Nichols v. Commissioner

Perry A. Nichols and Inez Nichols, et al., ^{Nichols v. Commissioner}

Docket Nos. 81752, 81753, 81754, 81755

United States Tax Court

37 T.C. 772; 1962 U.S. Tax Ct. LEXIS 207;

January 17, 1962, Filed

---

Decisions will be entered for the respondent.

In December 1955, petitioners, partners in a successful Miami law firm, were approached by L about a tax-saving plan involving the purported purchase of United States Treasury notes with borrowed funds. L "assured" petitioners that there would be no "short sale" of the pledged Treasury notes by the lender under his plan. Petitioners then entered a transaction which, in form, included ordering an aggregate of $ 6-million-face-amount United States Treasury notes from L, borrowing the purchase price of the Treasury notes from a finance company supplied by L, prepaying the interest on these loans with approximately 80 percent funds lent them without interest by L and with the remaining 20 percent from their own funds, receiving an option from L to sell the Treasury notes back to L in 9 months at a price slightly above par, and exercising this option in September 1956. L charged petitioners no fees or commission for the purported purchases, sales, options, and loans. Held, that, in substance, petitioners did not purchase Treasury notes, borrow funds, or pay interest which is deductible under section 163 of the 1954 Code. Eli D. Goodstein, 30 T.C. 1178">30 T.C. 1178, affirmed 267 F. 2d 127 (C.A. 1), followed.

Cyrus A. Neuman, Esq., for the petitioners.

Kenneth G. Anderson, Esq., for the respondent.

Raum, Judge.

---

RAUM

In these consolidated cases the Commissioner determined deficiencies in income taxes of the petitioners for the taxable year 1955 in amounts as follows:

Petitioners	Docket No.	Deficiencies
Perry A. Nichols and Inez Nichols	81752	$ 69,017.15
William C. Gaither and Elaine B. Gaither	81753	50,663.07
Walter H. Beckham and Ethel K. Beckham	81754	15,530.03
William S. Frates and Jean Frates	81755	14,960.59

The principal issue is whether petitioners paid interest on indebtedness to Corporate Finance and Loan Corporation of Boston, Massachusetts, within the meaning of section 163 of the Internal Revenue Code of 1954. If this issue should be decided in petitioners' favor, the Commissioner by amendment to his answer in each of these cases raises the alternative question whether petitioners realized taxable income in 1955 when they received purported loans from Livingstone & Company.

FINDINGS OF FACT.

The facts stipulated by the parties are incorporated herein by this reference.

Perry A. and Inez Nichols, William C. and Elaine B. Gaither, Walter H. and Ethel K. Beckham, and William S. and Jean Frates were husbands and wives, respectively, residing in Miami, Florida, during the taxable year 1955. Each couple filed a joint Federal income tax return for the calendar year 1955 on the cash basis method with the district director of internal revenue at Jacksonville, Florida. For convenience, the male petitioners will individually be referred to hereinafter as Nichols, Gaither, Beckham, and Frates, and will be collectively referred to as petitioners.

Petitioners and William C. Green were attorneys by profession and were engaged in the private practice of law in Miami, Florida, during the years 1952 through 1960 under the partnership firm name of Nichols, Gaither, Green, Frates, and Beckham. Under their partnership agreement dated March 1, 1955, the members of the partnership, insofar as practicable, limited their practice of law to the specialty of negligence cases, civil trials, and workmen's compensation cases.

None of petitioners were dealers in securities nor had any of the petitioners purchased or sold Government securities in substantial amounts prior to December of 1955.

During the year 1955 each of the petitioners derived and received substantial earnings principally from the private practice of law. In their joint Federal income tax returns for the taxable year 1955, petitioners reported adjusted gross income in amounts as follows: Nichols, $ 176,078.37; Gaither, $ 112,264.69; Beckham, $ 59,569.69; Frates, $ 58,401.60. On the same tax returns petitioners claimed deductions for amounts allegedly paid as interest to Corporate Finance and Loan Corporation of Boston, Massachusetts, in amounts as follows: Nichols, $ 100,546.88; Gaither, $ 80,437.50; Beckham, $ 30,164.06; Frates, $ 30,164.50. The present cases stem from the Commissioner's denial of these claimed interest deductions.

M. Eli Livingstone was a security dealer in Boston, Massachusetts, doing business in the form of a sole proprietorship under the name of Livingstone & Company, referred to hereinafter as Livingstone. Livingstone developed an "investment plan" whereby high income taxpayers theoretically would realize substantial "tax savings" by means of a large "interest" deduction on funds "borrowed" to finance the "purchase" of Government securities.

Petitioners first learned of Livingstone's tax reduction program on or about December 1, 1955, from a Chicago, Illinois, lawyer named Gerald G. Bolotin. Bolotin was a salesman for Livingstone, receiving a commission or "finder's fee" for his services. Bolotin's initial contact with petitioners came at a convention of trial attorneys in Miami Beach, Florida, on or about December 1, 1955. Bolotin was introduced to Frates at that convention by a mutual friend, James Dooley, a lawyer from Chicago, Illinois. Frates referred Bolotin to Gaither who was then serving as office manager of petitioners' law firm. Bolotin went to see Gaither at the latter's office and outlined Livingstone's tax reduction program to him. Gaither then arranged for Bolotin to see Arthur Hemmings, a certified public accountant and petitioners' tax adviser.

Bolotin had a conference with Hemmings and explained to him the Livingstone program which he proposed petitioners enter. At this meeting Hemmings expressed concern that the transaction was similar to one set out in Revenue Ruling 54-94, 1 C.B. 53">1954-1 C.B. 53, in which the Internal Revenue Service held that an interest deduction would not be allowable. Bolotin then showed Hemmings a memorandum prepared by a Chicago law firm which purported to distinguish the revenue ruling in question from the type of transaction which Bolotin said he had in mind for petitioners. In particular, he assured Hemmings that under the Livingstone program there would be no "short sale" of the Government securities by the lending institution as there was under the facts in the revenue ruling.

On the following day a conference took place at petitioners' offices attended by petitioners, their partner Green, Hemmings, Bolotin, and Livingstone. None of petitioners had met Livingstone prior to this occasion. At this conference Bolotin and Livingstone outlined Livingstone's Treasury note "purchase plan" for the entire group. Livingstone indicated that his brokerage firm would sell the Treasury notes to petitioners with 1 year's interest coupons detached and that he had access to numerous large banks and commercial lending institutions in New York, Boston, and Canada from which he could arrange for petitioners to borrow the full purchase price of the Treasury notes ordered. Livingstone did not specify which bank or lending institution would be used if petitioners decided to enter the program nor did he specify the rate of interest which would be charged. Since the interest on such loans would be payable in advance, Livingstone stated that his brokerage firm would lend petitioners without interest a substantial portion of the funds necessary to pay such interest. Livingstone also stated that his firm would grant petitioners a "put" or option to sell the Treasury notes back to Livingstone at a price somewhat above par. Livingstone told petitioners that if the market acted favorably there was a possibility of economic profit and that the plan as outlined had the advantage of protecting against loss.

Petitioners then asked Hemmings for his opinion of the tax consequences of the proposal. Hemmings mentioned the pertinent revenue ruling and stated that if Livingstone's transaction involved a sale by the lending institution of the Treasury notes held as collateral, he could not recommend to petitioners that they enter it. Livingstone assured Hemmings and petitioners that he was aware of the revenue ruling, that there would be no "short sale" of the collateral by the lending institution under his plan, and that his plan was similar to the one set out in the legal memorandum by the Chicago law firm which Bolotin had showed Hemmings the previous day. With these assurances, Hemmings expressed the opinion to petitioners that he believed the interest they paid to the lending institution would be deductible for Federal income tax purposes, that the gain from any subsequent sale of the notes would be capital gain, and that he, therefore, approved of the proposed transaction as outlined by Livingstone and Bolotin.

Petitioners and their law partner Green thereafter, on or about December 5, 1955, decided to enter the Livingstone-planned transaction for the primary purpose of reducing their Federal income taxes. The detailed steps of this transaction, in form, were as set forth in the following paragraphs.

Livingstone was to arrange the purchase of United States Treasury 2 7/8-percent notes due March 15, 1957, with interest coupons payable March 15, 1956, and September 15, 1956, detached, on behalf of each of petitioners and their law partner Green, in face amounts as follows: Nichols, $ 2,500,000; Gaither, $ 2,000,000; Green, $ 2,000,000; Beckham, $ 750,000; Frates, $ 750,000; or a total of $ 8,000,000.

Under date of December 5 and December 8, 1955, Livingstone delivered a letter

Livingstone issued confirmation slips to each of petitioners showing sales to them, as principal and for the account of Livingstone, of United States Treasury 2 7/8-percent notes due March 15, 1957, with March 15, 1956, and September 15, 1956, coupons detached. None of the confirmation slips showed any commission charged. Each confirmation slip showed the price as 97 1/2 and each confirmation slip showed the principal purchase price to be in amounts as follows:

Petitioner	Confirmation	Amount
	slip dated
Nichols	Dec. 5, 1955	$ 2,437,500
Gaither	Dec. 5, 1955	1,950,000
Beckham	Dec. 8, 1955	731,250
Frates	Dec. 8, 1955	731,250

Under date of December 5, 1955, Nichols and Gaither addressed letters to Livingstone instructing him to deliver the Treasury notes to Corporate Finance and Loan Corporation, 70 State Street, Boston, Massachusetts (hereinafter referred to as Corporate Finance), against payment by the latter of the purchase price. Under the same date, Nichols and Gaither addressed letters to Corporate Finance instructing it to receive and pay for the Treasury notes. Under date of December 8, 1955, Beckham and Frates addressed similar letters.

Petitioners each signed and delivered to Corporate Finance documents purporting to be promissory notes under seal, payable 1 year from the date of signature with interest at the rate of 4 1/8 percent per annum. Each note recited that the particular petitioner had prepaid interest and that he had deposited with Corporate Finance, as collateral, United States Treasury 2 7/8-percent notes due March 15, 1957, with March 15 and September 15, 1956, interest coupons detached. The face amounts of the "promissory notes," their signature dates and due dates, and the recited amounts of prepaid interest and deposited collateral were as follows:

	Face			Amount of	Face
Petitioner	amount of	Date of note	Due date	interest	amount of
	note			prepayment	collateral
				recited	deposited
Nichols	$ 2,437,500	Dec. 5, 1955	Dec. 5, 1956	$ 100,546.88	$ 2,500,000
Gaither	1,950,000	Dec. 5, 1955	Dec. 5, 1956	80,437.50	2,000,000
Beckham	731,250	Dec. 8, 1955	Dec. 8, 1956	30,164.06	750,000
Frates	731,250	Dec. 8, 1955	Dec. 8, 1956	30,164,06	750,000

None of the so-called promissory notes contained any provision for the reimbursement of interest in any amount to the petitioners by Corporate Finance if the principal amount were paid previous to the due date recited therein. Each note contained a provision that it should "be construed and interpreted in accordance with the laws of the State of Florida." Each also contained the following provisions:

The undersigned gives to the obligee a lien against the securities pledged for the amount of the obligations set forth herein, and gives to the obligee the right to hypothecate and use the securities pledged for any purpose while so pledged.

However, that there shall be no obligation on the part of the obligor, his executors, administrators or assigns hereunder, unless and until said Treasury Bonds being held as collateral hereunder are tendered to * * * [the particular petitioner] * * * his executors, administrators, or assigns, and provided, further, that no demand for payment hereunder shall be made at the maturity of this Note, or at any other time, by Corporate Finance * * * its successors and assigns, unless and until contemporaneous with said demand, the said Treasury Bonds being held as collateral hereunder, as hereinafter provided, are tendered to the obligor, his executors, administrators or assigns.

Said right to hypothecate and pledge is not to be inconsistent in any manner with the ownership by the undersigned of the said collateral, and with the right to the undersigned to obtain the return of the collateral at any time upon tender of payment of the amount due hereunder.

The transactions were recorded on the books of Corporate Finance by entries showing debits in the face amounts of the notes to the account "Notes Receivable, Clients" and offsetting credits to the account "Livingstone & Co., Loans Receivable."

"Prepayment of interest" to Corporate Finance on these notes was to be made for the period of 1 year at the rate of 4 1/8 percent per annum. The amounts, thus, purportedly owed to Corporate Finance were as follows: Nichols, $ 100,546.88; Gaither, $ 80,437.50; Beckham, $ 30,164.06; Frates, $ 30,164.06.

For the purpose of aiding in the "prepayment" of approximately 80 percent of the "interest" payable to Corporate Finance by petitioners, Livingstone delivered his check to each of petitioners on or about December 8, 1955. Petitioners deposited Livingstone's checks in their personal bank accounts in Miami, Florida, upon receipt. The checks and their amounts were as follows: To Nichols, $ 81,250; to Gaither, $ 65,000; to Beckham, $ 24,375; to Frates, $ 24,375.

Livingstone delivered letters to each of petitioners, dated December 5 and 8, 1955, which provided in part as follows:

With reference to a loan in the amount of * * * [applicable dollar amount] * * * made to you this day by us, this is to certify that this loan is subrogated to your rights against Livingstone & Co. on a "put" issued this day by them, and also to your rights against Corporate Finance * * * on a loan made by them to you this day against which you have deposited as collateral * * * [applicable dollar amount] * * * U.S. Treasury Notes 2 7/8% due March 15, 1957, with 3/15/56 and 9/15/56 coupons detached.

This Note shall not be collectible except on performance by Livingstone & Company and Corporate Finance * * * of their contracts referred to above.

At the time Livingstone made the above advances to petitioners, each of the petitioners signed and delivered to Livingstone a document which purported to be a promissory note. These documents provided that in December of 1956 each of the petitioners promised to pay Livingstone only the principal amount of the funds advanced "without interest." They contained no further provisions for the protection or benefit of Livingstone.

After allowing time for Livingstone's checks to clear his bank, each petitioner drew his personal check on his account at his bank in Miami, Florida, arranging to transfer funds by wire to the account of Corporate Finance at the Pilgrim Trust Company in Boston, Massachusetts. Such funds were the purported interest payments to Corporate Finance. Petitioners transmitted these funds to Corporate Finance between December 12 and 14, 1955, in amounts as follows: Nichols, $ 100,546.88; Gaither, $ 80,437.50; Beckham, $ 30,164.06; Frates, $ 30,164.06. On the same days the funds transmitted by wire were deposited to the credit of Corporate Finance at the Pilgrim Trust Company in Boston. The receipt of the funds was shown on the books of Corporate Finance as a debit to cash and a credit to deferred interest income.

On the same dates the credits were made to the account of Corporate Finance at the Pilgrim Trust Company, Corporate Finance drew its checks to Livingstone transmitting substantially all the funds forwarded by petitioners over to Livingstone. Immediately prior to receipt of the funds from Nichols, Gaither, and their law partner Green in the total amount of $ 261,421.88, on December 12, 1955, the account of Corporate Finance at the Pilgrim Trust Company showed a balance of $ 3,290.67. Corporate Finance then drew its check in the amount of $ 261,000 to Livingstone, leaving a balance of $ 3,712.55 after the transaction. Immediately prior to receipt of funds from Frates and Beckham in the total amount of $ 60,328.12 on December 14, 1955, Corporate Finance had a balance of $ 3,652.55. After drawing its check to Livingstone to transfer the funds received from Frates and Beckham to Livingstone, the account of Corporate Finance showed a balance of $ 3,670.67.

The advances to petitioners and their law partner Green in the total amount of $ 260,000 were charged against Livingstone's bank account at the Pilgrim Trust Company within 24 hours of the time the same funds passed from petitioners through Corporate Finance back to Livingstone. At the conclusion of the transaction on December 14, 1955, Livingstone had received back his $ 260,000, plus an additional $ 61,850.

Under dates of December 14 and 15, 1955, Livingstone delivered letters to petitioners wherein he acknowledged receipt of the signed notes each had sent to him. These letters provided in part as follows:

As to the procedure, on September 15, 1956, when your bonds are liquidated, we will at that time account to you for the proceeds. We will pay off the lien of Corporate Finance * * * and satisfy our own lien out of the balance.

In the event that the proceeds of the bonds are in excess of both liens, such excess will be paid to you. In view of the fact that you have our "put", there is no possibility of the proceeds being insufficient to satisfy both liens.

When the bonds have been liquidated, and both liens have been satisfied, you will receive both of your notes marked "Paid and Cancelled".

Livingstone delivered letters to each of petitioners under date of December 5 and 8, 1955, wherein he agreed to defend any challenge of the tax aspects of the transaction at his own expense. The entire text of such letters was as follows:

With respect to the purchase by you from us of U.S. Treasury 2 7/8% Notes due March 15, 1957, with 3/15/56 and 9/15/56 coupons detached, and the borrowing of the cost thereof and the prepayment of interest on a loan arranged by us, we agree to defend at our expense, any challenge of any aspect of the above transactions by the Bureau of Internal Revenue.

Also under date of December 5 and 8, 1955, Livingstone delivered separate letters to each of petitioners wherein he expressed his "considered judgment" that the "interest payments" on the "purchase" of the Treasury notes involved would be deductible on petitioners' income tax returns. These letters provided, in part, as follows:

In the event this deduction is disallowed, and you are allowed no credit for it on your tax return, you are hereby given authority to rescind the transaction and recover back any and all monies paid under this contract in the form of interest to the finance company.

In the event that the difference between the capital gain realized and the interest payment made by you to the finance company is allowed as an ordinary loss, you may rescind the transaction and recover back the net loss which you have sustained by reason of such disallowance, that is, the difference between the amount originally paid and the capital gain which you will receive, less the tax reduction allowed as a result of the loss.

In the event that this is allowed as a capital loss then such reimbursement will be to the extent of your net loss after taking into consideration the amount originally paid, less the amount recovered on liquidation with a credit for the tax saving on the capital loss.

These letters to petitioners were written without the knowledge or authority of Corporate Finance.

Neither Livingstone, Corporate Finance, nor petitioners ever obtained physical possession of the Treasury notes.

Livingstone maintained accounts with Salomon Bros. & Hutzler, Government bond dealers of New York, hereinafter referred to as Salomon Bros., and Chemical Corn Exchange Bank of New York, hereinafter referred to as Chemical Bank. The account maintained at Chemical Bank was a broker's clearance account.

On December 14 and 22, 1955, Livingstone placed simultaneous orders with Salomon Bros. instructing it both to deliver to and to receive from Chemical Bank United States Treasury 2 7/8-percent notes due March 15, 1957, in face amounts as follows:

Date	Face Amount
Dec. 14, 1955	$ 10,000,000
Dec. 22, 1955	8,135,000

The delivery dates prescribed were December 15 and 23, 1955, respectively. Identical matching delivery and receipt instructions were sent by Livingstone to Chemical Bank on the same dates.

The matching delivery and receipt instructions sent to Salomon Bros. on December 14, 1955, were composed of the following individual orders for United States Treasury 2 7/8-percent notes due March 15, 1957:

(a) Deliver
	Face Amount	Price
	$ 250,000.00	$ 252,070.32
	1,000,000.00	1,008,281.25
	1,000,000.00	1,008,281.25
	2,000,000.00	2,016,562.50
	2,000,000.00	2,016,562.50
	250,000.00	252,070.32
	1,000,000.00	1,008,281.25
	2,500,000.00	2,520,703.13
	Total		$ 10,082,812.52
(b) Receive
	$ 10,000,000.00	$ 10,081,250.00
	Total		$ 10,081,250.00

Livingstone issued confirmation slips to Salomon Bros. confirming both sides of the above transaction.

The matching delivery and receipt instructions sent to Salomon Bros. on December 22, 1955, were composed of the following individual orders for United States Treasury 2 7/8-percent notes due March 15, 1957:

(a) Deliver
	Face Amount	Price
	$ 1,600,000.00	$ 1,614,760.99
	1,000,000.00	1,009,225.62
	1,000,000.00	1,009,225.62
	750,000.00	756,919.22
	750,000.00	756,919.22
	300,000.00	302,767.69
	550,000.00	555,074.09
	750,000.00	756,919.22
	135,000.00	136,245.45
	500,000.00	504,612.81
	800,000.00	807,380.49
	Total		$ 8,210,050.42
(b) Receive
	$ 8,135,000.00	$ 8,208,779.31
	Total		$ 8,208,779.31

Livingstone issued confirmation slips to Salomon Bros. showing both sides of the transaction.

On each of the transactions with Salomon Bros., under dates of December 14 and 22, 1955, there was a difference of one sixty-fourth of a point between the buy and sell prices of the Treasury notes. The difference as to the $ 10-million-face-amount transaction of December 14, 1955, was $ 1,562.52. The difference as to the $ 8,135,000 face amount transaction of December 22, 1955, was $ 1,271.11. In each case Livingstone issued his checks to Salomon Bros. for this differential to balance the transactions. This differential of one sixty-fourth of a point constituted Salomon Bros.' fee for the transaction and covered the costs to Salomon Bros. of clerical work, wire expense, messenger service, and overhead and maintenance in carrying out the simultaneous and matching delivery and receipt instructions. These checks of $ 1,562.52 and $ 1,271.11 were the only funds of Livingstone employed in the two transactions with Salomon Bros.

After receipt of the instructions to deliver the Treasury notes to Chemical Bank under dates of December 14 and 22, 1955, Salomon Bros. issued confirmation slips to Livingstone confirming the sale of Treasury notes to Livingstone, account of Nichols, Gaither, Beckham, and Frates with delivery terms of December 15 and 23, 1955, respectively, at the Chemical Bank. Each of these confirmation slips showed that Salomon Bros. had acted in the transaction as principal. These confirmation slips showed the sale of Treasury notes in face amounts, prices, principal amounts, accrued interest, and total amounts as follows:

Date	Petitioner	Face	Price
		amount
Dec. 14, 1955	Nichols	$ 2,500,000	100 3/32 + 1/64
Dec. 14, 1955	Gaither	2,000,000	100 3/32 + 1/64
Dec. 22, 1955	Beckham	750,000	100 4/32 + 1/64
Dec. 22, 1955	Frates	750,000	100 4/32 + 1/64

Date	Principal	Accrued	Total
		interest	amount
Dec. 14, 1955	$ 2,502,734.38	$ 17,968.75	$ 2,520,703.13
Dec. 14, 1955	2,002,187.50	14,375.00	2,016,562.50
Dec. 22, 1955	751,054.69	5,864.53	756,919.22
Dec. 22, 1955	751,054.69	5,864.53	756,919.22

Although the confirmation slips from Salomon Bros. to Livingstone showed the sales to be for the account of each of the petitioners, such identification of the names of Livingstone's clients had no significance whatsoever to Salomon Bros. Salomon Bros. acted only pursuant to the instructions of Livingstone. It was not usual practice of Salomon Bros. to place the names of the broker's clients on confirmation slips issued to the broker. The names of petitioners were placed thereon by Salomon Bros. for the convenience of Livingstone and at his request.

The delivery and receipt instructions to Salomon Bros. and Chemical Bank matched each other in face amount so that the orders, in effect, canceled each other. On the one hand, Salomon Bros. sold the $ 10,000,000- and $ 8,135,000-face-amount Treasury notes to Livingstone, but at the same time Livingstone sold those Treasury notes back to Salomon Bros. The matching instructions to receive and deliver these Treasury notes were contained in the same letter of instruction to Salomon Bros. The Treasury notes purportedly involved never left the offices of Salomon Bros.

The function of Chemical Bank in each of the transactions was to "clear" (receive and deliver) securities, according to the instructions of Livingstone who had an account with the bank for that purpose. For its services, Chemical Bank received a fee.

Under date of January 5, 1956, Nichols and Gaither each received letters from Corporate Finance advising them that it had received Treasury notes from Livingstone for their accounts and purportedly listing the serial numbers of such notes. Beckham and Frates received similar letters from Corporate Finance under date of February 17, 1956.

The steps employed at the purported closeout of the above described transactions in September 1956 were, in form, as follows. Under date of September 24, 1956, Livingstone addressed letters to each of petitioners which provided, in part, substantially as follows:

We are enclosing herewith the necessary documents to effect the close-out of your treasury transaction involving * * * [applicable dollar amount] * * * U.S. Treasury 2 7/8% Notes due March 15, 1957.

These documents include our confirmation of purchase from you of the above-described securities, a statement of your account reflecting the current status, letters of instruction which should be signed and returned to this office as indicated, together with your "paid and cancelled" note from Livingstone & Company, which note was paid out of the proceeds due you on this transaction.

We have asked * * * [Corporate Finance] * * * to return to you your "paid and cancelled" note.

Receipt by us of signed instruction letters will complete this transaction. * * *

Confirmation slips dated September 15, 1956, were transmitted to petitioners by Livingstone's letters dated September 24, 1956, showing purchases from each of petitioners, as principal, and for the account of Livingstone, of United States Treasury 2 7/8-percent notes due March 15, 1957. None of the confirmation slips showed any commissions charged. Each confirmation slip showed the price as 100 3/4 and showed the principal purchase prices to be in amounts as follows: Nichols, $ 2,518,750; Gaither, $ 2,015,000; Beckham, $ 755,625; Frates, $ 755,625.

Under date of September 15, 1956, entries were recorded on the books of Corporate Finance showing debits to the account, "Loans Receivable, Livingstone & Company," and offsetting credits to the account, "Notes Receivable, Clients." The entries shown and the amounts thereof were as follows:

	Notes receivable,	Livingstone
Petitioner	clients	& Co., loans
	(credit)	rec. (debit)
Nichols	$ 2,437,500.00	$ 2,437,500.00
Gaither	1,950,000.00	1,950,000.00
Beckham	731,250.00	731,250.00
Frates	731,250.00	731,250.00

Each of petitioners returned instruction letters dated September 15, 1956, forwarded to him on September 24, 1956, to Livingstone instructing his company to receive the Treasury notes from Corporate Finance against payment to Corporate Finance of the amount each petitioner owed Corporate Finance. Similarly, petitioners each addressed instruction letters dated September 15, 1956, to Corporate Finance instructing that company to deliver the Treasury notes to Livingstone against payment by Livingstone of the applicable amount owed Corporate Finance. Each of these letters to Corporate Finance provided in part as follows: "Please apply these proceeds to discharge my loan with you."

The statements of account sent by Livingstone to petitioners with his letters of September 24, 1956, showed that in each case the purported sale on September 15, 1956, by petitioners of their Treasury notes to Livingstone at 100 3/4 provided exactly enough funds to pay off and discharge petitioners' notes with Corporate Finance and with Livingstone and, thus, left zero balances in each case.

On their Federal income tax returns for the taxable year ended December 31, 1956, petitioners each reported long-term capital gain from the sale of United States Treasury notes held for more than 6 months. Each elected the alternative tax computation with respect to such reported gain. The gain was reported as follows:

Name	Kind of property	Date	Date
		acquired	sold
Nichols	$ 2,500,000.00 U.S. Treasury	12-5-55		2 7/8% Notes 3-15-57.
Gaither	$ 2,000,000.00 U.S. Treasury	12-5-55	9-15-56
	2 7/8% Notes 3-15-57.
Frates	$ 750,000.00 U.S. Treasury	12-5-55	9-15-56
	2 7/8% Notes 3-15-57.
Beckham	$ 750,000.00 U.S. Treasury	12-5-55	9-15-56
	2 7/8% Notes 3-15-57.

Name	Gross	Cost	Gain
	sales price
Nichols	$ 2,518,750.00	$ 2,437,500.00	$ 81,250.00
Gaither	2,015,000.00	1,950,000.00	65,000.00
Frates	755,625.00	731,250.00	24,375.00
Beckham	755,625.00	731,250.00	24,375.00

Petitioners' law partner Green also entered the above-described transaction, purporting to purchase $ 2-million-face-amount United States Treasury 2 7/8-percent notes due March 15, 1957, with interest coupons payable March 15, 1956, and September 15, 1956, detached. The principal purchase price thereof from Livingstone was $ 1,950,000, which he also purported to borrow from Corporate Finance and as to which he purported to pay interest in the amount of $ 80,437.50. Green's transaction was arranged in the same form as petitioners'. Similar letters of instruction, confirmation slips, promissory notes, and similar documents were provided to him by Livingstone, including a $ 65,000 interest-free advance at the inception of the transaction in December of 1955.

Corporate Finance was a Massachusetts corporation, incorporated in 1954 and purportedly doing business as a finance company in the law offices of its president and treasurer, Harry N. Cushing, at 70 State Street, Boston, Massachusetts. Cushing was a longtime friend and former law associate of Livingstone but was not related to Livingstone. Livingstone was not a shareholder of Corporate Finance. Cushing was one of 10 shareholders of Corporate Finance; 4 of the other shareholders were related to Cushing and the remaining 5 were friends or clients of Cushing.

Corporate Finance never received a credit report on any of the individuals to whom it allegedly lent money, never met any of these individuals, and received substantially all if not all of its business on reference from Livingstone.

From the date of its incorporation through all periods pertinent hereto, Corporate Finance maintained a comparatively nominal cash position. It was incorporated with an initial capital contribution of $ 1,000 in 1954. No further capital contributions were made at any time. On December 5 and 8, 1955, the dates it was, in form, to pay $ 7,800,000 to Livingstone for the Treasury notes allegedly purchased by petitioners and their law partner Green, Corporate Finance had cash bank balances of $ 21,952.04 and $ 3,461.08, respectively. The bank balance of $ 21,952.04 was reduced by a series of checks drawn to the order of Livingstone, so that on December 6, 1955, the bank balance was $ 2,898.92. On December 14 and 22, 1955, the dates Livingstone, in form, theoretically made use of Corporate Finance's funds by purportedly placing orders for Treasury notes, Corporate Finance's cash bank balances were $ 3,670.67 and $ 1,482.18, respectively.

Corporate Finance maintained its books and records on a fiscal year basis. According to "Certificates of Condition" filed with the secretary of state of the Commonwealth of Massachusetts, Corporate Finance reported assets and liabilities at the end of its fiscal years March 31, 1955, and March 31, 1956, in amounts as follows:

	Fiscal year ended	Fiscal year ended
	Mar. 31, 1955	Mar. 31, 1956
Assets:
Cash	$ 7,504.07	$ 2,783.06
Accounts receivable, customers	65,950,323.55	280,430,957.38
Prepaid insurance, interest, taxes	45.99	37.47
Total assets	65,957,873.61	280,433,777.91
Liabilities:
Accounts payable	57,249,044.32	270,812,038.97
Accrued bond expense	472,085.94	4,001,327.50
Deferred interest	2,922,092.95	6,613,528.32
Bonds borrowed	6,240,000.00
Payroll taxes withheld		195.00
Capital stock, without par	1,000.00	1,000.00
Surplus	(926,349.60)	(994,311.88)
Total liabilities	65,957,873.61	280,433,777.91

Corporate Finance has declared and paid two dividends of $ 4 per share since its incorporation. These dividends of $ 1,000 each were paid in the fiscal years ending March 31, 1956, and March 31, 1957, and together returned to the stockholders double their original capital investment.

Corporate Finance has filed Federal corporate income tax returns for each year of its existence.

Corporate Finance's only tangible assets were so-called client folders, its books and records, a supply of letterhead stationery, and the "promissory notes" of clients in transactions similar to the one here under consideration.

In addition to being president and treasurer of Corporate Finance, Cushing was also an officer in at least seven similar "finance companies," including Charleston Investment Corporation, Suffolk Finance Corporation, Cushing Investment Corporation, Seaboard Investment Corporation, Gail Finance Corporation, Seaboard Investment Associates, Inc., and Corporate Finance Corporation (a separate entity from Corporate Finance and Loan Corporation, herein referred to as Corporate Finance). All such companies were allegedly doing business in Cushing's law offices at 70 State Street, Boston, Massachusetts, all were organized and operated like Corporate Finance, and all received substantially all if not all of their business on reference from Livingstone.

Cushing maintained all the books and records of Corporate Finance, its so-called client folders, and its supply of letterhead stationery in a four-drawer filing cabinet and an adjoining storage cabinet in his law offices at 70 State Street. In addition, he maintained the files, records, and supplies of the seven other similar "finance companies" in the same two cabinets.

Correspondence purporting to be prepared by Corporate Finance and signed by Cushing was actually prepared and typed on the letterhead stationery of Corporate Finance by Livingstone's office. When Livingstone required letterhead stationery from Corporate Finance, Cushing would provide it. Corporate Finance had no employee who could prepare or type such letters. It paid Livingstone for performing such administrative services.

Cushing's principal activities as president and treasurer of Corporate Finance were to receive so-called interest payment checks from clients and deposit them in Corporate Finance's only bank account at the Pilgrim Trust Company in Boston, maintain the files of the corporation, and pay out corporate funds, most of which went to Livingstone in the form of "finder's fees," borrowed bonds expense, and administrative expense. Cushing never had training as an investment banker nor had he dealt in Government securities. He never met Corporate Finance's so-called clients in person. Cushing did not meet the petitioners herein until the trial of the present case. Cushing's salary from Corporate Finance for the fiscal year ended March 31, 1956, was $ 15,882.

The only other employee of Corporate Finance was one of Cushing's children who served as clerk of the corporation at the three or four directors and stockholders meetings of Corporate Finance each year. Such meetings never lasted longer than about 30 minutes. The clerk was paid $ 3,975 for the fiscal year ended March 31, 1956.

Livingstone together with Cushing decided at the end of each year how much Corporate Finance would pay Livingstone for the transactions which had taken place. In this way Livingstone, although not an officer, director, or shareholder of Corporate Finance, exercised considerable dominion and control over the corporation's funds. In addition, Livingstone had the use of substantially all of Corporate Finance's funds throughout the year.

The high and low bid prices of United States Treasury 2 7/8-percent notes, no coupons detached, due March 15, 1957, between December 1, 1955, and March 15, 1957, were as follows:

Month -- Year	High	Low
December 1955	100 5/32	100 1/32
January 1956	100 18/32	100 2/32
February 1956	100 17/32	100 9/32
March 1956	100 10/32	100 6/32
April 1956	100 5/32	99 29/32
May 1956	100 4/32	99 30/32
June 1956	100 7/32	100 2/32
July 1956	100 9/32	100 2/32
August 1956	100 4/32	99 29/32
September 1956	99 30/32	99 27/32
October 1956	100	99 26/32
November 1956	99 31/32	99 27/32
December 1956	99 30/32	99 28/32
January 1957	100 1/32	99 29/32
February 1957	100	99 31/32
March 1957	99 31/32

Petitioners and their law partner Green each entered two additional United States Treasury note and United States Treasury bond transactions, one in 1956 and one in 1957, in which Livingstone was involved. The Commissioner has determined income tax deficiencies in connection with these additional transactions against each of petitioners and Green for the years 1956, 1957, 1958, and 1959. Petitioners and Green have each filed petitions with the Tax Court of the United States requesting redetermination of such deficiencies.

In the instant cases the Commissioner mailed statutory notices of deficiency to each of petitioners in which it was determined that the amounts each had forwarded to Corporate Finance did not "represent interest within the meaning of section 163 of the Internal Revenue Code of 1954" and thus were not deductible. By amended answers in the present cases, the Commissioner has raised an alternative issue that each of petitioners received taxable income to the extent of the advances made to him by Livingstone in December of 1955.

Petitioners did not in fact purchase any United States Treasury notes in December of 1955. They did not borrow any money from Corporate Finance, and they did not pay any interest on indebtedness to Corporate Finance in 1955.

OPINION.

We have made extensive findings of fact in these consolidated cases which we think clearly reveal that the transactions herein are in all essential respects the same as the transactions considered in the large body of precedent dealing with other Livingstone-directed dealings, Eli D. Goodstein, 30 T.C. 1178">30 T.C. 1178, affirmed 267 F. 2d 127 (C.A. 1); Broome v. United States, 170 F. Supp. 613">170 F. Supp. 613 (Ct. Cl.); Sonnabend v. Commissioner, 267 F. 2d 319 (C.A. 1), affirming per curiam a Memorandum Opinion of this Court; Lynch v. Commissioner, 273 F. 2d 867 (C.A. 2), affirming 31 T.C. 990">31 T.C. 990 and Leslie Julian, 31 T.C. 998">31 T.C. 998; Egbert J. Miles, 31 T.C. 1001">31 T.C. 1001; Becker v. Commissioner, 277 F. 2d 146 (C.A. 2), affirming a Memorandum Opinion of this Court; Morris R. DeWoskin, 35 T.C. 356">35 T.C. 356, appeal dismissed (C.A. 7); and with analogous "tax-saving" schemes, cf. Knetsch v. United States, 364 U.S. 361">364 U.S. 361; United States v. Roderick, 290 F. 2d 823 (C.A. 5); MacRae v. Commissioner, 294 F. 2d 56 (C.A. 9), affirming in part and remanding in part 34 T.C. 20">34 T.C. 20, certiorari denied 368 U.S. 955">368 U.S. 955; Kaye v. Commissioner, 287 F. 2d 40 (C.A. 9), affirming per curiam 33 T.C. 511">33 T.C. 511; Weller v. Commissioner, 270 F. 2d 294 (C.A. 3), affirming 31 T.C. 33">31 T.C. 33 and W. Stuart Emmons, 31 T.C. 26">31 T.C. 26, certiorari denied 364 U.S. 908">364 U.S. 908; William R. Lovett, 37 T.C. 317">37 T.C. 317; Empire Press, Inc., 35 T.C. 136">35 T.C. 136. The holding in each of these prior cases that the transactions therein considered were lacking in substance, were shams which can have no effect for tax purposes, is controlling here. In the instant case, as was true in the above-cited cases in which M. Eli Livingstone was also involved, there was no actual purchase of Government securities, ^{*244 petitioners' purported loans from Corporate Finance, a member of what has been aptly described as "the Livingstone bevy of nominal lending agencies," section 163 of the 1954 Code. We think the Commissioner's disallowance of the claimed interest deductions was proper.}

Petitioners contend that there is a fundamental difference between the present facts and the transactions considered in the earlier cases. They argue that the taxpayers in the cited precedents were all found to have been parties to the sham dealings therein, either directly through knowledge or indirectly through acquiescence or indifference, while in the instant transaction there is evidence that Livingstone assured petitioners that the Treasury notes would actually be purchased and held as collateral, that there would be no "short sale" of the notes, so that petitioners in no sense can be considered parties to Livingstone's sham. However, we are not impressed by this alleged basis of distinction.

Even if we accept as true the proposition that petitioners were fooled by Livingstone to the extent indicated, the contested deductions cannot stand. No matter what petitioners' intent may have been upon entering the transaction, the transaction itself remains a sham that cannot give rise to valid interest deductions. What was said by the Court of Appeals for the Second Circuit in Lynch v. Commissioner, supra at 872, in answer to a contention by the petitioners therein that they, too, were innocent of "the round-robin nature" of Livingstone's dealings, is especially pertinent here.

Save in those instances where the statute itself turns on intent, a matter so real as taxation must depend on objective realities, not on the varying subjective beliefs of individual taxpayers.

Cf. MacRae v. Commissioner, supra at 59. The "objective realities" here were that petitioners purchased no Treasury notes, borrowed no funds from Corporate Finance, and paid no true interest on indebtedness. Therefore, regardless of what petitioners may have intended or believed or expected, there can be no interest deductions under the statute. The "good faith" of petitioners is irrelevant. Cf. United States v. General Geophysical Co., 296 F. 2d 86 (C.A. 5), denying rehearing in 296 F. 2d 90, reversing 175 F. Supp. 208">175 F. Supp. 208 (S.D.Tex.).

In addition, we think the record herein fails to support petitioners' premise that they were totally innocent of Livingstone's actual doings. Petitioners' own testimony reveals that Livingstone's program was presented to them as a tax-saving scheme which they were informed from the outset was very close to a transaction that the Internal Revenue Service had decided in a published ruling (Rev. Rul. 54-94, 1 C.B. 53">1954-1 C.B. 53) would not support an allowable interest deduction. While the record indicates that petitioners and their tax adviser Hemmings were assured by Livingstone that his program would differ from the ruling's transaction because it would involve real Government securities which would not be sold "short" by the lender, it is apparent that petitioners -- all experienced lawyers -- made no independent investigation of the details of the transaction before purportedly investing $ 6 million of their funds. Not only did they not seek any assurances from Corporate Finance, which Livingstone theoretically could in no way bind by his assurances, but each petitioner proceeded to sign supposed promissory notes to Corporate Finance which gave this so-called lending institution "the right to hypothecate and use" the securities, a right upon which Cushing relied to justify the alleged "short sale." Cf. Eli D. Goodstein, supra at 1188. With this background, added to the undisputed facts that Livingstone charged petitioners no commissions for either the "purchase" or "sale" of $ 6-million-face-amount Treasury notes nor for the valuable option to sell the same notes back to him at a profit, that he supposedly lent petitioners $ 195,000 for 1 year without interest after having met petitioners for the first time only a few days earlier, that he agreed to defend at his own expense any resulting tax lawsuit and reimburse petitioners for the payments they had made "in the form of interest" to Corporate Finance if their deductions were disallowed, "it would strain credulity to the breaking point to suppose that taxpayers had no inkling that something highly unusual was going on." Lynch v. Commissioner, supra at 872; cf. MacRae v. Commissioner, supra at 59; Eli D. Goodstein, supra at 1188. When the entire transaction is viewed in perspective, it appears that any blind acceptance by petitioners of Livingstone's so-called assurances was rather an effort to isolate themselves from the realities of the situation, whatever they might be, than anything like innocent trust or genuine reliance. So long as Livingstone "told" them it would be done properly, petitioners evidently did not care how he actually accomplished the end result of securing for them the desired income tax deductions. In sum, assuming that petitioners had no actual knowledge of Livingstone's true maneuvers, we have no doubt on this record that they had ample reason to know that the transaction was not what it purported to be. In such circumstances, petitioners must be considered to be at least indifferent, if not outright willing participants in Livingstone's sham.

Since the entire transaction was lacking in substance and no real borrowing took place, petitioners' separate contention that their notes to Corporate Finance were valid indebtednesses under Florida law because signed under seal can have no effect. Cf. United States v. General Geophysical Co., supra. Moreover, the transactions before us were a sham, and it is obvious that a sham remains a sham whether or not under seal.

Because we have sustained the Commissioner's disallowance of the claimed interest deductions, we do not pass upon his alternative position that petitioners realized income by receipt of advances from Livingstone in 1955.

Decisions will be entered for the respondent.

---

Footnotes

• 1. Proceedings of the following petitioners are consolidated herewith: William C. Gaither and Elaine B. Gaither, Docket No. 81753; Walter H. Beckham and Ethel K. Beckham, Docket No. 81754; and William S. Frates and Jean Frates, Docket No. 81755.↩

• 2. This letter was only one of a group of documents which Livingstone forwarded to petitioners Nichols and Gaither under date of December 5, 1955, and to petitioners Beckham and Frates under date of December 8, 1955. Included within these packets, in addition to the option letters, were purchase confirmation slips from Livingstone, purported promissory notes to Corporate Finance and Loan Corporation and to Livingstone for petitioners' signatures, and letters of instruction to both Corporate Finance and Loan Corporation and to Livingstone for petitioners' signatures. Livingstone enclosed copies of all of these documents for petitioners to retain for their files. Separate reference is made to each of these documents in these findings.↩

• *. (Sic↩) 9-15-56.

• 3. Although the parties stipulated that the Treasury notes purportedly here involved were transferred from the New York offices of the bond dealers, Salomon Bros. and Hutzler, to the account of Livingstone at the Chemical Corn Exchange Bank and back again to Salomon Bros. and Hutzler all on the same day, it is apparent from testimony elicited at the trial that the matching, simultaneous delivery and receipt instructions to the bond dealers and the bank canceled each other so that the Treasury notes in fact never left the bond dealers' offices. Counsel for petitioners and the Commissioner indicated to the Court that the stipulation had been based on incomplete information obtained before trial from the same witness who testified at the trial. In these unusual circumstances the Court permitted the testimony to remain in the record at variance with the stipulation. Our findings of fact have taken such testimony into consideration. Of course, it makes little difference whether or not the Treasury notes were physically transferred to Livingstone's account for a few minutes or hours, as was true in the Goodstein↩ case; in either case no Treasury notes or Government securities of any kind were in fact purchased by petitioners.

• 4. Broome v. United States, 170 F. Supp. 613">170 F. Supp. 613, 615↩.