Legal Ruling 1956-179
California Franchise Tax Board
Legal Ruling No. 179
February 17, 1956
Nonresidents: Income From Intangibles
Nonresident members of an investment fund are taxable upon their distributive shares when the fund is managed by a resident member who is appointed as agent and given broad discretion as to management and securities are bought and sold with reasonable frequency in order to profit on a short-term basis.
Six brothers and sisters pooled their assets – chiefly corporate stocks – to form a family investment business to be managed by X, one of the brothers. The instrument designates each party as principal with X as their agent for management purposes. Under the agreement X is given practically an uncontrolled discretion as to the management and investment of the fund. None of the members of the fund were California residents in 1947 when the fund was created. Since 1947, X and two other members have become California residents. Most of the securities sold were acquired after X became a California resident and were sold within one to two years of purchase despite substantial dividends being paid regularly. The fund is charged with one-half of the expenses of X's law office.
Advice is requested as to whether the nonresident members of the fund are taxable on their distributive shares. The above ruling is based on the conclusion that the nonresident members are engaged in a trade or business within this State.
Under Reg. 17211-17214(f) the income from intangible personal property is taxable to a nonresident if:
- It has been employed as capital in this State or the possession and control of the property has been localized in connection with a business, trade or profession in this State, so that its substantial use and value attach to and become an asset of the business, trade or profession in this State. Under such conditions the property is said to have acquired a business situs in California, or
- The nonresident buys or sells stocks, bonds or other properties with such regularity as to constitute doing business within the State. Under these circumstances the income is taxable irrespective of the situs of the property.
In determining whether nonresident aliens are engaged in a trade or business within the United States so as to be taxable under Section 211(b) of the 1939 Internal Revenue Code, the Tax Court has set forth the rule to be followed in cases where a resident agent has been appointed to manage the investments of a nonresident alien. If the activities of the fund are extensive and the securities are bought and sold with reasonable frequency in order to profit on the short term basis then the nonresident, through his agent, is deemed to be engaged in a trade or business. Fernand C. A. Adda, 10 TC 273, aff'd. 171 Fed. 2d 457, cert. den. 336 US 952. If, on the other hand, the fund is managed as an investment account in which the securities are held for capital appreciation and income, the nonresident will not be deemed to be engaged in a trade or business. Chang Hsiao Liang, 23 TC 1040.
In the instant case the fact that the securities were sold within one or two years after acquisition, as compared with an average holding period of 5.8 years in the Chang Hsiao Liang case, and the integration of the fund management with X's law office lead this department to conclude that the fund activities were more of a trading nature than an investment nature. It follows that the nonresidents are engaged in a trade or business within this State through X, their agent, and that they are taxable on their distributive shares.