The facts speak for themselves. It would give undue dignity to petitioners' claims to belabor them or to repeat here what this Court and others have had to say about comparable situations in which we have repudiated "the right to engage in financial fantasies with the expectation that the Internal Revenue Service and the courts will play along." Saviano v. Commissioner,765 F.2d 643">765 F.2d 643, 654 (7th Cir. 1985), affg. 80 T.C. 955">80 T.C. 955 (1983).

"The long and short of it all is that the parties demeaned themselves in entering so dishonest a venture, unquestionably structured to garner for each of the taxpayers tax advantages to which they were not entitled and devoid of any realistic business purpose. * * * [Barnard v. Commissioner,731 F.2d [230] at 232 (4th Cir. 1984), affg. Fox v. Commissioner,80 T.C. 972">80 T.C. 972 (1983).]*605 "

See also Elliott v. Commissioner, 84 T.C. [227] at 247-248 [(1985), affd. without published opinion at 782 F.2d 1027">782 F.2d 1027 (3d Cir. 1986)]. [Harmon v. Commissioner,T.C. Memo. 1986-305, 51 TCM 1491 at 1498-1499, 55 P-H Memo par 86,305 at 86-1315, 86-1322 - 86-1323.]

In other cases, the master recordings in issue featured well-known artists as contrasted to the unknowns involved in AEL's program. Even in such circumstances we have indicated that meritless proceedings, where there is a total lack of support for the excessive values claimed, as so groundless as to justify an award of damages under section 6673. Hawkins v. Commissioner,T.C. Memo. 1987-233; see McCain v. Commissioner,T.C. Memo. 1987-285; Secoy v. Commissioner,T.C. Memo. 1987-286; Grace v. Commissioner,T.C. Memo 1986-304">T.C. Memo. 1986-304. ^{*606 If the question of profit objective had been the only issue at the time of trial as petitioners contend, this case might have been the subject of an oral opinion under Rule 152, Tax Court Rules of Practice and Procedure. Because of the procedural questions raised by petitioners, the opportunity left to petitioners to move to reopen the record for further expert testimony, and the status of this case as one to which other parties represented by petitioners' counsel will be bound, deferred and more comprehensive factual findings and opinion are appropriate.}

Economic Substance

In Rose v. Commissioner,88 T.C. 386">88 T.C. 386 (1987) we defined a generic tax shelter as having the following characteristics:

(1) Tax benefits were the focus of promotional materials; (2) the investors accepted the terms of purchase without price negotiation; (3) the assets in question consist of packages of purported rights, difficult to value in the abstract and substantially overvalued in relation to tangible property included as part of the package; (4) the tangible assets were acquired or created*607 at a relatively small cost shortly prior to the transactions in question; (5) the bulk of the consideration was deferred by promissory notes, nonrecourse in form or in substance. * * * [88 T.C. at 412.]

All of those characteristics are present here.

Under the analysis adopted in Rose, we conclude that the AEL lease program had no economic substance. The dealings between the lessees and AEL were based on promises of unrealistic tax benefits, lacked arm's-length price negotiation, and were not accompanied by any significant pre-transaction, investigation or post-transaction efforts to effectuate the distribution of the master recording. The claimed $ 186,000 sales price (between IHI and AEL) had no relation to the fair market value of the master, which was not more than $ 300. The master recording was produced after execution of the lease for a cost of approximately $ 300.

Because of the purported pass-through of the investment tax credit to the lessee from AEL, the relevant structure of the financing is the $ 185,000 note given by AEL to IHI. Bond and Kahn testified that approximately $ 200,000 had been paid to IHI in 1982 in relation to 600 or 700 tapes.*608 Otherwise, no payments had been made on the notes. The lack of reality to the notes and the lack of relationship between the notes and the fair market value is demonstrated by the following testimony of Kahn:

Q Okay. Now, you testified about the promissory notes in the amount of $ 185,000. Did you - what type of negotiations went on between yourself and Mr. Schwartz about setting that price?

A A precedent had been set. In 1981, my having produced through Western Educational Services approximately seven hundred, six-eighty-five, or seven something, seven hundred units for them, at a price, an average price of one hundred and eighty, or eighty-five thousand dollars.

Q Now, when you say average price, you mean you were given promissory notes:

A Yes. So --

A Just the down payment. I was never paid the balance of the note and it's still accruing. They're also -- there were 12-year notes.

Q Now, based on the promissory note that you had received, or that -- the promissory notes that you were getting in conjunction with EMC, how did that enter into your negotiations with Mr. Schwartz, in regard to American Educational Leasing and IHI?

A Well, it was a very important part*609 of our initial negotiations because I already had a price established and I also had a routine established, having been the President of Western Educational Services; I had effectively run all of the routines that were necessary to begin production for his company. So, that's where the prices come from.

Q Did the amount of the promissory note in 1983 go down?

A Yes, it did.

Q And what amount did -- were the promissory notes given to you in 1983?

A I believe the gentleman mentioned -- I don't remember the exact -- it might have been one-sixty or --

Q Was it one-sixty-five?

A I think it was that, yes. And it was --

Q And, how -- what was the reason for --

A Well, it was Mr. Schwartz' position that he was the best customer I had and that he should get a discount in quantity, and we argued over this early on in the negotiations of 1983, and finally, I really didn't have a choice because he was my biggest customer at the time, and I agreed.

The unavoidable conclusion from the evidence is that the notes bore no relationship to fair market value and would never be paid. There was absolutely no consideration of the merits or values of particular titles. Thus the "recourse" *610 label on the notes must be disregarded as mere form without substance.

The final factor analyzed in Rose in determining whether a transaction has economic substance is perceived congressional intent is to impose the sanctions discussed below on taxpayers who engaged in transactions of the sort promoted by AEL.

Because petitioners' lease transaction is totally lacking in economic substance, petitioners are not entitled to any deductions or investment tax credit.

Additions to Tax and Additional Interest

Petitioners have failed to satisfy their burden of proving that the underpayment of tax in 1982 relating to the master recording activity is not due to negligence or intentional disregard of rules and regulations. They did not rely on anyone having expertise in the recording industry, and the promises of Mattingly, the sales agent for AEL, were simply too good to be believed. As the Court of Appeals for the Ninth Circuit stated in another tax shelter context, "no reasonable person would have trusted this scheme to work." Hanson v. Commissioner,696 F.2d 1232">696 F.2d 1232, 1234 (9th Cir. 1982). The addition to tax for negligence must be sustained.

Petitioners claimed*611 on their returns a "passed through" adjusted basis of $ 186,272 and an investment tax credit of $ 18,627, $ 6,853 of which was used in 1982. With respect to a lease, section 48(d)(1) limits the amount eligible for the investment tax credit to the fair market vallue of the property acquired by the lessee. In this case, we have concluded that the property had a fair market value of not more than $ 300. We have also concluded that the transaction so lacked economic substance that the correct adjusted basis for purposes of the investment tax credit is zero. See Zirker v. Commissioner,87 T.C. 970">87 T.C. 970, 978 (1986).

Section 6659 provides in pertinent part:

(a) Addition to the Tax. -- If --

(1) an individual, or

(2) a closely held corporation or a personal service corporation,

has an underpayment of the tax imposed by chapter 21 for the taxable year which is attributable to a valuation overstatement, then there shall be added to the tax an amount equal to the applicable percentage of the underpayment so attributable.

(b) Applicable Percentage Defined. -- For purposes of*612 subsection (a), the applicable percentage shall be determined under the following table:

If the valuation claimed is
the following percent of the	The applicable
correct valuation --	percentage is:
150 percent or more but
not more than 200 percent	10
More than 200 percent but
not more than 250 percent	20
More than 250 percent	30

(1) In general. -- For purposes of this section, there is a valuation overstatement if the value of any property, or the adjusted basis of any property, claimed on any return is 150 percent or more of the amount determined to be the correct amount of such valuation or adjusted basis (as the case may be).

(2) Property must have been acquired within last 5 years. -- This section shall not apply to any property which, as of the close of the taxable year for which there is a valuation overstatement, has been held by the taxpayer for more than 5 years.

In the statutory notice, respondent applied the 30 percent addition to tax to the total amount attributable to the master recording activity. The disallowed investment tax credit is correctly*613 subjected to section 6659(a). The deductions other than the investment tax credit, however, are not attributable to a valuation overstatement. See Zirker v. Commissioner,87 T.C. at 980-981. The correct amount of the addition to tax under section 6659, therefore, is 30 percent of $ 6,853, or $ 2,055.90.

Finally, in the statutory notice, respondent determined that additional interest under section 6621(d), now section 6621(c), would apply to the sum of $ 7,354, including $ 6,853 disallowed investment tax credit. The disallowed investment tax credit was attributable to a valuation overstatement and thus accrues additional interest under section 6621(c)(3)(A)(i).

The balance of the underpayment attributable to petitioners' master recording activity results from disallowance of the deductions for amortization of the lease payment and the distribution fee and advertising expenses paid. The underpayment attributable to these deductions is subject to additional interest under section 6621(c) for either of two reasons.

First, because we have found that petitioners did not have an actual and honest profit objective, the deductions are not allowed pursuant to section*614 183. Temporary Regulations adopted on December 26, 1984, pursuant to section 6621(d)(3)(B) [now section 6621(c)(3)(B)] applicable to interest accruing after December 31, 1984, state that "any deduction disallowed for any period under section 183" is subject to additional interest. Sec. 301.6621-2T, A-4(1), Proced. & Admin. Regs. (Temporary), 49 Fed. Reg. 59394 (Dec. 28, 1984). See Rose v. Commissioner, supra at 427.

Second, section 1535 of the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085, 2750, amended section 6621(d) [redesignated as section 6621(c) by the Act] to include in the list of tax-motivated transactions "(v) any sham or fraudulent transaction." This language surely describes the transaction entered into by petitioners with AEL. See Patin v. Commissioner,88 T.C. 1086">88 T.C. 1086, 1128-1129 (1987).

Decision will be entered in accordance with this opinion.

Footnotes

1. Except as otherwise noted, all section references are to the Internal Revenue Code as amended and in effect during the years in issue. ↩
2. Petitioners did not have present at trial any witnesses to fair market value of the master recording in question and claimed that certain witnesses were evading service of subpoenas. Petitioners were allowed 30 days to move to reopen the record for such expert testimony. They failed to do so. In view of petitioners' post-trial omissions, we might conclude that they have abandoned the case and dismiss it. See Stringer v. Commissioner,84 T.C. 693">84 T.C. 693 (1985), affd. without published opinion 789 F.2d 917">789 F.2d 917 (4th Cir. 1986), and Calcutt v. Commissioner,84 T.C. 716">84 T.C. 716↩ (1985). Because other petitioners are bound by the result in this case, we have filed this opinion.
3. Respondent states in his brief that the refund claimed by petitioners for 1981 was not paid to them under respondent's refund freeze program. See Rev. Proc. 84-84, 2 C.B. 782">1984-2 C.B. 782; Rev. Rul. 84-175, 2 C.B. 296">1984-2 C.B. 296. Respondent asserts that the unrefunded amount constitutes a rebate for the purpose of computing an underpayment of tax. Compare Persh v. Commissioner,78 T.C. 100">78 T.C. 100 (1982), in which refunds based on carrybacks had actually been paid. There is no evidence of the status of petitioners' refund in the record, however. See Rule 143(b), Tax Court Rules of Practice and Procedure.↩
4. By press release issued February 17, 1987, the Chief Judge set forth conditions under which motions to amend an answer to assert additions to tax under sec. 6661↩ normally would be granted at trial. Those conditions, i.e., timely and adequate notice, were satisfied here.
5. This finding is based inpart on the Court's inspection of and hearing of the tape. ↩
6. Hawkins v. Commissioner,T.C. Memo. 1987-233, the first such case in which damages were actually awarded, was filed after this case was tried. We reached the issue of damages under sec. 6673 on our own volition where it was obvious that the taxpayer had testified in an effort to mislead the Court. McCain v. Commissioner,T.C. Memo 1987-285">T.C. Memo. 1987-285, and Secoy v. Commissioner,T.C. Memo 1987-286">T.C. Memo. 1987-286, were also filed after trial of this case. Respondent has not moved for an award of damages here, and the circumstances are distinguishable from those in Hawkins.We see no reason not to award such damages, however, in any future case comparable to this one.
Petitioners' apparent post-trial abandonment of this case (failing to file an adequate opening brief or to file any reply brief) may well be an acknowledgement of the futility of their claims. Their conduct may also support a conclusion that this proceeding was maintained primarily for delay. ↩

Document Info

Docket Number： Docket No. 26815-85.

Filed Date： 11/16/1987

Precedential Status： Non-Precedential

Modified Date： 11/20/2020

Authorities (2)

Estate of Sydney S. Baron, Sylvia S. Baron, Administratrix, ... ( 1986 )

Ernest J. Saviano and Margaret Saviano v. Commissioner of ... ( 1985 )

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