## Facts

- A French citizen temporarily admitted to the United States as a nonimmigrant held roughly $300,000 in U.S. marketable securities in New York and was not engaged in U.S. business.
- Relying on financial advice, she decided to establish two trusts of about $100,000 each for her two minor children, with a New York trust company as trustee.
- A trust officer advised that converting assets into certain U.S. government obligations could allow use of a regulatory gift-tax exemption for qualifying gifts by nonresident aliens of specified federal obligations issued before March 1, 1941.
- In January 1941, the trustee-custodian sold some of her securities and purchased U.S. Treasury notes costing about $189,986.58 in the aggregate.
- On January 22, 1941, she executed two trust instruments and transferred Treasury notes of approximately $100,000 principal amount to each trust.
- After the trusts were created, the trustee sold the Treasury notes on several occasions and reinvested the proceeds into higher-yielding, diversified, nonexempt securities.
- The Tax Court found that the purchases, trust funding, and subsequent sales/reinvestment were carried out pursuant to a prearranged plan to convert the notes into nonexempt investments for the beneficiaries.
- The Commissioner determined a gift-tax deficiency, treating the transfers as taxable gifts rather than exempt gifts of federal obligations; the Tax Court sustained the deficiency.

## Issues

1. Whether transfers in trust of U.S. Treasury notes qualified for the nonresident-alien gift-tax exemption for certain federal obligations when the notes were acquired shortly before transfer and promptly sold under a prearranged reinvestment plan.
2. Whether, under a substance-over-form analysis, the true subject of the gift was the nonexempt property the trustee was intended to acquire rather than the exempt Treasury notes temporarily held.

## Decision

- The Second Circuit affirmed the Tax Court’s decision sustaining the Commissioner’s deficiency determination.
- The court held the Commissioner and Tax Court were justified in concluding the transfers were not exempt gifts of Treasury notes.
- Based on the prearranged plan finding, the court treated the transactions as taxable gifts of nonexempt property the notes were intended to be converted into.
- The court accepted the Tax Court’s factual finding of a prearranged plan as supported by the record and declined to disturb it on appeal.

## Legal Principles

- Tax consequences may be determined by the substance of a transaction rather than its formal steps, particularly where intermediate steps are used to obtain an exemption inconsistent with the transaction’s economic effect.
- A regulatory exemption for gifts of specified U.S. government obligations to which a nonresident alien would otherwise be entitled does not apply when the obligations serve as a temporary conduit in a prearranged plan for prompt sale and reinvestment in nonexempt property.
- When a transfer of exempt obligations is integrated with an intended, near-immediate conversion into other assets for the beneficiaries, the “subject matter” of the gift may be characterized as the assets intended to be acquired, not the briefly held exempt obligations.
- Appellate review gives substantial deference to the Tax Court’s supported findings of fact, including findings that a plan was prearranged.

## Conclusion

The court upheld gift-tax liability because the Treasury notes were used as a short-lived step in a prearranged scheme to place nonexempt, income-producing securities into trust; the exemption for gifts of certain federal obligations to nonresident aliens did not apply to that integrated transaction.


De Goldschmidt-Rothschild v. Commissioner, 168 F.2d 975 (2d Cir. 1948)