54 T.C. 460">*460 The respondent determined deficiencies in petitioners' income taxes in the following amounts for the following years: 54 T.C. 460">*461

1970 U.S. Tax Ct. LEXIS 193">*195 The issues for our decision are as follows:

(1) Whether the Dri-Powr distributors' contributions to the Dri-Powr Distributors Association Trust (hereinafter referred to as the trust) are includable in Wynn's gross income under the provisions of section 61(a) of the Internal Revenue Code of 1954. ¹

(2) Alternatively, whether such contributions are taxable to the trust.

(3) If such contributions are taxable to either Wynn or the trust, is such taxpayer entitled to deductions for unexpended amounts retained in reserve for the anticipated redemption of tokens.

FINDINGS OF FACT

Some of the facts have been stipulated by the parties. The stipulated facts and the exhibits attached thereto are incorporated herein by this reference. A summary of the salient facts is set forth below.

Mack Richkind (hereinafter referred to as Richkind) is the trustee of the trust. At the time of filing the petition herein on behalf of the1970 U.S. Tax Ct. LEXIS 193">*196 trust, Richkind had his legal residence in California. The trust filed its Federal income tax returns for the calendar years 1962 and 1963 with the district director of internal revenue at Los Angeles, Calif.

Clarence M. Wynn (hereinafter referred to as Wynn) and Evelyn B. Wynn were husband and wife residing in Arcadia, Calif., at the time of filing their petition herein. They filed their joint Federal income tax returns for the calendar years 1962 and 1963 with the district director of internal revenue at Los Angeles, Calif.

In 1935, Wynn invented certain formulae for various petroleum products, chiefly oil additives. He commenced manufacturing such additives in the basement of his home and selling them himself. Throughout the period from 1953 to April 1, 1963, Wynn operated his business of manufacturing oil additives in the form of a sole proprietorship known as Dri-Powr Co. (hereinafter referred to as the company). The products of same were manufactured and distributed under the registered trademark "Dri-Powr." Representative competitors of Dri-Powr products in the oil additive field are Bardahl, STP, and Wynn's Friction-Proofing.

54 T.C. 460">*462 By agreement dated April 1, 1963, 1970 U.S. Tax Ct. LEXIS 193">*197 Wynn transferred the assets of the company to a previously inactive California corporation, Dri-Powr Co., Inc. (hereinafter referred to as the corporation). At all times relevant hereto, Wynn was president of the corporation and he and his wife owned all of its outstanding stock.

Under the terms of the agreement of April 1, 1963, the corporation assumed the liabilities of the company, and paid Wynn a net sales price of $ 48,397.52. Wynn retained ownership of the registered trademark "Dri-Powr" and the formulae for making the various Dri-Powr petroleum products. Since April 1, 1963, the corporation has paid Wynn a royalty for the use of such trademark and formulae.

In 1940, Wynn began making agreements with various independent distributors located throughout the United States for the sale of his products. Such distributors were selected through a process of application, screening, and interview. Around 1950, Wynn discontinued selling his products himself, and thereafter such products were distributed nationally by independent distributors. These distributors purchased Dri-Powr products from the company and after April 1, 1963, from the corporation, and then marketed such products1970 U.S. Tax Ct. LEXIS 193">*198 directly, primarily to service stations. The service station operators then resold to the ultimate consumers. The distributors regularly called on their customers in their own vans, specially adapted and identified to market Dri-Powr products.

The distributors of Dri-Powr products were not employees of Wynn or the corporation, but instead were independent businessmen in business for themselves. Wynn required that the distributors make advance payment (i.e., in the form of a cashier's check, certified check, or a personal check) with each purchase order, and that the distributors pay all freight, f.o.b. plant, Azusa, Calif. He further required that the distributors arrange and pay for all advertising and promotion of Dri-Powr products. The same requirements continued after incorporation. Each distributor entered into an agreement with Wynn and later with the corporation agreeing to these requirements.

Prior to 1957, each individual Dri-Powr distributor arranged and paid for his own freight, advertising, and promotion of Dri-Powr products. The distributors eventually came to the conclusion that it would be advantageous for them to pool their funds to achieve a unified advertising1970 U.S. Tax Ct. LEXIS 193">*199 effort, and to equalize freight costs among all distributors. As a result, about 1957 they formed the Dri-Powr Distributors Association (hereinafter referred to as the association), an unincorporated association of Dri-Powr distributors.

Soon after the formation of the association, representatives came 54 T.C. 460">*463 to Wynn with the proposal that a trust fund be set up to pool the funds of the contributing distributors in order to obtain common and unified advertising and promotion benefits. Distributors sought Wynn's cooperation in organizing the trust and asked him to become trustee of the fund. Wynn agreed to cooperate and was trustee of the trust from its inception until the end of December 1961.

In obtaining the cooperation of all distributors in pooling their funds, one of the main problems faced by the association was the equalization of freight costs to all distributors. It was necessary that some concession be made by local distributors to out-of-town and out-of-State distributors regarding freight, because local distributors could pick up their merchandise at the plant and avoid any freight cost, whereas an out-of-State distributor could pay as much as $ 7.50 a case for 1970 U.S. Tax Ct. LEXIS 193">*200 freight. No final resolution of this problem was worked out between the distributors until about 1964.

During the period that the distributors were working out their differences on equalization of freight to all distributors, Wynn, and later the corporation, made contributions to the trust or actually paid the freight in part for out-of-State distributors, known as A distributors, in order to aid them during this period of negotiation of the freight problem. There were no such concessions or contribution made by Wynn and the corporation to local distributors, known as B distributors. Wynn and the corporation deducted these contributions on their tax returns as business expense. Wynn and the corporation expended no other amounts for freight. Although until December 1963 the other freight costs were often billed to the company, these bills were paid by the trust.

During the formative years of the association, Wynn and the corporation also made contributions to the trust for advertising, at the request of the distributors for aid in a current promotion. These contributions ceased about 1964. Wynn and the corporation expended no other amounts for advertising. Wynn and the corporation1970 U.S. Tax Ct. LEXIS 193">*201 deducted these contributions on their tax returns as business expense.

A document entitled "Trustee-Trust Agreement" was executed by Wynn and 25 distributors, representing about one-third of the total number of distributors of Dri-Powr Co. This document provided in pertinent part, as follows:

We hereby ratify that in accordance with discussions and agreements between Dri-Powr Distributors and Dri-Powr Company, during the month of December 1961, Dri-Powr Company was appointed Trustee of "Dri-Powr Distributors Sales Promotion Trust Fund," with the following instructions:

1. (a) Cash and/or checks paid to Dri-Powr Company by Dri-Powr Distributors in accordance with current Dri-Powr Distributors Price List, shall be 54 T.C. 460">*464 divided on the basis of no less than 56% of same to be placed on deposit in the "Dri-Powr Distributors Sales Promotion Trust Fund," and become the exclusive property of that Trust Fund, and the remainder to become the exclusive property of Dri-Powr Company in payment for Dri-Powr products.

(b) Any and all other money paid to Dri-Powr Company by Dri-Powr Distributors is to be placed 100% on deposit for the "Dri-Powr Distributors Sales Promotion Trust Fund" and become1970 U.S. Tax Ct. LEXIS 193">*202 the exclusive property of that Trust Fund.

* * * *

4. All money in the "Dri-Powr Distributors Sales Promotion Trust Fund" is to be spent, and spent only, for Advertising, Freight, Sales Promotions, and for the best interests of Dri-Powr Distributors and of Dri-Powr Company.

* * * *

8. All Advertising, Sales Promotions, etc., must be O.K.d by Dri-Powr Distributors and Dri-Powr Company.

Wynn never performed as trustee under this document. The decisions as to authorized expenditures of the trust funds were made solely by the distributors. Wynn followed their instructions and did not seek to influence the amount of advertising expenditures. During the period that Wynn was trustee of the trust, from about 1957 to the end of 1961, he performed to the satisfaction of the distributors.

Sometime in late 1961, the distributors conceived of a new and unique promotional program, known as the token or money-in-cans program, to boost Dri-Powr sales. It was proposed that tokens redeemable in U.S. currency be placed in the various cans of Dri-Powr merchandise to reward gas station owners (dealers) and attendants for selling Dri-Powr products to the ultimate consumers. The idea behind the token1970 U.S. Tax Ct. LEXIS 193">*203 program was that when a motorist asked a dealer or attendant to recommend an oil additive, the dealer or attendant would recommend Dri-Powr over the other competitive brands because he knew he would receive a token redeemable in cash for every can of Dri-Powr merchandise he sold.

When the distributors approached Wynn with their idea for the token program, he asked to be relieved of his duties as trustee because he knew that such a program would require a man who could devote more time to the affairs of the association. In addition, the distributors expressed a desire to have a certified public accountant administer the trust, especially since large sums of money would be placed in the trust for the redemption of tokens. Richkind, a certified public accountant who had audited the books of the company since the early part of 1961, gradually became the distributors' choice to succeed Wynn as trustee. On or about January 1, 1962, Richkind assumed the duties of trustee and continued to serve in that capacity throughout the years in controversy and beyond. Richkind was not appointed by a written document, but instead accepted the position of trustee 54 T.C. 460">*465 by his acts and words, 1970 U.S. Tax Ct. LEXIS 193">*204 and through lack of dissent from the distributors.

Richkind continued to audit the books and records of the company during 1962, 1963, and 1964. He also audited the trust for the years 1962, 1963, and 1964. Richkind became treasurer of the corporation at the time of its formation in 1963, and has remained an officer of the corporation since that time. Throughout 1962 and 1963, Richkind continued to maintain a private accounting practice. He spent about 1 day a week at the Dri-Powr office attending to his duties as trustee during this period.

After several months of preliminary planning and negotiation, on or about May 1, 1962, the distributors put into operation the token program. Metal discs (tokens) were placed in the cans of Dri-Powr Co. merchandise in amounts per token of 10 cents, 25 cents, 40 cents, and 50 cents, which represented the cash value of these tokens when presented for redemption. The distributors asked Wynn for his cooperation in putting the token premium program into operation. Wynn was not enthusiastic about the idea when first approached, but did agree to cooperate with the distributors by letting them use his plant's facilities and personnel, especially1970 U.S. Tax Ct. LEXIS 193">*205 for the placing of the tokens in the cans of his merchandise.

The tokens embodied an unconditional promise to pay the face amount of the token to any dealer or attendant who presented them for redemption. The tokens were made out of a composition of aluminum, and were approximately 2 inches long and about 1 1/4 inches wide. The tokens were immediately melted down after redemption, since they were considered by the parties to be as good as money; therefore, none are available that were issued during the taxable years in issue. The tokens issued in 1962 and 1963 are substantially the same as those currently issued. The language on tokens currently issued states the following:

DRI-POWR

Trademark Registered in U.S. Patent

Office, Counterfeiters will be prosecuted.

50 cents

REDEEMED SOLELY BY

INDEPENDENT

DISTRIBUTORS ASSOCIATION

Restricted to Dealers & Attendants only.

EXP. 5-20-70

VOID WHERE ILLEGAL, REGULATED OR TAXED.

The expiration dates on the tokens were usually dated 1 year from date of issue. A token was considered issued when the can of merchandise 54 T.C. 460">*466 containing the token was purchased by a distributor and left the premises of Dri-Powr Co. The expiration dates were1970 U.S. Tax Ct. LEXIS 193">*206 used for informational purposes only, so that the trust could determine the lag period between issuance and redemption of various denominations of tokens. The expiration date did not affect the redeemability of the token in any respect. The trust has never refused to redeem a token because it was presented after the expiration date stamped on the token.

From sometime prior to 1962 until November of 1962, the association maintained a single bank account entitled "Dri-Powr Distributor Advertising Trust Fund." During 1962 substantially all of the expenses of the association for advertising, freight, general products promotion, and the token program were paid out of this account. The opening of the Dri-Powr Products Promotion Fund and the Dri-Powr Token Redemption Fund on November 9, 1962, was accomplished by the transfer of funds directly from the Dri-Powr Distributor Association Trust Fund, which account became inactive and was finally completely closed out on February 11, 1963.

During most of the year 1963, the only association bank accounts that were active were the Dri-Powr Products Promotion Fund and the Dri-Powr Token Redemption Fund. The Dri-Powr Products Promotion Fund was1970 U.S. Tax Ct. LEXIS 193">*207 the association's general fund for advertising, freight, and products promotion expenses. The Dri-Powr Token Redemption Fund was established as a separate account at the request of the distributors. They had been encountering claims by competitors that the token program, involving unconditional promises to pay the face amounts of the tokens, would not be honored. The distributors felt that the establishment of a separate token redemption fund in which money would be set aside, dollar-for-dollar, to redeem every token outstanding would lend more credence to the promises that were made to the dealers and attendants and overcome the rumors being spread by competitors. On or about November 29, 1963, the Dri-Powr Distributors Sales Promotion Fund and the Dri-Powr Distributors Token Redemption Fund were opened by Richkind in his capacity as trustee to succeed to the functions served by the Dri-Powr Products Promotion Fund and the Dri-Powr Token Redemption Fund respectively. The latter two accounts became inactive and were closed early in 1964.

The foregoing and other relevant facts with respect to the various checking accounts maintained at different times by the company, the corporation, 1970 U.S. Tax Ct. LEXIS 193">*208 and the association at the Azusa, Calif., branch of the Bank of America may be summarized as follows: 54 T.C. 460">*467

1970 U.S. Tax Ct. LEXIS 193">*209 There were two types of Dri-Powr distributors, namely, A and B distributors. The distributor himself determined which type he wished to become. He could change from an A to a B distributor, or vice versa, at any time. An A distributor was one who usually had employees working for him selling Dri-Powr products, and thus did not want to contribute as much money to the trust for advertising and promotion. An A distributor would continue to do his own advertising and promotion individually, as he saw fit. He was more than likely an out-of-State distributor located in the East. A B distributor did all his own selling personally, had no employees under him, and believed in contributing more money to the trust in unity with the other B distributors to obtain the benefits of common advertising and promotion efforts. He was more than likely a local or in-State distributor. There were also some distributors in remote areas who chose not to contribute at all and to pay only a set purchase price for the Dri-Powr merchandise. Approximately 40 percent of the distributors were located out-of-State.

The amounts that would go to the company (and after April 1, 1963, to the corporation) as1970 U.S. Tax Ct. LEXIS 193">*210 the purchase price for its merchandise and the amounts that would go into trust were determined in the manner described below. The company (and later the corporation) would determine the price for its merchandise and the distributors would negotiate among themselves to determine how much each group of distributors (A and B) would contribute to the fund and what the 54 T.C. 460">*468 money would be used for. At no time did Wynn or the corporation determine the amount that would go into the trust. These respective amounts were entered on price sheets which broke down the price to Dri-Powr Co. for their merchandise and the amount which was to go into the trust, in separate columns. There were different price sheets for the A and B distributors, since A distributors chose not to contribute as much to the fund and in turn received less benefit from it. Pertinent portions of a B distributor's price sheet in effect on December 15, 1962, are set forth below:

DRI-POWR COMPANY.

* * * *

RIGHT RESERVED to CANCEL or to CHANGE PRICES or any PART of the following WITHOUT NOTICE.

TERMS: CERTIFIED CHECK WITH ORDER.

DRI-POWR FREIGHT POLICY -- F.O.B. FACTORY.

Freight prepaid on 100-lbs. or over on scheduled1970 U.S. Tax Ct. LEXIS 193">*211 trucks when ordered at these prices by B Distributors.

B DIVISION

Effective: December 15, 1962

The distributors would order Dri-Powr products by filling out purchase orders in their own handwriting. The purchase order was set up so that the distributor, using the pricelist then in effect, would fill in column 1 of the purchase order designating the quantity, type of product, token denomination, and cost of the Dri-Powr products he desired to order. The cost figure in this column represented the total of the purchase price of the1970 U.S. Tax Ct. LEXIS 193">*212 Dri-Powr merchandise and the distributor's contribution to the trust. If the distributor desired that a larger token denomination be included in the cans, he used column 2 of the purchase order to compute the additional cost thereof (e.g., an additional $ 2 per case for 50-cent rather than 40-cent tokens). Column 3 of the purchase order was used to order advertising material (e.g., decals, displays, etc.) to be given to dealers for use at their service stations. The total amount shown in column I would be allocated between the company and the trust in accordance with the price sheet in effect 54 T.C. 460">*469 at that time. All amounts in columns 2 and 3 would go into the trust. The purchase order also allowed the distributor to treat the tokens he was turning in for redemption from the trust as the equivalent of money, and receive a credit for them against the total amount due the company and the trust.

The total amount due Dri-Powr Co. and the trust, after provision for credits for tokens redeemed, was paid by one check made out to and endorsed by Dri-Powr Co. Prior to 1962, the distributors had used two checks, one to Dri-Powr Co. for merchandise, the other to the trust for advertising; 1970 U.S. Tax Ct. LEXIS 193">*213 the distributors found this inconvenient and began to make out one check for the total amount, relying on the trustee or his agents to make the separation. As soon as the purchase order was received, the proper amounts to go into the trust were immediately calculated on the back of the order sheet and the proper journal entries made on the books of the trust. The total amount to the trust would be the agreed amount from the price sheets, plus any additional amounts that the distributor wished to contribute for extra benefits. The amounts to go to Dri-Powr Co. as the price for its merchandise were also immediately calculated on the back of the order sheet from the price sheets and the proper journal entries made on the books of Dri-Powr Co. The respective amounts were never commingled on the books of Dri-Powr Co. or the trust. During 1963 the amount allocated to the trust increased from 56 percent to 67 percent. As the volume of sales of Dri-Powr products increased during 1963, the company and later the corporation reduced the cost of Dri-Powr merchandise paid by the distributors.

Duplicate deposit slips were used to deposit the checks and cash received from the distributors, 1970 U.S. Tax Ct. LEXIS 193">*214 and the bank was instructed to deposit, and did so deposit, the respective amounts, which had been calculated previously, directly to the proper separate bank accounts, either the company bank account or the trust bank account. After the Dri-Powr Token Redemption Fund account was opened in November of 1962, funds would be transferred from the Dri-Powr Products Promotion Fund to the Dri-Powr Token Redemption Fund as needed to back up, dollar-for-dollar, the amount of tokens being issued. The respective amounts belonging to Dri-Powr Co. and the trust were known to the company, the distributors, and the trustee. The distributors determined the amounts they wished to contribute to the trust and Dri-Powr determined the price for its merchandise. These respective amounts were never commingled in the separate and distinct company and trust bank accounts.

The association did not have a formal minute book in 1962 and 1963, or any formal setup of officers, although there were certain distributors 54 T.C. 460">*470 who were considered the leaders of the association. The local distributor-members of the association met weekly in 1962 and 1963, during the implementation of the new token promotion. 1970 U.S. Tax Ct. LEXIS 193">*215 Often these meetings were recorded on tape. Distributors not attending meetings were kept informed by telephone or mail and by personal conferences with other distributors when they were in town, which was usually once or twice a year. No complaints were ever received from distributors that information was lacking, and none objected to the programs and promotions with which they were asked to cooperate.

The distributors were unconcerned about who were the authorized signatories on the various trust bank accounts or who attended to the mechanical and administrative detail incident to the operation of the trust. These duties they delegated to their trustee to take care of as he saw fit. Both Wynn and Richkind relied heavily on the employees of Dri-Powr Co. to attend to the detail for them, and they assigned various tasks to such employees. Wynn and other employees of Dri-Powr Co. remained authorized signatories on the trust bank account(s) after Mack Richkind succeeded Wynn as trustee, because they were readily available to sign checks every day, a necessity if the trust was to operate as envisioned.

The local distributors would usually visit the plant at least once a week to 1970 U.S. Tax Ct. LEXIS 193">*216 purchase their merchandise. They had requested that the books and records of the trust, the operation of which centered around the Dri-Powr plant, be always available at the plant for inspection. These distributors often made such an inspection. The distributors were not as interested in written accountings (which they in fact discouraged because they did not want information about the trust getting out to competitors) as they were with reviewing the canceled checks and bank statements of the trust bank accounts.

During the years in question, Richkind prepared annual accountings regarding the token program and other funds allocated and expended for general advertising, freight, and promotion. These were made available to the distributors for their review, but they expressed little interest in them, continuing to focus their attention on the canceled checks and bank statements to insure that the trust was being run properly. Richkind also initiated a voucher system to enable him to keep track of trust expenditures, and reviewed all checks and reconciled all trust bank statements.

From the creation of the trust in about 1957, through May 1, 1962, the distributors specified that 1970 U.S. Tax Ct. LEXIS 193">*217 the trust contributions be used only for the following purposes: General advertising and promotion, equalization of freight charges to all distributors, and miscellaneous expenses incident to the operation of the trust. After May 1, 1962, the beginning 54 T.C. 460">*471 date of the token promotion program, the specified trust purposes remained the same except that the redemption of tokens pursuant to the token program became an additional authorized purpose for the use of trust funds. No trust funds were ever expended for any other purposes than these. The distributors intended that the trust act as a conduit for the expenditure of their contributions as they specified. During the taxable years in issue, the only amounts received as contributions by the distributors that were not actually expended were the amounts set aside in the Dri-Powr Token Redemption Fund bank account. All other amounts received for general advertising, freight, postage, and miscellaneous expense were always completely expended by the end of the year of receipt.

During the period that Wynn was trustee of the trust, he received no compensation for his services, or for the time his employees or accountant devoted 1970 U.S. Tax Ct. LEXIS 193">*218 to trust administrative matters, nor did he receive any fees for the use of his company's plant and facilities for record-keeping, meetings, etc. The corporation likewise has received nothing from the trust in the way of payment for use of company facilities or personnel.

The following schedule, which was prepared by Richkind from the books and records of the trust, reflects the trust's token redemption experience during the years 1962 through 1968:

The trust conducted a survey of the inventory of tokens in the field awaiting redemption as of December 31, 1968, and found that 99.36 percent of all tokens ever issued could be accounted for (91.2 percent actually redeemed, 8.16 percent in the field awaiting redemption), and 0.641970 U.S. Tax Ct. LEXIS 193">*219 percent of all tokens issued have been unaccounted for.

Both the company and the trust have always maintained their books and filed their tax returns on an accrual basis with their taxable year as the calendar year.

54 T.C. 460">*472 Neither Wynn nor the trust reported the distributors' contributions as income on their Federal income tax returns filed for the years 1962 and 1963. Respondent made alternative determinations that the amount of such contributions less allowable deductions for token redemptions, advertising expenses, freight expenses, and postage expenses was taxable able either to Wynn or the trust.

OPINION

Respondent argues that the distributors' contributions to the trust during the period from January 1, 1962, to April 1, 1963, are taxable to Wynn as "Gross income derived from business" within the meaning of section 61(a)(2). ² Wynn contends that, if the trust funds constitute income to anyone, then they are income to the trust rather than himself.

1970 U.S. Tax Ct. LEXIS 193">*220 In support of his position that the trust contributions are taxable to Wynn, respondent mounts a two-pronged offensive. First, he contends that Wynn's sole proprietorship received the trust contributions under a claim of right and without restriction as to the disposition thereof, invoking the rule of North American Oil v. Burnet, 286 U.S. 417">286 U.S. 417 (1932). We cannot agree. In our view the claim-of-right doctrine has no proper application to the case at bar.

In order to explain fully the ratio decidendi compelling this conclusion, it becomes appropriate for us to consider the landmark case of 286 U.S. 417">North American Oil v. Burnet, supra. The facts of that case are that the United States held the legal title and claimed beneficial rights in various oil properties being operated by the taxpayer oil company. In 1916, during the course of proceedings instituted by the Government before the District Court to oust the company from possession of the oil lands, a receiver was appointed to operate such property and hold the net income derived therefrom. The Government's action was dismissed by the District Court in 1917, and in1970 U.S. Tax Ct. LEXIS 193">*221 that year the net profits for 1916 were paid by the receiver to the taxpayer. The Court of Appeals affirmed the lower court decision in 1920, and a further Government appeal to the Supreme Court was dismissed by stipulation in 1922.

The taxpayer reported the net profits paid to it by the receiver in an amended return for 1916. The Commissioner determined a deficiency on the basis that the net profits were taxable for the year 1917. The 54 T.C. 460">*473 taxpayer contended that the profits were properly reported in 1916, or alternatively should have been reported in 1922. It was conceded by the parties that the net profits constituted income to the taxpayer so that the only question for decision concerned the appropriate year of inclusion. The Supreme Court held that the profits were not reportable in 1916 since at that time they had not been received and might never be received by the taxpayer. The Court said that there was no constructive receipt of the profits in 1916 "because at no time during the year was there a right in the company to demand that the receiver pay over the money." The Court further held that the profits were taxable in 1917 and not in 1922, inasmuch as it was 19171970 U.S. Tax Ct. LEXIS 193">*222 when the company "first became entitled to them and when it actually received them." Justice Brandeis, delivering the opinion for the Court, then enunciated the oft-quoted claim-of-right rule:

If a taxpayer receives earnings under a claim of right and without restriction as to its disposition, he has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent. * * * [Citations omitted.]

At the outset, we note that the focus of the North American Oil case was on the narrow question of when income is reportable. Equitable Life Insurance Co. of Iowa v. United States, 340 F.2d 9, 14-15 (C.A. 8, 1965); and Growers Credit Corporation, 33 T.C. 981">33 T.C. 981, 33 T.C. 981">998 (1960). The question before us here is whether the trust receipts are income, and if so, who is the proper taxpayer. Hence, it would seem that the claim-of-right doctrine is entirely inapposite to the issue at hand. Nevertheless, some court decisions can be read as extending the scope of this judicial doctrine beyond1970 U.S. Tax Ct. LEXIS 193">*223 its original perimetry. See Lister, "The Use and Abuse of Pragmatism: The Judicial Doctrine of Claim of Right," 21 Tax L. Rev. 263 (1966). Therefore, we shall proceed to apply the elements of the doctrine to the facts of this case.

The following prerequisite elements must be shown before the claim-of-right doctrine becomes operative: (1) The taxpayer must receive income; (2) under a claim of right; and (3) without restriction as to its disposition. These fundamental factors have been present in those instances where this Court has seen fit to invoke the doctrine. See for example Bramlette Building Corp., 52 T.C. 200">52 T.C. 200, 52 T.C. 200">206 (1969), on appeal (C.A. 5, June 5, 1969); Fort Hamilton Manor, Inc., 51 T.C. 707">51 T.C. 707, 51 T.C. 707">721 (1969); Conlorez Corp., 51 T.C. 467">51 T.C. 467, 51 T.C. 467">471 (1968); Ralph E. Wilson, 40 T.C. 543">40 T.C. 543, 40 T.C. 543">548 (1963); and Arthur L. Kniffen, 39 T.C. 553">39 T.C. 553, 39 T.C. 553">569 (1962).

The facts of the instant case simply do not fall within the mold required to trigger the operation of the claim-of-right doctrine. First, assuming arguendo1970 U.S. Tax Ct. LEXIS 193">*224 that the trust contributions can be characterized 54 T.C. 460">*474 as income, it is not at all clear that either Wynn or the company received same. Respondent stresses the fact that the distributors made out a single check to the company covering both the Dri-Powr merchandise cost and the trust contribution, and that such check was endorsed by the company. However, the facts also show that immediately upon receipt of a distributor's check with a purchase order, certain Dri-Powr employees designated by Richkind would calculate the amounts due the company and the trust respectively in accordance with the information shown on the current price sheet, which sheet showed in separate columns the cost due the company for its merchandise and the contribution the distributors independently agreed should be made to the trust. The appropriate journal entries were then made on the separate books of the company and the trust, and duplicate deposit slips were prepared showing the respective amounts to be credited to the separate accounts of the company and the trust. The bank then credited to the company's account only that portion of the deposit representing the sales price of Dri-Powr merchandise, 1970 U.S. Tax Ct. LEXIS 193">*225 and then credited the balance representing the distributor's trust contribution directly to the trust's separate account. Thus, the amounts due the trust went directly from the distributor's checking account to the trust's bank account without ever passing through the company's account. In view of this, it is difficult for us to see how it can be said that Wynn or the company either actually or constructively received the distributors' contributions to the trust.

However this may be, it is patent in the record before us that Wynn never asserted a claim of right to the trust funds. As the Supreme Court said in Healy v. Commissioner, 345 U.S. 278">345 U.S. 278, 345 U.S. 278">282 (1953): "There is a claim of right when funds are received and treated by a taxpayer as belonging to him." The record is barren of any evidence that Wynn ever treated the association's funds as belonging to himself or the company. Indeed, there is credible testimony from Richkind and the three Dri-Powr distributors that at no time did Wynn divert the trust funds to his own use or benefit or that of the company.

Finally, it naturally follows from the foregoing discussion that in our view Wynn did not1970 U.S. Tax Ct. LEXIS 193">*226 have unfettered control over the disposition of the amounts in the trust. Respondent disputes this by pointing out that, while the total amount paid by the distributors during 1963 did not change, the portion thereof going to the trust increased during 1963 from 56 percent to 67 percent with the result that proportionately smaller percentages were being deposited in the company account. Respondent finds it inconceivable that the distributors could be unilaterally determining the percentage contributed to the trust when the practical effect was to reduce Wynn's profit margin on Dri-Powr 54 T.C. 460">*475 merchandise. However, Wynn gave a reasonable and credible answer to this when he testified that the company and corporation reduced its merchandise prices in 1963 when the sales volume of Dri-Powr products increased. Possibly, the token program increased Dri-Powr sales enabling Wynn and the corporation to reduce its profit margin per case of merchandise.

Respondent also intimates on brief that the distributors could not have known how much money was being allocated to the trust and the company, respectively. The facts belie this. The distributors prepared the purchase orders themselves1970 U.S. Tax Ct. LEXIS 193">*227 from the price sheets which broke down the respective amounts due to the trust and the company. Moreover, the books and records of the company and the trust were open for the distributors' inspection. Also available to them were detailed schedules prepared by Richkind showing for each individual distributor the amount per transaction going to the company, the amount to the trust, and a further breakdown of the trust contribution showing the various sums for token redemption, freight, advertising, etc.

It follows from the foregoing discussion that we deem the Supreme Court's decision in 286 U.S. 417">North American Oil v. Burnet, supra, inapplicable to the facts herein.

The second prong of respondent's effort to include the distributors' contributions in Wynn's gross income is his argument that the trust lacks validity. He questions whether the declaration of trust is reasonably certain with respect to its material terms (e.g., as to the subject, purpose, and beneficiary of the trust) as required under local (California) law, citing Simpson v. Simpson, 80 Cal. 237">80 Cal. 237, 22 P. 167 (1889), and Cal. Civ. Code secs. 1970 U.S. Tax Ct. LEXIS 193">*228 2221, 2222 (West 1954). From the premise that a valid trust was never created, respondent reasons that it follows that the association's bank accounts were in reality nothing more than separate bank accounts maintained by the company as reserve funds for the payment of freight, advertising, and promotion expenses, and for the redemption of tokens contained in Dri-Powr merchandise.

In view of the convincing state of the record before us, we are constrained to take a contrary view. From 1940 when Wynn first began making agreements with various distributors until the date of trial, Wynn and subsequently the corporation had a standing requirement ³ that the distributors (who were independent contractors in business for themselves and not employees of Wynn or the corporation) must 54 T.C. 460">*476 pay for all freight, f.o.b. plant, and arrange and pay for all advertising and promotion of Dri-Powr products. This long-standing company policy provided the impetus for the distributors to band together and form the association to achieve the benefits of sharing freight costs and conducting a unified advertising campaign. To this end, the distributor members of the association opened their own1970 U.S. Tax Ct. LEXIS 193">*229 separate bank account; set up a trust fund for the pooling of their funds; and requested Wynn to act as trustee of their fund. Upon being approached by the distributors regarding the token program proposal, Wynn asked to be relieved of his duties as trustee, and Richkind gradually became the distributors' choice to succeed Wynn as trustee.

The local distributors met weekly during the years in issue. Out-of-town distributors would only attend meetings once or twice a year, but were kept informed by Richkind and the distributors of the decision made by the other distributors in these meetings. The distributors determined the amounts that would 1970 U.S. Tax Ct. LEXIS 193">*230 be contributed to the trust and the purposes for which such contributions would be expended (e.g., freight, advertising, product promotion, and token redemption). Wynn, and later Richkind, administered the trust in accordance with the instructions of the distributors, and solely for the benefit of the association and its members.

Admittedly, the history and development of the trust was not quite as neat and tidy as the foregoing summary may suggest. The association did not have a formal minute book, or any formal setup of officers during the years involved herein. There was no written declaration of trust ⁴ and Wynn and Richkind were not formally elected or appointed by written document to assume the duties of trustee. Wynn and Richkind did not make a formal acceptance of the duties of trustee, but instead gradually assumed such duties through their words, acts, and course of conduct.

1970 U.S. Tax Ct. LEXIS 193">*231 Nevertheless, we do not understand California law to require formalism as a precondition to the creation of a valid trust. The California courts have upheld the creation of a trust under immeasurably less formal circumstances. See Weiner v. Mullaney, 59 Cal. App. 2d 620">59 Cal. App. 2d 620, 140 P.2d 704, 710-711 (1943) (intention to create a trust inferred from acts subsequent to an informal declaration); and In Re Hovland's Estate, 38 Cal. App. 2d 439">38 Cal. App. 2d 439, 101 P.2d 500, 503-504 (1940) (intention to create trust inferred from course of conduct and surrounding circumstances). 54 T.C. 460">*477 Under California law, an express trust in personal property need not be in writing, but instead may be created, declared, or admitted verbally and may be proved by parol evidence. Lefrooth v. Prentice, 202 Cal. 215">202 Cal. 215, 259 P. 947, 952 (1927); and Cal. Civ. Code sec. 2222 (West 1954). It also appears that formal appointment of a trustee is not necessary under California law inasmuch as section 2219 of the California Civil Code simply provides that "Every one who voluntarily assumes1970 U.S. Tax Ct. LEXIS 193">*232 a relation of personal confidence with another is deemed a trustee." Furthermore, it is not necessary that the trustee specifically accept the terms of the trust for any act or conduct on his part which indicates with reasonable certainty that he understands and accepts the terms thereof is sufficient. Cooper v. Cooper, 3 Cal. App. 2d 154, 39 P.2d 820, 823 (1934). Finally, as our earlier review of the facts surrounding the creation of the trust shows, there can be no question but that reasonable certainty was present as regards the material terms of the trust (i.e., the intention of the distributors to create a trust; Wynn's and Richkind's acceptance of the trust; and the subject, purpose, and beneficiary of the trust) in accordance with the provisions of sections 2221 and 2222 of the California Civil Code, which provisions are set forth in the margin. ⁵

1970 U.S. Tax Ct. LEXIS 193">*233 In essence, respondent's contention that the trust lacks validity asks us to view the trust as a sham and to attribute the distributors' contributions thereto to Wynn. To do so we would have to ignore the credible testimony of five witnesses (i.e., Wynn, Richkind, and three Dri-Powr distributors) to the effect that the trust was made of real substance. This we are not prepared to do. Painstaking perusal of the record convinces us that the trust was indeed a living, breathing, viable entity.

Based upon the foregoing, we hold that no portion of the amounts contributed by the distributors to the trust is includable in Wynn's gross income.

Respondent makes the alternative argument that if, as we have determined, the trust contributions are not income to Wynn, then a 54 T.C. 460">*478 fortiori they constitute income to the trust. The trust concedes that it is an association taxable as a corporation within the purview of section 7701(a)(3). Nevertheless, the trust contends that the distributors' contributions were not income either to it or anyone else. We agree with the trust. In our view, the trust acted as a mere depository1970 U.S. Tax Ct. LEXIS 193">*234 of the distributors' contributions and as a conduit for the expenditure thereof in accordance with the distributors' instructions. Consequently, we consider our decisions in Seven-Up Co., 14 T.C. 965">14 T.C. 965 (1950), and its progeny to be controlling of the instant case.

In the Seven-Up Co. case, the taxpayer manufactured and sold 7-Up extract to various franchised bottling companies (hereinafter referred to as bottlers). The bottlers bought their own sugar, made their own syrup, and manufactured and sold the bottled beverage known as 7-Up. The taxpayer gave each bottler an exclusive territory, and each bottler carried on his own sales promotion and local advertising within his respective territory. The bottlers initiated discussions among themselves concerning the inauguration of a national advertising program and the establishment of a trust fund since they anticipated having to pay the cost of any such program. An advertising agency familiar with the bottlers' problem presented to the taxpayer, and subsequently to the bottlers, an advertising program, which program was eventually adopted by a majority of the bottlers. The advertising program as adopted1970 U.S. Tax Ct. LEXIS 193">*235 called for a "pay as you go" plan wherein each bottler agreed to pay $ 17.50 per gallon of extract (over and above the prevailing price of the extract) to be billed at the time of purchase.

The 7-Up bottlers had no central organization of their own and the advertising agency therefore recommended that the bottlers make their contributions to the taxpayer company since the agency had no facilities for handling the bottlers' contributions. Before selecting and placing the advertising, the advertising agency discussed its selections and the cost thereof with officers of the taxpayer who served as custodians of the fund. Periodic reports were also made directly to the bottlers by the advertising agency. Although the bottlers' contributions to the national advertising fund were not segregated in a separate bank account, they were segregated and earmarked on its books, and such books remained open for the bottlers' inspection. Due to the fact that the advertising agency was only able to secure a limited amount of desirable advertising space, all of the moneys in the national advertising fund were not expended at the end of the taxable years in issue. The Commissioner included the excess1970 U.S. Tax Ct. LEXIS 193">*236 of the bottlers' contributions over the advertising expenditures in the taxpayer's income.

The close parallel between the facts involved in the Seven-Up Co. case and the instant case is striking. We are unable to discern any 54 T.C. 460">*479 material differences. In this case, just as there, the distributors were expected to pay their own advertising expenses; a trust was set up to handle the pooled funds of the distributors; the company's facilities and employees were used for convenience in the administration of the fund; the amounts belonging to the trust were meticulously segregated on the books and records at all times; and finally such records were always open for the inspection of the distributors. If anything, the facts herein are stronger since a practicing C.P.A. (although he was the company's C.P.A. and an officer of the company) rather than the company served as trustee and the funds were segregated in separate bank accounts.

In the Seven-Up Co. case we expressed our rationale and conclusion as follows:

The respondent has determined that the amounts received by petitioner from the bottlers in each of the taxable years should be included in gross income and the amounts1970 U.S. Tax Ct. LEXIS 193">*237 expended for advertising should be taken as deductions. The effect of such a determination is to charge petitioner with a gain or profit to the extent of the excess of receipts over expenditures. But petitioner did not receive the bottlers' contributions as its own property. They were burdened with the obligation to use them for national advertising. No gain or profit was realized on their receipt because of this offsetting obligation. All of the relevant facts and circumstances convince us that the respondent erred in including the payments made by the bottlers in petitioner's gross income for the taxable years, and we so hold. [14 T.C. 965">14 T.C. 979]

Similar considerations compel us to reach the same conclusion in this case. Pursuant to the instructions of the distributors, all of the money received by the trust for general advertising, freight, postage, and miscellaneous expense were always completely expended by the end of the year of receipt. The only amounts received from the distributors as contributions that were not actually expended by yearend were the amounts set aside in the Dri-Powr Token Redemption Fund account awaiting the return of the issued1970 U.S. Tax Ct. LEXIS 193">*238 but still outstanding tokens. It was absolutely essential to the success of the token program that this account at all times contain sufficient funds to redeem dollar-for-dollar the outstanding tokens. The end result of the respondent's determination herein is to charge the trust with a gain or profit to the extent of the amounts residing in the Dri-Powr Token Redemption Fund account at the end of each of the years at issue. But in reality no gain or profit was realized by the trust on these amounts for they were burdened with the obligation of redeeming outstanding tokens of offsetting amounts. Thus, all of the relevant facts and circumstances of this case convince us that the trust was a mere depository of the distributors' contributions and a conduit for the expenditure of such funds. The distributors restricted the purposes for which the trust funds 54 T.C. 460">*480 could be expended to freight, product advertising and promotion, postage, token redemption, and limited miscellaneous expenses. Richkind and Wynn followed the instructions of the distributors, and no trust funds were expended for any other than the authorized trust purposes. It is not the mere possession of receipts1970 U.S. Tax Ct. LEXIS 193">*239 that creates income, but rather the unfettered control over their disposition; the trust never had such dominion.

Our decisions in Broadcast Measurement Bureau, Inc., 16 T.C. 988">16 T.C. 988 (1951), and Angelus Funeral Home, 47 T.C. 391">47 T.C. 391 (1967), affd. 407 F.2d 210 (C.A. 9, 1969), also strongly support our conclusion herein. The case of Krim-Ko Corporation, 16 T.C. 31">16 T.C. 31 (1951), relied upon by respondent was distinguished in 16 T.C. 988">Broadcast Measurement Bureau, Inc., supra, at 1002, as follows:

Our decision in the recent case of Krim-Ko Corporation, 16 T.C. 31">16 T.C. 31, is similarly distinguishable on the facts. Taxpayer there was a profit-making concern. It had not undertaken to return the unexpended sums it received from some of its customers for the purpose of furnishing designated advertising materials and services. Its agreements with customers did not place any restriction on the use of any amounts received by it for advertising, nor indicate in any way it was to act as a trustee.

The same characteristics are equally applicable1970 U.S. Tax Ct. LEXIS 193">*240 to distinguish that case from the instant one.

Based upon the foregoing, we hold that the distributors' contributions are not taxable to the trust. In view of this holding, we do not find it necessary to pass upon the question of whether a deduction is allowable for the amounts retained in the trust for the anticipated redemption of tokens. Accordingly,

Decisions will be entered for the petitioners.