Hager v. Comm'r of Internal Revenue

• Citation: 76 T.C. 759
• Decision Date: 14 May 1981
• Docket Number: Docket Nos. 11952-77,283-78.
• Parties: EDWARD B. HAGER and JANE E. HAGER, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENTCONSTANTINE L. HAMPERS and LAVONNE J. HAMPERS, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: United States Tax Court

76 T.C. 759

EDWARD B. HAGER and JANE E. HAGER, PETITIONERS

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENTCONSTANTINE L. HAMPERS and LAVONNE J. HAMPERS, PETITIONERS

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket Nos. 11952-77

283-78.

United States Tax Court

Filed May 14, 1981.

In 1971, Ps became limited partners of X. At the same time, X purchased 107 head of imported cattle from Y, a related entity, for $1,614,000. As consideration for the purchase, X paid $20,000 in cash, executed a short-term note for $529,000 on which it was liable, and executed a nonrecourse promissory note, secured by the cattle, for $1,065,000. In 1971, there was no established market price in the United States for such cattle, but during that year, such cattle normally sold in England for less than $1,000 per animal. Held:

1. The purchase price paid by X for the cattle was at least 3 times their value, and the nonrecourse note did not represent genuine indebtedness or an actual investment in property. Accordingly, Ps were not entitled to deduct their shares of interest paid by X on such note or their shares of depreciation attributable to the inclusion of the note in the basis for the cattle.

2. The purchase of the cattle by X was an activity not engaged in for profit under sec. 183, I.R.C. 1954. L. Joyce Hampers and Richard R. Endacott, for the petitioners.

Charles W. Maurer, Jr., and Peter J. Panuthos, for the respondent.

SIMPSON , Judge:

The Commissioner determined the following deficiencies in the petitioners' Federal income taxes:

+-----------------------------------------------------+
                ¦Petitioners                      ¦Year  ¦Deficiency  ¦
                +---------------------------------+------+------------¦
                ¦                                 ¦      ¦            ¦
                +---------------------------------+------+------------¦
                ¦Edward B. Hager                  ¦1971  ¦$10,345.57  ¦
                +---------------------------------+------+------------¦
                ¦Edward B. Hager and Jane E. Hager¦1972  ¦8,132.62    ¦
                +-----------------------------------------------------+
                

                                              1973 18,964.17
                Constantine L. Hampers and Lavonne J. Hampers 1971 13,731.00
                

 1972 2,971.00
                 1973 3,459.00
                

The Commissioner concedes that his determination of a deficiency in the tax of Dr. and Mrs. Hager for 1973 was the result of a mathematical error and that, in fact, Dr. and Mrs. Hager overpaid their tax for 1973 by $18,964.17. However, such taxable year remains in issue for determining whether Dr. and Mrs. Hager made a further overpayment in such year. The sole issue for decision is whether the petitioners were entitled to deduct any part of the losses reported in 1971 through 1973 by a partnership of which Dr. Hager and Dr. Hampers were limited partners and which was engaged in the purchase and breeding of South Devon cattle.

FINDINGS OF FACT

Some of the facts have been stipulated, and those facts are so found.

The petitioners, Edward B. and Jane E. Hager, became husband and wife in 1972. They resided in South Lyndeboro, N.H., when the petition in this case was filed. Dr. Hager filed his individual Federal income tax return for 1971, and Dr. and Mrs. Hager filed their joint Federal income tax returns for 1972 and 1973, with the Internal Revenue Service, Andover, Mass. The petitioners, Constantine L. and Lavonne J. Hampers, husband and wife, resided in Weston, Mass., when they filed their petition in this case. They filed their joint Federal income tax returns for 1971 through 1973 with the Internal Revenue Service, Andover, Mass. Dr. Hager and Dr. Hampers will sometimes be referred to as the petitioners.

Dr. Hager and Dr. Hampers are medical doctors who specialize in nephrology. Dr. Hager was involved in the development of kidney transplantation, and Dr. Hampers was involved in the development of the artificial kidney. Both doctors have been heavily involved in providing artificial kidney services throughout the country.

In 1971, Dr. Hager and Dr. Hampers became limited partners of the U.S. South Devon Co. (USSD), a partnership organized for the purpose of purchasing South Devon cattle from a related partnership, Big Beef Hybrid International Co. (Big Beef). During the 1960's and early 1970's, a variety of European breeds of cattle were introduced into the United States for the first time. It was not uncommon for such cattle to sell in the United States at a substantial premium over the purchase price in the exporting country. At the time, American cattlemen were seeking new genetic stock to improve their herds, and they were willing to pay high prices. In addition, there was a strong market in the country for domestic cattle and such market served to strengthen the demand for imported cattle.

The premiums paid for foreign cattle also reflected the time, expense, and risk involved in bringing such cattle into the country. The importer bore not only the cost of shipping the animals, but also the risk that in being transported from overseas the animals would become sterile as the result of stress or would injure themselves. In addition, in most cases, it was required that the cattle be quarantined for at least 30 days upon their arrival in the country to be sure they were free of disease. See 9 C.F.R. sec. 92.11-92.34 (1973).

During the 1960's, Canada established quarantine stations to facilitate the importing of cattle into North America. After being quarantined in Canada, cattle were permitted to enter the United States without further quarantine. See 9 C.F.R. secs. 92.11, 92.19-92.20. Most of the cattle brought to the United States from Europe during the late 1960's and early 1970's came through Canada.

Big Beef was formed as a limited partnership under Minnesota law in 1968. ¹ Its general partners were James D. Bishop, Arthur V. Palmer, J. Bruce Stevenson, and two corporations. At least one of the corporations, Stevenson Bishop McCredie, Inc., was controlled by Mr. Bishop and Mr. Stevenson. Big Beef was formed for the purpose of acquiring South Devon cattle, a breed of cattle native to England. From 1968 through 1970, using the Canadian facilities, Big Beef brought at least 69 South Devons into the United States and Canada.

In 1970, Dr. Hager approached Mr. Bishop of Big Beef on behalf of himself and Dr. Hampers concerning the possibility of making an investment in the imported South Devons. The petitioners did not know Mr. Bishop personally; Mr. Bishop had been recommended to Dr. Hager by a relative of Dr. Hager. Mr. Bishop gave Dr. Hager a written proposal in which Big Beef offered its entire herd (with the birth of new calves, 234 animals) “for sale with a leaseback * * * for 3 years.” The proposal set the price at $3 million and stated that half of the purchase price would be required in cash and half in the form of a nonrecourse promissory note secured by the cattle, that the sale would be made through USSD, and that Big Beef would be required to pay lease fees totaling $720,000. The proposal included a sample calculation of the return which could be expected by a limited partner of USSD. The calculation set forth the depreciation, interest, and other expenses which USSD would incur under the proposal. The calculation indicated that such expenses would be greater than the lease fees but that, nevertheless, the partners would realize a return on their contributions to USSD since USSD's expenses would be deductible from the income of the partners for Federal income tax purposes. The calculation did not indicate that the value of the herd would be likely to rise in the future, or that the nonrecourse note was to be repaid, or that aggregate lease fees under the 3-year lease and any future leases were ever expected to exceed aggregate expenses.

In promoting investments in South Devon cattle, Mr. Bishop told Dr. Hager and others that after the sale Big Beef intended to test the cattle thoroughly to establish the quality of the breed and to create demand for it. He stated that after the quality of the breed was established, Big Beef would market semen collected from the bulls; according to Mr. Bishop, there were no plans to market the animals themselves. Mr. Bishop also represented to Dr. Hager and others that Big Beef had acquired the exclusive rights to import South Devon cattle into the United States and that the value of such cattle, and of the semen of the bulls, would be likely to rise in the future. In considering the proposal, Dr. Hager did not obtain an independent appraisal of the cattle, or inspect the cattle, or seek to determine the prices at which South Devon cattle sold in England. He did discuss the proposal with his lawyer, and occasionally, he read publications of the cattle industry in an effort to educate himself.

During 1971, while Big Beef's proposal was outstanding, Big Beef was under commitment to ranchers to purchase cattle which had been sired by bulls owned by the company. Big Beef failed to fulfill all of its purchase commitments for such year. During 1971, Big Beef also lost whatever exclusive rights it may have had to import South Devon cattle, and in that year, at least one group of South Devons was imported by a Kansas rancher, William Scully. From the spring of 1971 to October 1971, agents for Mr. Scully selected 29 cows and 6 bulls in England, quarantined them for about 2 weeks in Glasgow, Scotland, flew them to Canada and quarantined them again there, boarded them on a farm in Canada for a short time, and brought them to Kansas. Dr. Hager was not aware in 1971 that Big Beef had lost its exclusive rights to the South Devon breed or that Big Beef had failed to fulfill its purchase commitments.

USSD was created by an agreement of limited partnership dated December 15, 1971 (the partnership agreement). The general partners were Mr. Bishop and Stevenson Bishop McCredie, Inc. Dr. Hager and Dr. Hampers executed the partnership agreement as limited partners, and they made a joint contribution of...