Were nonresident members taxable on shares of a family securities fund actively traded in California by a resident agent with broad discretion?

Plain-English summary

California Legal Ruling 179 held that nonresident members of a family securities fund were taxable on their distributive shares because they conducted a California trade or business through their resident agent.

The fund was not treated as a passive account holding securities for long-term appreciation and income. The resident manager had nearly uncontrolled discretion, securities were bought and sold with reasonable frequency for short-term profit, and management was integrated with his California law office.

Facts addressed by the ruling

Six siblings pooled assets, principally corporate stocks, to create a family investment business in 1947.

Their agreement designated each member as a principal and X, one brother, as agent for management. X had practically uncontrolled discretion over management and investment.

No member was a California resident when the fund began. Later, X and two other members became California residents.

Most securities sold were acquired after X became a resident and were sold within one or two years, despite paying substantial regular dividends. The fund was also charged half of the expenses of X's law office.

Historical California rule for intangible income

The ruling described former regulation 17211-17214(f) as taxing a nonresident's intangible-property income when either:

1. the property was employed as capital or localized in a California business so that it acquired a California business situs; or
2. the nonresident bought or sold stocks, bonds, or other property with enough regularity to constitute doing business in California, regardless of the property's situs.

FTB relied on the second branch and on the resident agent's activities.

Trading business versus investment account

The ruling drew a line between:

• extensive, reasonably frequent securities transactions aimed at short-term profit; and
• an investment account holding securities for capital appreciation and income.

Under the cited federal cases, a nonresident could be engaged in a trade or business through a resident agent who actively managed the account.

The fund's one-to-two-year holding periods contrasted with the 5.8-year average holding period in the passive-investment case cited by the ruling.

Why the nonresidents were taxable

FTB viewed the fund's activity as trading rather than investing because of:

• X's broad agency authority;
• recurring securities purchases and sales;
• the relatively short holding periods;
• the stated short-term profit objective; and
• integration of management with X's California law office.

The nonresident principals were therefore engaged in a California trade or business through X and taxable on their distributive shares.

What this means for you

Nonresident investors

Under the historical ruling, owning intangible property did not automatically keep income outside California tax. Active California trading conducted by an authorized resident agent could connect the nonresident principals to a California business.

Family investment funds

The operating agreement, manager's discretion, transaction frequency, holding periods, objectives, and payment of office expenses all affected whether the arrangement was a trading business or passive investment.

Accountants and tax professionals

Document agency authority, decision location, trade frequency, holding periods, income objectives, shared expenses, and each member's residence. Apply current statutes and regulations before reaching a sourcing conclusion.

Common questions

Q: Were the nonresident members taxable on their fund shares?

A: Yes, under the ruling's conclusion that they conducted a California trade or business through X.

Q: Did the intangible nature of the stocks prevent California taxation?

A: No. The historical rule taxed intangible income tied to a California business or regular California trading activity.

Q: How much authority did X have?

A: The ruling describes his management and investment discretion as practically uncontrolled.

Q: What distinguished trading from passive investment?

A: Extensive and reasonably frequent transactions for short-term profit, compared with holding securities for appreciation and income.

Q: Why did the law-office expenses matter?

A: Charging half of X's office expenses to the fund supported FTB's view that management was integrated with a California business operation.

Citations and references

• Former California regulation 17211-17214(f)
• Internal Revenue Code of 1939 § 211(b)
• Adda v. Commissioner, 10 T.C. 273, aff'd, 171 F.2d 457
• Chang Hsiao Liang v. Commissioner, 23 T.C. 1040

Source

• Landing page: California FTB Legal Rulings
• Official HTML: Legal Ruling 179

Original ruling text

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California Franchise Tax Board Legal Ruling 1956-179 February 17, 1956

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.

Nonresidents: Income From Intangibles

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.

Last updated: 09/24/2025