fed. Tax Rep. para. 4699A-4699E.15. However, such treatment requires that the basis of the duPont shares held by the stockholder be reduced by the market value of the General Motors shares received. Int. Rev. Code of 1954, § 301(c) (2); see 5 CCH 1966 Stand. Fed. Tax Rep. para. 4699E. Therefore, upon the sale of those securities, the sum received in excess of the new, reduced basis will be subject to capital gains taxation and the proceeds, allocable to principal, reduced accordingly. It is clear, therefore, that the corpus will be taxed, in part, on sums which have been diverted to the life tenant. In addition, in those cases in which the basis of the duPont holdings
[ 423 Pa. Page 414]
are exceeded by the value of the General Motors shares received, the trust, merely by reason of its receipt of the latter shares, even though allocated to income, will have incurred taxable capital gains. Int. Rev. Code of 1954, § 301(c) (3) (A); see 5 CCH 1966 Stand. Fed. Tax Rep. para. 4699E.10. Thus, significant burdens will be incurred by the corpus were the General Motors shares not available to offset the tax consequences of the transaction.
To substantial numbers of shareholders in duPont, those acquiring their holdings subsequent to the acquisition of the General Motors shares duPont's investment in General Motors represented capital, and, the appreciation in value of those shares, capital appreciation. To others, those acquiring duPont prior to the acquisition of its General Motors holdings, those holdings may be viewed as deferred income, appreciated in value through duPont's investment of previously earned surplus in General Motors. While the application of our common law rule of apportionment would make such matters, in part, dispositive, the enactment of the Principal and Income Act precludes reference to such considerations. The need for administrative convenience and the limitations of our former rule have led the Legislature to invoke rules of general application, which, by necessity, may not do perfect justice. Yet, on balance, we are of the view that the distribution of the General Motors shares to corpus will, in most instances, most equitably treat the successive interests in the trust. In this fashion, substantial losses to the sole detriment of remaindermen will be avoided; while income cestuis will continue to be the beneficiaries of the income produced and distributed by General Motors.
Decree affirmed. Each party to pay own costs.
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Concurring Opinion by Mr. Justice Cohen:
The legislature, when it passed the Act of July 3, 1947, P. L. 1283, 20 P.S. § 3470.1 et seq., never contemplated a situation such as the one with which we are now confronted and made no provision for the application of the Act to this problem. Thus we should not apply the Act to this situation and be required, as the majority does, to make a choice between the provisions of § 5(1) or § 5(3), since neither of those sections nor any other section of the Act was within the contemplation of the legislature, applicable to the duPont situation.
Several states have been more realistic and with a greater degree of probity have by recent legislation expressly provided that a court forced distribution by a corporation of the shares of another corporation shall be deemed principal. Florida, Illinois, Maryland and Wisconsin had statutory enactments relating to the distribution of principal and income, but have recognized the uniqueness of this situation and the lack of their applicable statutory guides and provided the solution by additional statutory enactment.
The Pennsylvania legislature did not so act; thus the situation presented by this problem has no statutory solution in Pennsylvania and any attempt to distinguish and apply various sections of our existing Principal and Income Act to provide a statutory solution to this situation is nothing more than tortuous rationalization. In fact, the majority's determination made without guidelines may prove to be a dangerous precedent.
Thus, I would disregard all of our existing statutory enactments and base my conclusion solely on the concept that a contrary determination would be most inequitable to the remaindermen of the trust and not within the settlor's contemplation.