DocketNumber： Docket No. 48659-86
Citation Numbers： 60 T.C.M. 874, 1990 Tax Ct. Memo LEXIS 562, 1990 T.C. Memo. 509
Judges： WHITAKER
Filed Date： 9/25/1990
Status： Non-Precedential
Modified Date： 11/20/2020
SUPPLEMENTAL MEMORANDUM FINDINGS OF FACT AND OPINION
By timely statutory notice respondent determined a deficiency in petitioners' 1975 Federal income tax of $ 184,226 and the increased rate of interest on a substantial underpayment attributable to a tax-motivated transaction under
FINDINGS OF FACT
Petitioner's motion places before us the residual value of computer equipment involved in a purported sale/leaseback transaction between Bari Associates (Bari) and CIG Products, Inc. (CIG Products). The facts pertaining to that transaction are set forth in detail in Coleman I,
In June 1975, Bari agreed to purchase computer equipment from CIG Products for $ 25,000,000 and immediately to lease that equipment back to the seller. Petitioner, Delbert Coleman, was one of Bari's partners. Bari paid $ 1,900,000 cash down and gave CIG Products a nonrecourse promissory note for the remaining $ 23,100,000. The note was to be paid in 96 monthly payments with a balloon principal payment of $ 6,500,000 due at termination of the *565 lease on June 30, 1983. If Bari and CIG Products made all payments under the note and lease, respectively, Bari would have a net cash flow on the lease of $ 1,932,240, not taking into account the cash down payment or any payment on the final $ 6,500,000 balloon payment. CIG Products was required to pay all expenses pertaining to the lease or the equipment, including taxes. Bari retained CIG Products to broker sales or releases of the equipment after termination of the lease in return for a fee of the lesser of 50 percent of net proceeds or 125 percent of expenses. Bari claimed deductions attributable to the transaction amounting to $ 7,462,564 in 1975.
This is the fourth opinion pertaining to the Bari transaction. In Coleman I, we denied deductions attributable to the Bari equipment claimed by Mr. Coleman in 1976. We found the purchase price approximated the fair market value of the Bari equipment in June 1975. However, applying seven factors, we held that Bari did not become the owner of the computer equipment for Federal tax purposes. Coleman I, 56 P-H Memo T.C. par. 87,195 at 938, 943,
We concluded that Bari's position was indistinguishable from that of a financier. Bari's expectations of profit stemmed solely from the $ 32,240 guaranteed over the 8 years of its lease to CIG Products rather than relating to the value or income-producing potential of the computer equipment. Coleman I, 56 P-H Memo T.C. par. 87,195 at 938, 947,
The computer equipment in the Bari portfolio consisted of IBM systems 360, 370-135, and 370-155 central processing units, compatible components, and peripheral units manufactured by IBM and by other manufacturers. We relied on the testimony of respondent's expert, Frederic G. Withington, in determining the residual value of the Bari *567 equipment. Mr. Withington testified that in June 1975 he would have predicted an aggregate residual value in June 1983 of $ 1,892,093 to $ 2,292,093. Mr. Withington further stated that the midpoint of that range was the most likely value, but that his projection contained an uncertainty factor of 10 percent.
In contrast, petitioners' expert, Svend Hartmann, testified that in 1975 he would have predicted that the residual value of the Bari equipment in 1983 would be somewhere in the range of $ 2,467,000 to $ 8,580,000. Mr. Hartmann could not say whether any value within that range was more probable. We found Mr. Withington's methodology the more reliable. Mr. Withington's projections were based upon residual value forecasts which he had made close to time of the Bari transaction. In addition, we found that an investor would not have found Mr. Hartmann's advice useful because of the breadth of his projected range and his inability to designate more probable values within that range. Coleman I, 56 P-H Memo T.C. par. 87,195 at 938, 945-947,
Subsequent to our opinion in Coleman I, petitioners filed a motion to reopen the record or to hold an evidentiary hearing. *568 Petitioners asserted that Mr. Withington had failed to produce all documents called for in a subpoena duces tecum and offered into evidence a letter (the Levin letter) written by Mr. Withington in 1973. According to petitioners, the Levin letter refuted Mr. Withington's trial testimony on the residual value of IBM 360 and 370-135 equipment. We considered and denied petitioners' motion in Coleman I-A. We concluded that the Levin letter was consistent with Mr. Withington's testimony in Coleman I and, to the extent it may have been material, the letter was merely cumulative of other similar evidence introduced at trial. Coleman I-A, 58 P-H Memo T.C. par. 89,248,
By Order dated May 22, 1989, we directed petitioners to show cause why Coleman I and Coleman I-A should not control the outcome of Coleman II. In their response, petitioners argued that they had discovered additional discrediting documents prepared by Mr. Withington which were not produced pursuant to the subpoena in Coleman I. Petitioners asked that we reject Mr. Withington's Coleman I testimony and that we allow Mr. Hartmann and a new expert, Mr. Esmond C. Lyons, Jr., to testify at trial in Coleman *569 II.
Because of our concern regarding Mr. Withington's response to the subpoena in Coleman I, we granted petitioners' request to hold an evidentiary hearing, the result of which is the subject of Coleman II. The sole purpose of that hearing was to examine Mr. Withington with respect to residual value of the Bari computer equipment in light of the new documents proffered by petitioners. By Order dated July 31, 1989, we informed petitioners that if testimony and documents introduced at the hearing did not reveal facts which were materially different from the facts found in Coleman I, a second trial before a different trial judge was not justified.
At the hearing we admitted the documents offered into evidence by petitioners. However, we found that the documents which Mr. Withington failed to produce in Coleman I were either cumulative, redundant, or not relevant to the residual value of the Bari equipment. Coleman II, 59 P-H Memo T.C. par. 90,099 at 449, 451-452,
In addition, Mr. Withington revised his residual value projection upward to a value of between $ 3,550,193 and $ 4,339,125, with the midpoint of that range more probable. *571 However, other than with respect *570 to scrap value, Mr. Withington did not revise his residual value projections for Bari's IBM 360, 370-135, 370-155, and related equipment. Mr. Withington made no revisions based upon the documents which petitioners introduced at the hearing.
Although we agreed that Mr. Withington's revisions tended to weaken his original testimony, we found Mr. Withington's reasons for revising his projection of aggregate residual value reasonable. Petitioners failed to persuade us that the facts regarding residual value were so materially different from the facts in Coleman I that our decision in that case should not be controlling. After consideration of the record in both Coleman I and Coleman II, we remained convinced that Bari could not reasonably have expected the residual value of the Bari equipment in 1983 to equal or exceed the balloon payment due in that year. Therefore, we determined that a second trial on residual value was not justified. Coleman II, 59 P-H Memo T.C. par. 90,099 at 449, 451,
We adopted and incorporated the findings of fact from Coleman I and Coleman I-A. After consideration of those findings on residual value and other pertinent factors, we reaffirmed our holding that Bari was not the owner of the computer equipment for Federal tax purposes. Therefore, *572 we denied deductions attributable to the Bari transaction which petitioners claimed in 1975. Coleman II, 59 P-H Memo T.C. par. 90,099 at 453,
Because our holding on the issue of whether Bari had the benefits and burdens of ownership was determinative, we did not reach respondent's economic substance argument in Coleman I. However, unlike Coleman I, the increased rate of interest on a substantial underpayment attributable to a tax-motivated transaction, as set forth in
We concluded that the Bari transaction lacked economic substance. Three factors led to that conclusion. The residual value of the computer equipment at the end of the lease term was less than the amount Bari still owed on the nonrecourse loan. Bari's use of nonrecourse financing facilitated abandonment of the transaction. Finally, Bari's use of nonrecourse financing and the fact that Bari had no reasonable possibility of *573 economic profit on the equipment led us to conclude that Bari's real expectations of profit from the transaction rested on hoped-for tax benefits. Coleman II, 59 P-H Memo T.C. par. 90,099 at 449, 454,
By Order dated December 19, 1989, we denied petitioners' request to call Mr. Hartmann and Mr. Lyons to give additional testimony on residual value at a second trial. We determined that Mr. Hartmann's and Mr. Lyons' testimony would have been needlessly cumulative in light of our opinion in Coleman II. We also denied petitioner's motion for an order directing respondent to show cause why the residual value of the Bari IBM 370 equipment, with respect to the IBM 370-135 equipment, was not governed by
OPINION
Petitioners seek reconsideration of several different aspects of our opinion. Petitioners' *574 arguments often overlap because the focus of each argument is ultimately an objection to our determination that the June 1983 residual value of the Bari equipment could not reasonably have been expected to equal or exceed $ 6,500,000. We have attempted to separate the principal objections and address each separately. We find that none of petitioners' arguments persuade us that we should grant their motion for reconsideration.
1.
Petitioners contest our conclusion that the residual value of Bari's IBM 370 equipment (excluding 370-155 equipment) is not governed by the residual value found for computer equipment in
In
In August 1975, executives of the
We held that the
Petitioners in this case attempt to invoke collateral estoppel against respondent. See
Petitioners have failed to show that all five conditions for application of collateral estoppel have been met. Specifically, petitioners have shown neither that the issue with respect to the residual value of the
We reject petitioners' argument that Mr. Withington's partial reliance on a May 1975 report concerning IBM 370-145 equipment when projecting the residual values of the IBM 370-145 equipment in
Furthermore, assuming arguendo that petitioners showed all five conditions for application of collateral estoppel had been met, we would not agree that the resulting residual value would justify a determination that Bari had a possibility of recouping its investment or profiting on the transaction. First, petitioners misread
2.
Petitioners contest our reliance on Mr. Withington's residual value testimony in determining the residual value of the Bari equipment. Again, petitioners' objection is multi-faceted. First, petitioners maintain that we rejected Mr. Withington's testimony in
Because of his use of the May 1975 report, petitioners claim that we rejected Mr. Withington's testimony in
However, that statement did not constitute rejection of Mr. Withington's residual value testimony. Indeed, we stated:
we do not view [Mr. Withington's] testimony as inconsistent with our finding but instead attribute the discrepancy to the fact that the report may have been prepared prior to the dissemination of rumors about IBM's abandonment of the FS program or to Mr. Withington's more conservative approach. [
We note that Mr. Withington's residual value projection of 9 to 17 percent in
Intertwined with the argument discussed above, petitioners reiterate their contention that in other respects Mr. *583 Withington's testimony at the evidentiary hearing discredited his testimony in Coleman I. When we adopted and incorporated the factual findings of Coleman I, we, implicitly if not explicitly, reaffirmed our determination that Mr. Withington's residual value testimony in that case remained more reliable and useful than Mr. Hartmann's residual value projection.
Mr. Withington relied on his contemporaneously prepared reports to determine a 1983 residual value for each type of equipment in the Bari portfolio. Those residual values were a projected percent of the purchase price, with a range of uncertainty unique to each type of equipment. Mr. Withington then calculated the aggregate residual value by summing the midpoints of his ranges for each type of equipment and allowing an aggregate range of uncertainty of plus or minus 10 percent.
In contrast, Mr. Hartmann's opinion was not predicated upon contemporaneous market information. Mr. Hartmann extrapolated residual value using a three-step method. First, Mr. Hartmann estimated the remaining economic useful life of the types of equipment in the Bari portfolio as of 1975. Second, Mr. Hartmann drew straight-line approximations of declining residual value curves for each type of equipment. The curves started with residual values of 100 percent in June 1975, declining to a zero residual value at the end of *585 the estimated useful life. Mr. Hartmann then projected a range of residual value for the Bari equipment from the straight-line approximations which resulted from aggregation of the approximated straight-line rates of decline for each type of equipment. Mr. Hartmann could not adequately explain why his straight-line approximation should predict residual values as accurately as residual value curves prepared using information available in 1975. Coleman I, 56 P-H Memo T.C. par. 87,195 at 946,
After a review of the records in Coleman I and Coleman II with particular emphasis on Mr. Withington's post-trial upward revisions, we adhere to our determination that Mr. Withington's methodology and results were more reliable with respect to residual value than that of Mr. Hartmann. Mr. Withington did not apply his methodology to his revisions in Coleman II. However, we found the reasons for any upward revision in residual value reasonable. *586 been based on reports prepared in 1975, as were Mr. Withington's.
Moreover, we remain convinced that Mr. Hartmann's residual value projection of between $ 2,467,000 and $ 8,580,000 would have had minimal usefulness to an investor in 1975 because of its broad range in relation to an investment of $ 1,900,000. Indeed, Mr. Hartmann testified *587 that his range would likely have been narrower if based upon residual value range projections prepared close to the time of the Bari transaction in June 1975. We recognize that uncertainty and volatility in projecting future residual values often limits expert opinions to ranges of values, as asserted by petitioners. See, e.g.,
The utility of this prediction is further discredited by Hartmann's testimony that he could not say whether any particular value within this range was more likely to occur than any other value within the range. [Coleman I, 56 P-H Memo T.C. par. 87,195 at 938, 947,
3.
Approaching our residual value determination from yet another angle, petitioners claim that we improperly looked to the midpoint of Mr. Withington's and Mr. Hartmann's residual value ranges rather than to the maximum of such ranges when determining if the Bari *588 transaction should be recognized for Federal tax purposes. *589 Mr. Hartmann projected a residual value ranging from $ 2,467,000 to $ 8,580,000. The midpoint of that range, $ 5,523,300, is approximately $ 1 million less than the amount of the balloon payment. [Coleman II, 59 P-H Memo T.C. par. 90,099 at 449, 452,
According to petitioners, it is improper for this Court to find that the residual value which could reasonably have been expected upon entering into a computer leasing transaction is equal to any specific value, particularly the midpoint of a range. Petitioners' arguments on brief assume that we equated the midpoint of projected residual value ranges with thatR B residual value which could reasonably have been expected. We disagree that we articulated such a "midpoint test" and with petitioners' contention that we must not determine specific residual values, as opposed to residual value ranges. Initially, petitioners fail to recognize that in Coleman I we did not find that the residual value of the Bari equipment was equal to the midpoint of ranges projected by either Mr. Withington or Mr. Hartmann. The sole issue in Coleman II was whether petitioners could show that there had been such a material change *590 in the facts as to residual value from those found in Coleman I that our decision in Coleman I should not be controlling. Petitioners failed to satisfy that burden. We incorporated the factual findings of Coleman I and followed our decision in Coleman I that Bari could reasonably have expected the 1983 residual value of the Bari equipment to be within the
Further, we are under no obligation to accept the maximum of any expert's projected range of residual values. Inquiries into whether a purported computer sale/leaseback has economic purpose apart from tax benefits, or whether the benefits and burdens of ownership have passed to the purported investors, are inherently factual.
We rely upon expert testimony to determine what residual value could reasonably have been expected at the time the transaction was initiated.
the question is not who was correct in predicting the actual residual value of the computer equipment in 1984; rather, the question is what was reasonable to believe in 1977 with respect to what the residual value of the computer equipment would be in 1984. * * * [
The opinions of all experts must be weighed in light of each expert's qualifications and all other relevant evidence of value.
On the other hand, a determination that the methodology and results of one expert are more reliable than those of an opposing expert does not require us to accept that expert's maximum projected residual value. See
Mr. Withington testified at trial and at the hearing in Coleman II that the midpoint of his projected residual value range was the most likely value. We found Mr. Withington's methodology more reliable with respect to residual value than Mr. Hartmann's. Our conclusion pertaining to methodology did not change after consideration of the record in Coleman II. In view of those facts, had we concluded we should accept a higher residual value for the Bari equipment than determined in Coleman I, the record would have supported a residual value equal to the midpoint of Mr. Withington's revised residual *593 value range.
Moreover, even had we completely rejected Mr. Withington's residual value testimony and relied upon Mr. Hartmann's projection, the record would not support a determination that the residual value was equal to the maximum of the range projected by Mr. Hartmann. Again we emphasize that Mr. Hartmann's methodology was not based upon residual value information available at the time of the Bari transaction. Mr. Hartmann could not say whether any value within his $ 6,000,000 range was more likely. Moreover, Mr. Hartmann admitted that, had he used contemporaneously prepared residual value projections, his projected range would have been narrower. Upon such a record, we could not say that Bari could reasonably have expected a residual value equal to the maximum of Mr. Hartmann's residual value range. At most, the record would have justified a finding that Bari could reasonably have expected a residual value approaching the value in the middle of Mr. Hartmann's range. Thus, the language to which petitioners object refers to a residual value which, had we rejected Mr. Withington's testimony in Coleman I, we would have found to be reasonable and supported by the record. We *594 reject petitioners' proposition that we articulated a bright line standard which looks only to the midpoint of a range of projected residual value in such instances.
Furthermore, relevant case law does not establish a rule requiring that we look only to the maximum of projected residual value ranges, or solely to ranges rather than specific residual values, when deciding whether a purported sale/leaseback transaction should be recognized for Federal tax purposes. Generalizing about evaluation of expert testimony on residual value may be difficult because the inquiry is factual and necessarily turns on the quantity and quality of evidence in any particular case. However, petitioners impute an unwarranted meaning to cases in which we did not determine a specific residual value or in which we looked to the maximum of a range of projected residual values.
Often the record in a particular case reveals that the maxima of ranges of residual values expected by participants in computer leasing transactions are clearly supported or clearly unreasonable. In such cases, we are unwilling to perform an unnecessary determination of a particular residual value.
Moreover, on occasion our determination is made upon a record containing expert testimony projecting specific residual values. For example, projections of residual value in a placement memorandum led investors to expect residual values of $ 15,000, $ 39,680, and $ 80,000, respectively, on investments in the three computer-leasing transactions in issue in
| Withington | Lyons | Morgan | |
| Mukerji investment | $ 18,500-$ 20,572 | $ 35,000-$ 46,000 | 0 |
| Hurchalla investment | 71,845 | 30,000- 50,000 | 7,600 |
| Thrall investment | 65,476 | 50,000- 81,000 | 4,000 |
We *596 found Ms. Morgan's testimony less reliable than Mr. Withington's and Mr. Lyons' testimony, primarily because her opinion was not based upon contemporaneous residual value forecasts or market information.
Petitioners contend that only broad ranges of residual value are reliable because of the uncertainty in estimating future values. We are under no obligation to accept broad ranges for residual values merely because of the inherent uncertainty in residual value forecasts. Other expert testimony which projects a narrower range or a specific value may contain greater indicia of reliability. In that respect, we further distinguish cases in which we have accepted broad ranges of residual value. See, e.g.,
Recitation of the facts surrounding our examination of residual value testimony in further computer sale/leaseback transaction cases would serve no useful purpose. We decline to accept petitioners' contention that we must look solely to the maximum residual value projections contained in a record. On the contrary, *598 in all cases we must make a determination as to what residual value could reasonably have been expected. See, e.g.,
4.
In order to impeach Mr. Withington's residual value testimony, petitioners make a proffer of additional residual value testimony by Mr. Hartmann. Petitioners also make a proffer of new testimony on residual value by Mr. Lyons. Mr. Hartmann's proffer is substantially similar to his testimony in Coleman I, with two major revisions. First, Mr. Hartmann incorporates Mr. Withington's revision with respect to scrap value. Second, Mr. Hartmann increases his residual value projection for IBM 360 plug-compatible memory equipment based upon a newly discovered document which Mr. Hartmann prepared in 1975. The net effect is to revise Mr. Hartmann's residual value projection upward. Mr. Lyons' proffer of testimony is substantially similar to that of Mr. Hartmann.
It is inappropriate *599 to reopen the record to receive testimony which is merely cumulative or impeaching.
Moreover, we reiterate our conviction that the outcome of the case would not change were we to reject Mr. Withington's testimony and rely on the testimony of Mr. Hartmann or Mr. Lyons. In determining whether investors in a computer sale/leaseback transaction could reasonably expect to recoup their investment or make a profit, we must consider not only residual value, but also the amount of a taxpayer's investment, the expected or guaranteed income *600 flowing from computer leases, and expenses such as broker's fees.
The Bari transaction involved a large balloon payment on nonrecourse purchase money debt due at the end of the Bari-CIG Products lease. Bari had an agreement to pay CIG Products the lesser of 50 percent of the net proceeds or 125 percent of the expenses upon sale or re-lease of the equipment at the end of the lease. Initially, we looked to see if the sum of the residual value which Bari could reasonably have expected at the time the balloon payment was due plus expected income flows from the equipment were greater or less than the amount of the balloon payment. *601 residual value plus income from the lease was substantially less than the amount of the balloon payment, no possibility existed for Bari to recoup its investment or make a profit. Further computations taking CIG Products broker's fee into consideration were, therefore, unnecessary.
Petitioners apparently assume that the question of Bari's ability to recoup its investment or to make a profit would be resolved in their favor, if we relied upon the testimony of Mr. Hartmann or Mr. Lyons to find that a reasonable expectation of residual value equaled or exceeded $ 6,500,000. However, in such an instance, the CIG Products broker's fee would come into play to reduce the figure for net profit or loss.
The manner in which profit or loss on the Bari transaction should be computed is demonstrated in the Appendix. The computations there set forth show that with a residual value of $ 6,500,000, an apparent profit of $ 32,240 could have been obtained. However, that figure does not take into account the broker's fee which Bari would owe to CIG Products *602 for resale or release, and therefore we consider such an apparent net profit illusory. A possibility of profit on the transaction existed only if the residual value of Bari's equipment approached 30 percent or greater, figures in the outer limits of the range projected by Mr. Hartmann (and the range discussed in Mr. Lyons' proffer of testimony). Again, the fee arrangement to CIG Products would come into play to reduce such apparent profits. Moreover, even if CIG Products' fee did not reduce apparent profits, and even if we relied solely upon Mr. Hartmann's testimony, this record still does not support a residual value equal to, but not less than, the upper limits of Mr. Hartmann's range. Thus, the outcome of the case would not change.
5.
It is appropriate at this point to consider whether petitioners are collaterally estopped from denying that our decision in Coleman I is correct. Petitioners contend that our Order allowing the evidentiary hearing constituted a determination that collateral estoppel cannot apply against them. On the contrary, consideration of collateral estoppel was merely placed *603 in abeyance until resolution of the issues pertaining to compliance with the subpoena in Coleman I.
As we stated previously, collateral estoppel prevents parties from relitigating issues previously decided but relating to a different tax year.
Nonetheless, the fact that all other conditions for collateral estoppel are met is highly persuasive. The issue of the residual value of the Bari equipment in Coleman II is identical to the issue resolved in Coleman I. Petitioners were parties who actually litigated the issue of residual value in Coleman I. The residual value of the Bari equipment was essential *604 to our decision in Coleman I that Bari did not have sufficient benefits and burdens of ownership for Federal tax purposes. Finally, as we have explained at length, petitioners have failed to show that the controlling facts with respect to residual value have materially changed from those in Coleman I and applicable legal rules remain unchanged. See
A further trial at this point would not be in the best interests of judicial economy or the doctrine of stare decisis. Litigation involving petitioners and the residual value of the computer equipment in the Bari transaction has consumed 3 years and has been the subject of four opinions. In light of this Court's lengthy consideration of the record regarding residual value, petitioners cannot complain that they have been denied the opportunity for a fair trial. At this point, it is appropriate that the record stand and the parties accept our determination with respect to residual value or appeal.
6.
Petitioners object to the imposition of the increased rate of interest on substantial underpayments attributable to tax-motivated transactions, pursuant to
An inquiry into the economic substance of a sale/leaseback transaction is essentially an "analysis of the objective factors indicating whether the transactions had a reasonable opportunity of producing a profit, exclusive of tax benefits."
In the present case, we found the purchase price to reflect the fair market value of the Bari equipment. Bari and CIG Products negotiated at arm's length, and Bari apparently *606 adhered to the terms of the transaction, although CIG Products twice ceased making its lease payments.
However, proof that a possibility of profit existed using the residual value would provide the requisite economic substance.
However, even were we to reconsider our decision on economic substance, we would still find that petitioners are liable for the increased rate of interest found in
We found that Bari was not the owner of the computer equipment in the Bari portfolio for Federal tax purposes. Thus, Bari had a zero basis in the computer equipment. Petitioners' claimed deductions *608 reflect an overstatement in adjusted basis of an infinite amount. Accordingly, petitioners' underpayment, substantially greater than $ 1,000, is attributable to a tax-motivated transaction within the meaning of
To summarize, petitioners' motion to reconsider is denied in its entirety. Our decision in Coleman I is controlling on all issues which that case resolved pertaining to the Bari transaction. In addition, the language of our opinion is amended to the extent necessary to replace the figure $ 50,240 with the figure $ 32,240, wherever such figure appears.
APPENDIX
POSSIBILITY OF PROFIT AT VARIOUS RESIDUAL VALUES FOR THE BARI EQUIPMENT