The opinion of the court was delivered by: CURTIN
This action was commenced by the plaintiff to recover $3,092.59 in estate taxes and interest. The dispute arose over the proper method of valuation of mutual fund shares in an estate tax proceeding.
Ethel Bennett died testate on December 4, 1964, owning the following shares in mutual funds:
Investors Mutual, Inc. 2568.422 (in her
2067.531 (in her
name as trustee for
Dorothy B. Cartwright)
Investors Selective Fund, 2269.376
Investors Selected Fund,
Investors Mutual, Inc., Investors Stock Fund, Inc., and Investors Selective Fund, Inc. [hereinafter referred to as "the funds"] are open end investment companies registered with and subject to the regulations of the Securities and Exchange Commission. They are regulated by Sections 1 through 53 of the Investment Company Act of 1940 [15 U.S.C. §§ 80a-1 through 80a-52]. The funds were organized and are managed by Investors Diversified Services, Inc., not an open end investment company but the underwriter, distributor, and manager for the funds.
Upon the death of Ethel Bennett, her executor reported the value of the shares on the estate tax return at their net asset value, also called the bid or redemption price. The Commissioner of Internal Revenue assessed a deficiency on the estate tax, claiming that the estate tax value of these shares was the asked for or public offering price. The executor paid the deficiency on the accrued interest and, on December 6, 1967, filed a claim for refund of federal estate taxes and interest in the amount of $3,092.59.
The issue is whether Treasury Regulation 20.2031-8 (b) (1963),
which requires that shares in mutual funds be valued for estate tax purposes at the public offering or asked price on the date of death, is reasonable. Plaintiff's position is that the shares should be valued at the redemption price.
The court has considered the extensive stipulation of facts, testimony of witnesses, and the briefs filed by the parties. The following constitutes the findings of fact and conclusions of law.
The regulation was held reasonable and its application by the Commissioner was upheld in Estate of Wells v. Commissioner of Internal Revenue, 50 T.C. 871 (1968) (six judges dissenting), aff'd. as Ruehlmann v. Commissioner, 418 F.2d 1302 (6th Cir. 1969), and in Howell v. United States, 290 F. Supp. 690 (N.D.Ind.1968), aff'd. 414 F.2d 45 (7th Cir. 1969). However, in Davis v. United States, 306 F. Supp. 949 (D.C.1969), the court held that the regulation was unreasonable and found for the plaintiff. That decision is on appeal to the Ninth Circuit.
If Treasury Regulation 20.2031-8 (b) is reasonable, it must be upheld by the court [United States v. Correll, 389 U.S. 299, 306-307, 88 S. Ct. 445, 19 L. Ed. 2d 537 (1967)], even if another method of valuing the shares would conform to the statute [Mearkle's Estate v. Commissioner of Internal Revenue, 129 F.2d 386, 388-389 (3d Cir. 1942)].
The price at which shares in the funds are sold to the investor is the current public offering price or asked price, which is determined by adding the net asset value and the load or sales charge. The net asset value of a share is computed by adding the market value of all securities and other assets owned by the fund and subtracting the liabilities of the fund and dividing that figure by the then total outstanding shares. The load charge usually covers the cost of expenses and profit to the broker,
but does not include any management fee. The redemption price or bid price is the current net asset value and does not include the load charge. Ethel Bennett acquired her shares by gift, inheritance, and by purchase at the bid price by re-investing her capital gains and ordinary dividends. She did not acquire any shares by purchase at the asked price.
If an individual acquires shares in the funds through purchase, he realizes at the time of the original acquisition that he is paying a load charge. He further understands that, if he later wants the company to redeem the shares, they will be redeemed on the date of redemption at the net asset value. There are no restrictions on the transferability of shares in the funds, but they are not sold in the securities market. The ordinary and only practical method of disposition is redemption. If the holder disposes of these shares during his lifetime, tax computation is based upon net asset value.
Provisions similar to Section 2031 (a) of the Internal Revenue Code of 1954 [26 U.S.C. § 2031 (a)], which requires that the gross estate of a decedent shall be determined by including the value of all of his property at the time of death have appeared in the Revenue Act since 1916. Prior to the promulgation of Regulation 20.2031-8 (b) (1963), effective after April 10, 1963, there was no regulation specifying how shares in mutual funds should be valued for estate tax purposes. From 1940, when the Investment Company Act became effective, until the early 1960's, the Commissioner had no fixed policy for the valuation of mutual funds. During this period of time, the taxpayer could value the shares at redemption price if he desired. In about the year 1962, some Revenue agents demanded that mutual fund shares in estate tax returns be valued at the asked price or at the mean between the bid and the asked price. However, after taxpayers filed refund actions, the government accepted the bid prices as the fair market value and settled the cases.
The government bases its argument of reasonableness of Treasury Regulation 20.2031-8 (b) (1963) on several grounds. The first is that the regulation applies the general principle of valuation expressed in Treasury Regulation 20.2031-1 (b) to the valuation of mutual fund shares. Secondly, it brings the valuation of these shares into harmony with cases like Guggenheim v. Rasquin, 312 U.S. 254, 61 S. Ct. 507, 85 L. Ed. 813 (1941), which held that replacement cost rather than cash surrender value is the correct measure of value of a single premium insurance contract. Thirdly, the argument for reasonableness is based on the fact that no hardship is imposed on the estate or the beneficiaries if they dispose of the shares at a loss. Treasury Regulation Section 20.2053-3 (d) (2).
The government, citing Commissioner of Internal Revenue v. South Texas Lumber Co., 333 U.S. 496, 501, 68 S. Ct. 695, 92 L. Ed. 831 (1948), argues that, since the "Regulations constitute a contemporaneous construction by those charged with the administration of the revenue statutes [it] should not be overruled except for weighty reasons."
The general principle of valuation expressed in Treasury Regulation 20.2031-1 (b) defines fair market value as "the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts." The government's position is that the only time that the willing buyer-willing seller situation exists in the sale of mutual fund shares is at the time of original sale by the investment company to purchaser. At the time of redemption sale, since the company is under an obligation of law to purchase at the ...