762 F.2d 361 (4th Cir. 1985), 84-5085, United States v. Mallas

Docket Nº84-5085(L), 84-5258.
Citation762 F.2d 361
Party NameUNITED STATES of America, Appellee, v. James G. MALLAS; Robert V. Jones, Jr., Appellants. (Two Cases)
Case DateMay 20, 1985
CourtUnited States Courts of Appeals, Court of Appeals for the Fourth Circuit

Page 361

762 F.2d 361 (4th Cir. 1985)

UNITED STATES of America, Appellee,


James G. MALLAS; Robert V. Jones, Jr., Appellants. (Two Cases)

Nos. 84-5085(L), 84-5258.

United States Court of Appeals, Fourth Circuit

May 20, 1985

Argued Feb. 6, 1985.

R. Stan Mortenson, Washington, D.C. (Jonathan B. Sallet, Miller, Cassidy, Larroca & Lewin, Washington, D.C., on brief), for appellants.

Deborah Wright Dawson, Dept. of Justice, Tax Division, Washington, D.C. (Glenn L. Archer, Jr., Asst. Atty. Gen., Washington, D.C., Charles R. Brewer, U.S. Atty., Asheville, N.C., Michael L. Paup, Robert E. Lindsay, Dept. of Justice, Tax Division, Washington, D.C., on brief), for appellee.

Before SPROUSE and WILKINSON, Circuit Judges, and HAYNSWORTH, Senior Circuit Judge.

WILKINSON, Circuit Judge:

Defendants appeal from their convictions for evasion of federal income taxes. We find that their contested business practices raise novel questions of tax liability to which governing law offers no clear guidance. Because the defendants therefore could not have ascertained the legal standards applicable to their conduct, criminal proceedings may not be used to define and punish an alleged failure to conform to those standards. We reverse the convictions.


James G. Mallas and Robert V. Jones, Jr., investment counselors in Charlotte,

Page 362

North Carolina, began in 1977 to design a tax shelter program based on deductions allowed to participants in coal-mining enterprises. Mallas, as sole shareholder, formed Genesis Leases, Inc., for the corporate purpose of locating and purchasing leases of coal property in Kentucky. Jones, as sole shareholder, formed Trinity Properties, Inc., which would sublease the coal rights from Genesis for $3.40 per extracted ton. Trinity would then re-sublease its rights to individual investors for $3.50 per extracted ton. These investors would contract to pay Trinity an advance minimum royalty during each year for the four-year lease period. In return, Trinity warranted that economically recoverable coal in the leased property was sufficient to permit the investor to recoup his advance minimum royalties; if the coal reserves proved to be inadequate, Trinity promised to supplement the lease with other property that would allow for complete recoupment. Finally, Mallas, as sole shareholder, formed Omega Energy, Inc., to purchase from the individual investors, for specified royalties, their rights to mine coal. Omega would then mine and market the coal, either by itself or by subcontract.

Omega Energy also served an important purpose in the financial structure of Mallas and Jones's tax shelter program. The investor, who was obligated to pay Trinity an individually negotiated advance minimum royalty, had to pay at least 2/7 of that amount from personal funds. The investor could then, if he wished, borrow the remaining 5/7 from Omega in exchange for a non-recourse promissory note secured by the investor's subleased mineral rights. As Omega mined and sold each ton of coal, it would retire the non-recourse note by retaining half of the royalty that it owed the investor. Omega financed these loans by borrowing Trinity funds that had been accumulated from the investors' initial personal payments. Through such loans by Trinity to Omega and by Omega to the investors, 1 Omega was able to fund 5/7 of every electing investor's obligation to Trinity without an outside source of funding.

According to its promoters, the Mallas-Jones program offered significant tax savings to prospective investors. Under Treasury Regulation Sec. 1.612-3(b)(3), the advance minimum royalty was deductible at the taxpayer's option either when the royalty was paid or when the coal was mined and sold. For a deduction taken at payment, an investor who had received an Omega loan for 5/7 of the royalty obligation would receive $3.50 of deduction for every $1.00 invested. This opportunity attracted fifty-three investors to the leasing venture in 1977, and Mallas...

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