Karme v. Comm'r of Internal Revenue

Decision Date24 March 1980
Docket NumberDocket No. 3059-73.
Citation73 T.C. 1163,6 Fed. R. Evid. Serv. 1079
PartiesALAN B. KARME and LAILA M. KARME, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
CourtU.S. Tax Court

OPINION TEXT STARTS HERE

Held, a series of transactions whereby petitioner Alan B. Karme purportedly borrowed money to purchase stock did not create a genuine indebtedness with the result that petitioners are not entitled to a deduction in 1969 under sec. 163, I.R.C. 1954, for a purported $60,000 interest payment. Harry Margolis, W. Palmer Kelly, Richard Gladstein, and Maureen O'Connell, for the petitioners.

John E. Lahart and William E. Bonano, for the respondent.

FEATHERSTON, Judge:

This case was tried before Special Trial Judge Lehman C. Aarons pursuant to Rule 180, Tax Court Rules of Practice and Procedure. His report was served on the parties. Petitioners filed exceptions, and respondent filed a brief in response to petitioners' exceptions. After careful consideration, the Special Trial Judge's report, which is set forth below, is adopted with minor modifications.

REPORT OF THE SPECIAL TRIAL JUDGE*AARONS, Special Trial Judge: Respondent determined a deficiency in petitioners' Federal income tax for 1969 in the amount of $29,626 and an addition to tax of $1,481 under section 6653(a).1 After concession of the negligence penalty by respondent on brief, the only issue remaining for decision is whether $60,000 is deductible as interest in 1969.

A constitutional objection raised by petitioners has already been disposed of. Petitioners' constitutional claim was originally presented in the form of a motion for summary judgment. Near the close of trial, with leave of the Court, the motion for summary judgment was withdrawn by petitioners, who were granted permission to embody their constitutional objection in an amendment to their petition. The matter was disposed of when the Court granted respondent's motion to strike the amendment for reasons set forth in a Memorandum Sur Order dated October 27, 1978. This memorandum is a part of the record herein and fully sets forth the positions of the parties with respect to the constitutional issue as well as the Court's disposition of the matter.

In the opening brief in this case, filed after trial and after the Court's order striking the amendment, petitioners' counsel again raised certain arguments with respect to the motion for summary judgment and the Court's granting of respondent's motion to strike. A short response to these arguments is in order.

Petitioners' counsel requested that the motion for summary judgment be reinstated, apparently only insofar as it related to the merits of the case. They contend that if the Court accepts as true the allegations in the affidavits accompanying the original motion, judgment should be entered for petitioners on factual grounds. However, the Court specifically stated at trial that it would accept the allegations contained in the affidavits as true only for purposes of passing upon the constitutional claim and not as dispositive of any ultimate fact relating to the merits of the case. Furthermore, if we were to treat the request contained in petitioners' brief as a motion to reinstate the motion for summary judgment, it would be within the Court's discretion to deny it. We can see no purpose in considering a motion for summary judgment at this late point, after full trial on the merits of the case. Moreover, a dispute exists as to certain of petitioners' factual allegations, contained in the affidavits, which relate to the substance of the transactions involved in this case.

Counsel for petitioners also argued that the Court denied petitioners due process by striking the amendment to the petition without first holding an evidentiary hearing. As indicated in the Memorandum Sur Order, in ruling on respondent's motion to strike, the Court accepted as true (for purposes of that motion) the factual allegations contained in petitioners' amendment to petition and in Margolis' affidavit in opposition to the motion. Petitioners have alleged no new facts which would cause the Court to alter its position as set forth in the memorandum. Under these circumstances, petitioners are not entitled to an evidentiary hearing. Cf. Cohen v. United States, 378 F.2d 751, 760 (9th Cir. 1967), cert. denied 389 U.S. 897 (1967); Fed. R. Civ. P. 43(e).

FINDINGS OF FACT

Some of the facts in this case have been stipulated and those facts are so found. The stipulation of facts and the exhibits attached thereto are incorporated herein by reference.

Petitioners Alan B. Karme (hereinafter petitioner) and Laila M. Karme (Laila) resided in Pasadena, Calif., when they filed their petition in this case. They filed their return for 1969 with the Internal Revenue Service Center, Ogden, Utah.

During 1969 and 1970, petitioners were husband and wife. Petitioner was a licensed physician, practicing medicine as a psychiatrist in the State of California. At the same time, Laila was concluding specialized medical studies as a licensed physician.

In October 1969, petitioners sought tax and estate planning advice from Elaine B. Fischel (Fischel), an attorney who maintained offices in southern California. On November 20, 1969, Fischel met with Harry Margolis (Margolis), an attorney with whom she was associated and who maintained offices in the San Francisco Bay area. They discussed possible tax planning ideas which could be employed by petitioners in 1969. Margolis developed a plan, explained below, which was acceptable to petitioners. Although Margolis played so significant a role in petitioners' tax affairs, petitioners did not meet him until 1972. Instead, they dealt largely with Fischel in her southern California office, and with Neil Eskind (Eskind), an associate of Fischel. The fee for the planning services of Margolis and his associates was agreed to be in toto one-third of any tax savings achieved, plus costs.

The tax plan developed by Margolis involved basically the payment of $600,000 by petitioners to World Minerals, N.V., a Netherlands Antilles corporation, for the purchase of 40,000 shares of common stock of Associated Care Enterprises (Care), a Delaware corporation operating in the health care field. Petitioners were to borrow the $600,000 from Alms, N.V., another Netherlands Antilles corporation, and to pay the first year's interest on the loan, $60,000, before the close of 1969.2 In addition, a trust was to be established for petitioners with Aruba Bonaire Curacao Trust Co., Ltd. (ABC Trust Co.), located in the Bahamas, as part of the comprehensive tax plan.

Care was incorporated in 1969 for the express purpose of combining a number of convalescent hospitals and pharmacy enterprises. It was to acquire or lease six such facilities in exchange for a total of 1 million shares of its stock and 30,000 stock purchase warrants.3 Care also planned to make a public offering of an additional 250,000 shares of common stock at $15 per share, which would have brought the net tangible book value of each share to $4.93, up from $2.42 before the proposed public offering. The original registration statement for this public offering was submitted for the approval of the Securities and Exchange Commission in September 1969.

In April 1969, Care contracted to purchase four of these six facilities from Associated Convalescent Enterprises (Convalescent), a California corporation. (Fischel was president of Convalescent at this time and owned all of the stock of Maryelle Corp., Convalescent's parent. Margolis, who had been Convalescent's consultant and legal counsel since its inception in 1967, represented it in this matter.) As part of the consideration for the sale of the four facilities, Convalescent received 282,334 shares of unregistered Care stock. These shares were placed in escrow pending the transfer of the health care facilities to Care. Escrow agreements involving the various facilities were not closed until early 1970.

Fischel, as president of Convalescent, executed (at the instruction of Margolis) three investment letters, addressed to Care and dated October 15, 1969, which covered these unregistered shares. Each letter stated that the shares—-

are being acquired by me for my own account and interest for investment and not with a view to distribution. The undersigned further agrees that he will make no resale of any of said securities unless said shares are registered with the Securities and Exchange Commission or are exempt from such registration.

If such securities are sold in an exempt transaction, I agree that such sale will not be made until I have (1) advised you of the basis of the exemption, (2) obtained an opinion of counsel, satisfactory to you, that such transfer is in conformance with the preceding paragraph and will not violate federal or state securities laws, and (3) secured and delivered to you an investment letter, similar to this, from the transferee.

Convalescent had previously entered into an “Agreement for Sale of Real Property,” dated September 1, 1969, with World Minerals. (World Minerals was a Netherlands Antilles corporation originally organized at Margolis' request to serve as a foreign vehicle for investments of certain of his clients.) This agreement provided for the sale by World Minerals to Convalescent of certain real property underlying a portion of one of the facilities which Convalescent had contracted to convey to Care. The consideration for this sale was set at $400,000—-$364,000 to be paid to World Minerals and $36,000 to be paid to Behar Corp., a creditor of World Minerals.

In spite of the terms of the October investment letters, Convalescent had also granted World Minerals, under this real property sales agreement, the right to purchase certain shares of Care stock. After stating that Convalescent expected to receive a substantial interest in Care, the agreement provided in part as follows:

ACE (Convalescent) agrees to set aside for WORLD ...

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