Explanation Howard Hughes Exploitation of Charitable Trusts PDF

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LWZ011 Trusts Observations on the Practical Significance of Charitable Trusts The Howard Hughes Jnr. Factor Let me take you on a short historical journey which is a breathtaking study in the accumulation of wealth. This is not a work of original research but rather a collection of anecdotes garnered from the press over the years which, without a lawyer’s insight, might have painted Mr Hughes, in the eyes of an unqualified observer, as being a generous philanthropist. As the American Wild West was dying, in the latter years of the 19th century, a very vibrant mining industry developed in the western states. Nevada, Arizona and California had a significant range of gold, silver, lead and copper mines from the 1890s onward. Howard Hughes Snr., a Texan mining engineer (who was later to become the father of the Howard Hughes - the world-famous billionaire recluse) was active in that mining industry. He patented and produced some significant industry tools the main one of which was a drill bit for use in drilling for oil in inaccessible places. He established the Hughes Tool Company in 1909. It was a successful company that had respectable financial substance but it was by no means a commercial colossus. Howard Hughes Snr died in 1924, leaving his son Howard Hughes Jnr. as his only heir. The young Howard Hughes was then under age but he was given permission by the Courts to succeed to the estate, at the age of 19, under a special American status known as "Emancipated Minor". Hughes Jnr had a keen interest in anything mechanical and quickly filled his father's shoes in industry. However his interests were much wider than engineering. Between 1925 and 1955 he built one of the world's great fortunes in a diversity of industries. In the 1940s and 1950s, his RKO Pictures was Hollywood's major studio. He created stars and blockbuster movies. Jane Russell is still remembered for her starring role in his film "The Outlaw". Hughes is credited with having perfected the engineering principles that are the fundamental basis on which the lingerie industry has modelled the female brassiere, ever since. He designed it in the late 1940s to show off Miss Russell’s natural attributes. In the 1930s and 1940s, his RKO Radio network dominated the amusement and advertising industries over the entire continental United States. In the early 1930s he established an aircraft manufacturing enterprise, Hughes Aircraft, which was responsible for leading edge aero-technology in the rearmament era prior to the Second World War. His designs and innovations are reputed to have been the inspiration of fighter planes used by Germany and Japan in that conflict. In the 1940s, Hughes Aircraft designed and a transport aircraft, the H-4 Hercules seaplane (known as the "Spruce Goose") which, with a wingspan of 100 m, remains to this day credited with being the world's largest aircraft ever to fly. It was

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capable of carrying 700 fully equipped infantry soldiers. In the 1940s he also established Trans World Airlines (TWA) which remained a premium air passenger carrier until the early 1980s. The crown of his achievements was "the Howard Hughes Medical Institute". At the time of his death this entity had a net worth of $16 billion. But just how did this 19 year old young man become a Titan of United States business and industry by the early 1930s (a mere five years after his late father's death)? Obviously it was partly for reasons related to his innate talents and willingness to work hard. He also got off to a good start with the capital base of his inheritance from his father. But is that the whole explanation? Except for his motion pictures, the products that Hughes produced were not suitable for universal consumption. Howard Hughes was no Bill Gates in that he was not producing commodities that were universally purchased throughout the world. He was in heavy industry and, for many years of his commercial life most industry was in recession because of the Great Depression of 1929 - 1940. Other people inherit capital, have talent and energy, and yet cannot grow those advantages to the point where they are world figures. The explanation for Howard Hughes' accumulation of enormous wealth, in such a remarkably short period of time (within five years of his inheritance he was one of the major figures in the United States), lies in income-tax. He did not pay any. In a normal environment, the more money one makes, the more tax one has to pay. That factor is usually a significant impediment to economic growth and the accumulation of savings. Hughes applied his creative genius to overcoming that retarding factor. At that time, United States state and federal law exempted the earnings of charitable institutions from liability to tax (and continue to do so; but in a modified form). Hughes exploited that hiatus in the financial appetite of his regulatory environment. To give you a technical insight as to how he did that, I can only rely on speculative sources. Neither he nor his successors have shared with observers like myself the precise details as to how he actually achieved a situation whereby he virtually paid no tax on anything that he earned. My information is that it went something like this. Hughes established a corporation that was intended to serve as a trustee. For identification purposes, in this discussion, I will call it "the Foundation". He settled money on the Foundation as a trust. The purpose of the trust was for the Foundation to devote the trust fund to medical research for the improvement of medicines and cures for serious illnesses. On anyone's definition such objectives are charitable and they were recognised as such by the Revenue authorities of the State and Federal governments of the United States. Hence the Foundation was exempt from income, and other, taxes.

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One would think that such a situation is no more than what would be appropriate in the circumstances; but, there was a refinement of very great commercial significance. The Foundation, once established, acquired the share capital in all of Hughes' commercial enterprises. Thus when the motion picture studios made multi millions of dollars per annum, all of that profit went to the Foundation, as the only shareholder. There was a similar position in relation to the aircraft plant, the airline, Hughes Tool Company and anything else in which this dynamic young tycoon was involved. Those circumstances had the result that none of the earnings of Hughes's enterprises were subject to income, or any other, taxes. There may be those who would think: "What a remarkably generous man! Fancy that, he gives all of the income of all of his enterprises to charity. He must be a saint." Then on the other hand there would be those who would ask: " What was he up to?" The sentiments of the second group are the more realistic. In the main, Hughes was able to have his cake and to eat it also. How was that done? The Foundation became the banker for all of Hughes' enterprises. That is, any funds required by those enterprises for expansion and development were loaned back from the Foundation to the operating entities. A provision in the trust deed enabled that to occur without a breach of trust. Moreover, the trust deed was crafted in a manner that enabled the Foundation, as trustee, to "cover the expenses" of key participants in the administration of its trust. So, for practical purposes, Mr Hughes required no income. All of his expenses were covered by the Foundation. It only takes a subjective definition of the concept of “expenses” to create a situation where the person who set up the “charitable trust” has all the spending money that they may wish for. All of Hughes businesses had the added competitive advantage of being able to retain 40% more of their earnings (the component normally diverted to taxes) than their competitors could. This created a corporate machine that was financially unstoppable thanks in large measure to the generosity of the US taxpayer. 24 August 2009 Kind Regards Geoff James Lecturer in Law, Charles Darwin University

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