16 F.3d 821 (7th Cir. 1994), 92-1902, Coleman v. C.I.R.

Docket Nº:92-1902, 92-1903.
Citation:16 F.3d 821
Party Name:Delbert W. COLEMAN and Karen A. Graham, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
Case Date:February 23, 1994
Court:United States Courts of Appeals, Court of Appeals for the Seventh Circuit
 
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16 F.3d 821 (7th Cir. 1994)

Delbert W. COLEMAN and Karen A. Graham, Petitioners-Appellants,

v.

COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

Nos. 92-1902, 92-1903.

United States Court of Appeals, Seventh Circuit

February 23, 1994

Argued May 4, 1993.

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[Copyrighted Material Omitted]

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David J. Fischer, Stuart E. Horwich, Roger A. Pies (argued), Zapruder & Odell, Washington, DC, for petitioners-appellants.

Richard Farber, Gary R. Allen, Bridget Rowan, Frank P. Cihlar (argued), Dept. of Justice, Tax Div., Appellate Section, Washington, DC, for respondent-appellee.

Before CUDAHY, FLAUM, and KANNE, Circuit Judges.

CUDAHY, Circuit Judge.

These consolidated tax appeals involve a 1975 computer sale and leaseback transaction between Bari Associates (Bari) and CIG Computer Products, Inc. (CIG Products). Delbert W. Coleman 1 is one of twenty-two limited partners in Bari, a Connecticut limited partnership. As a result of the transaction, Bari reported substantial losses in the tax years 1975 and 1976, primarily based on depreciation expenses that exceeded income. Coleman and the other Bari investors allocated these losses among themselves and applied them as deductions in computing their respective federal income taxes. The Commissioner of Internal Revenue challenged these deductions on the grounds that the transaction was a sham and lacked economic substance, that Bari lacked sufficient benefits and burdens of ownership to be treated as the owner of the computer equipment for tax purposes and that Bari did not enter into the transaction with an intent to make a profit. Coleman filed timely petitions challenging the Commissioner's disallowance of the Bari deductions for 1975 and 1976. Each of these tax years was addressed in a separate proceeding before the Tax Court, and in each instance the court upheld the Commissioner's disallowance. Coleman v. Commissioner, 53 T.C.M. (CCH) 598, 1987 WL 40311 (1987) (Coleman I ); Coleman v. Commissioner, 58 T.C.M. (CCH) 1525, 1990 WL 17274 (1990) (Coleman II ). Coleman now appeals these adverse rulings, which have been consolidated for purposes of appeal. We affirm.

I. Background

Bari was a limited partnership formed in 1974, to which Coleman contributed $150,000 in 1975. On June 30, 1975, Bari entered into an agreement with CIG Products to purchase over 1,900 pieces of computer equipment. 2

At the time Bari purchased this computer equipment, 90% of the equipment was under lease from CIG Products to third parties, with the remaining equipment available to be leased. Further, the computer equipment purchased by Bari was subject to bank liens not in excess of $21,000,000. Despite these significant liens, Bari agreed to pay a purchase price of $25,000,000 for the equipment and to subordinate its security interest to the bank liens.

Bari agreed to pay $1,900,000 in cash as a downpayment, with the remaining $23,100,000 of the purchase price in the form of a nonnegotiable, nonrecourse promissory note. Terms of the note required Bari to repay the note in installments over the course of eight years with a final "balloon payment" of $6,500,000 due on June 30, 1983. The note was accompanied by a security agreement under which CIG Products' only recourse was to the equipment itself, with Bari and the limited partners having no personal liability.

At the time of sale, Bari leased the equipment back to CIG Products for a period of eight years, paralleling the term of the note. In addition, the lease allowed Bari to set off rental payments due from CIG Products against its obligations under the promissory note. Under this arrangement, the rent payable by CIG Products covered all of Bari's monthly note payments except the final $6,500,000 balloon payment, and also provided Bari with an additional $1,950,240, or $50,240

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after recouping the downpayment, prior to the balloon payment.

Further, the arrangement between Bari and CIG Products was a "net" lease, under which CIG Products was obligated to pay not only rent but also taxes and any expenses connected with repairs or with damage, destruction or loss of the equipment. Broad provisions of the lease made CIG Products responsible "for all costs and expenses of any nature whatsoever, arising out of or in connection with or related to this Lease or the Equipment," unless specifically provided otherwise. CIG Products also agreed to insure the equipment to its full value and to hold Bari harmless and indemnify it from any liabilities arising from the equipment.

The lease also granted CIG Products broad powers over the equipment, including the power to dispose of any or all of it, provided similar equipment was substituted. In addition, CIG Products could enter into commercially reasonable subleases extending beyond the term of the Bari lease and subject the equipment to additional liens. 3

These sale and leaseback arrangements generated heavy losses for Bari in 1975 and 1976, allocable to its limited partners including Coleman. The Commissioner challenged Coleman's deductions of the losses, resulting in the Tax Court cases that are the subject of this appeal.

  1. Coleman I Litigation

    In Coleman I, the Tax Court disallowed the 1976 deduction, holding that Bari had not acquired sufficient benefits and burdens of ownership of the computer equipment to be treated as an owner for federal tax purposes.

    Coleman I relied heavily on expert testimony with respect to the residual value of the computer equipment at the end of the lease term. The government expert, Frederic Withington, testified that, due in part to the technical advances that quickly make computer equipment obsolete, a 1975 investor would have estimated the 1983 residual value to be between $1,892,093 and $2,292,093. On the other hand, Coleman's expert, Svend Hartman, did not believe that a 1975 investor would predict that the equipment would become obsolete as rapidly as did Withington. Hartman testified that in 1975 he would have projected a 1983 residual value between $2,467,000 and $8,580,000. 4 The Tax Court found Withington's testimony more credible than Hartman's because Withington presented what the Tax Court believed to be more reliable evidence, and the range of Hartman's estimates was too broad to be of practical value.

    Using Withington's low estimates of residual value--far less that the $6,500,000 balloon payment--Bari could have had no intention of making the final payment and taking possession of the equipment at the end of the lease period. Any loss or gain accruing to Bari would result from the fixed periodic payments under the contract and have no relation to the equipment itself. Thus the Tax Court concluded that Bari did not acquire sufficient benefits or burdens to be treated as the owner of the equipment.

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    Subsequently, Coleman moved to reopen the record or, in the alternative, to hold an evidentiary hearing to determine if the record should be reopened to receive new evidence. Before the trial in Coleman I, Withington, under subpoena, had produced documents prepared by him in connection with his testimony. After Coleman I and during the Coleman II litigation, Coleman discovered documents that Withington had not produced in response to the subpoena in Coleman I. Coleman argued that this new evidence suggested a residual value estimate as of 1975 that would be markedly higher than what Withington had indicated at trial.

    In a separate opinion denying these motions, the Tax Court rejected Coleman's characterization of the missing documents. Coleman v. Commissioner, 57 T.C.M. (CCH) 493, 1989 WL 52685 (1989). The court concluded that the new evidence was in fact consistent with Withington's testimony. As a result, the Tax Court refused to reopen the record because the evidence was merely cumulative and impeaching. Edgar v. Finley, 312 F.2d 533 (8th Cir.1963); Kithcart v. Metropolitan Life Ins. Co., 119 F.2d 497, 500 (8th Cir.1941), cert. denied, 315 U.S. 808, 62 S.Ct. 793, 86 L.Ed. 1207 (1942).

  2. Coleman II Litigation

    Coleman's federal income tax deductions for 1975 were addressed in a separate proceeding before the Tax Court. Coleman II. The Tax Court, however, ordered Coleman to show cause why the decision of Coleman I should not control the decision in this second case. In response, Coleman pointed to the documents that Withington had failed to produce pursuant to a subpoena in Coleman I. Coleman argued that this evidence justified a new trial. Coleman also sought to call two witnesses to give additional expert testimony regarding residual value.

    The Tax Court in Coleman II held an evidentiary hearing to resolve the issues of Withington's subpoena compliance. At the hearing, Withington explained that he had not produced the documents in question because they were either cumulative, redundant or not relevant to the equipment at issue. After reviewing the evidence, the Tax Court agreed and determined that additional expert testimony regarding these documents would also be needlessly cumulative or irrelevant. Accordingly, the court denied Coleman's request to call expert witnesses for additional rebuttal testimony on the residual value issue.

    During the evidentiary hearing, Withington revised his prior testimony with respect to the residual value of the computer equipment. Instead of arriving at a residual value estimate of $1,892,093 to $2,292,093, as he had at trial in Coleman I, Withington now estimated a residual value of $3,550,193 to $4,339,125. These revisions were based upon sources that were not available to Withington at the time of Coleman I and also reflected the inclusion of an allowance for the scrap value of the equipment. While the Tax Court conceded that these revisions weakened Withington's...

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