Kennedy v. C.I.R.

• Decision Date: 05 June 1989
• Docket Number: 88-1255,Nos. 88-1254,s. 88-1254
• Citation: 876 F.2d 1251
• Parties: -5030, 89-1 USTC P 9358 David L. KENNEDY (88-1254), Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. Joseph D. AUBERGER and Wanda Auberger (88-1255), Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 1251

876 F.2d 1251

64 A.F.T.R.2d 89-5030, 89-1 USTC P 9358

David L. KENNEDY (88-1254), Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

Joseph D. AUBERGER and Wanda Auberger (88-1255), Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

Nos. 88-1254, 88-1255.

United States Court of Appeals Sixth Circuit.

Submitted April 18, 1989.

Decided June 5, 1989.

William Randolph Klein, Sarasota, Fla., for David Kennedy, Joseph and Wanda Auberger.

Gary R. Allen, Chief, U.S. Dept. of Justice, Appellate Section Tax Div., William S. Rose, Jr., Mary Francis Clark, Gilbert S. Rothenberg, Dept. of Justice, Washington, D.C., for C.I.R.

Before WELLFORD and GUY, Circuit Judges, and BROWN, Senior Circuit Judge.

RALPH B. GUY, Jr. Circuit Judge.

Petitioners David L. Kennedy and Joseph and Wanda Auberger appeal the United States Tax Court's decision finding them liable for 1978 and 1979 tax deficiencies. The petitioners claim that the Tax Court erred by (1) disallowing their mining expense deductions as a consequence of its erroneous finding that the gold mining tax shelter in which they invested was a sham entered into for tax rather than profit motives, and (2) procedurally prejudicing their case. We find that the petitioners' claims lack merit and, accordingly, affirm the Tax Court's determinations.

Both Kennedy and the Aubergers participated in a tax shelter promotion entitled "Gold For Tax Dollars" (GFTD) sponsored by the International Monetary Exchange (IME). Kennedy invested $5,000 in the program in 1979. The Aubergers invested $4,000 in the promotion in 1978 and $4,000 again in 1979. The details of this promotion are discussed thoroughly in the Tax Court's opinion. ¹ In brief, the promotion offered investors the opportunity to lease small plots of gold bearing land in gold mining concessions in Panama (in 1978) and in French Guiana (in 1979 and 1980). Investors were not charged for IME's services in procuring leases or for the leases themselves. Instead, the taxpayers acquired the leases by paying cash plus the proceeds from non-recourse notes (in 1978) or the sale of options (in 1979 and 1980) ² to develop the mines. IME lured investors by heavily promoting the availability of immediate tax deductions in substantial multiples of the taxpayers' initial investments. For example, in 1978 IME advertised a four hundred percent tax shelter to high income investors based on each investor borrowing $3.00 for every $1.00 of cash invested and on paying the total funds out as development expenses that same year. IME also claimed that taxable income would only be generated if gold was actually mined and that the investors would control if and when gold on their plot would be mined.

After calculating his desired tax deduction, ³ an investor would pay IME up front twenty-five percent of his desired tax deduction and IME, in 1978, would agree to lend him the remaining seventy-five percent on a non-recourse basis with ten percent interest per annum. IME, as the investor's agent, allegedly would pay the entire sum to a mining contractor hired to prepare the investor's claim to the point at which gold could be extracted. IME assured investors via literature and a tax opinion letter that this procedure would render each investor a "miner" in 1978 for federal income tax purposes, enabling him to deduct, pursuant to section 616(a) of the Internal Revenue Code (IRC), 26 U.S.C. Sec. 616(a), ⁴ his initial sum plus the amount paid to the contractor as mine development expenses.

The 1979 and 1980 tax shelters essentially operated in the same fashion; however, an option arrangement was substituted for the non-recourse loan to the investor to preserve the deductibility of the expenditure. The investor again would invest cash equal to twenty or twenty-five percent of his desired tax deduction for that year. IME, as the investor's agent, sold to a third party an option to buy gold extracted from the investor's individual plot. The option price equalled the remaining seventy-five to eighty percent of the desired deduction but the option was exercisable only after the gold had been extracted and investors controlled when gold would be extracted. Again, IME would pay the full sum to a mining contractor and the investor deducted his cash investment plus the option sale proceeds in 1979 and/or 1980.

An IRS survey regarding GFTD disclosed that from 1978 through 1980, 3,025 investors claimed mining expense deductions of approximately $118,619,444. Among those investors, Kennedy claimed a deduction of $17,795 based on his $5,000 initial investment and on $12,795 invested and funded by the sale of an option. The Aubergers claimed a deduction of $20,000 in 1978 based on a $4,000 cash investment plus $16,000 obtained through a non-recourse loan. Similarly, in 1979 they claimed a $20,000 deduction based on a $4,000 investment coupled with $16,000 in proceeds from an option sale.

After examining the petitioners' income tax returns, the Commissioner issued notices of deficiency to them that disallowed their claimed mining deductions. The Commissioner indicated that the petitioners failed to demonstrate that they had acquired an interest in any mineral property, that mining expenses were paid, and that the mining transactions had actually occurred as alleged. The petitioners sought a redetermination of their tax liability and, while their petitions were pending before the Tax Court, that court decided Saviano v. Commissioner, 80 T.C. 955 (1983), aff'd, 765 F.2d 643 (7th Cir.1985). In Saviano, the court considered the tax consequences of the GFTD financing procedures and concluded that the 1978 mining expenses funded via non-recourse loans could not be attributed to the investor for federal tax purposes because repayment of the non-recourse note was, by its terms, too contingent to establish a true debt. Thus, the amounts of the non-recourse loans were not deductible as mining expenses. Similarly, the court concluded that because the 1979 and 1980 option arrangement did not create an unconditional right of acceptance in the offeree, it was not a true option. Therefore, investors had to include option sale proceeds as income in 1979 and 1980. Displeased with the Saviano ruling, which was rendered on cross-motions for summary judgment, petitioners in this case sought a trial to develop the facts more fully. Prior to trial, petitioners moved, unsuccessfully, to apply collateral estoppel or res judicata against the Commissioner on the basis of S.E.C. v. Rogers, 790 F.2d 1450 (9th Cir.1986). Thereafter, the petitioners' cases were consolidated with others for trial.

The Tax Court found that GFTD was a sham promotion that produced little more than a paper trail to support illegitimate tax deductions. The evidence disclosed that of roughly 3,000 mines leased by investors, only one was actually developed. The court recognized that the GFTD program here was identical to that in Saviano and, like the Saviano court, disallowed the mining expense deductions supported by the non-recourse loans and the option sales. Moreover, the Tax Court concluded that each taxpayer's initial cash investment was also an impermissible mining expense deduction because the GFTD promotion was not feasible as promoted, claimed expenditures were never made, and the investors never acquired any interest in mineral property. ⁵ In short, the Tax Court concluded that the promotion was a fraudulent sham and the investors were motivated by securing promised tax benefits and not by potential profit realization. Accordingly, the petitioners were also assessed increased interest, pursuant to 26 U.S.C. Sec. 6621(c), for substantial underpayment attributable to tax motivated transactions. That provision was enacted pursuant to the Tax Reform Act of 1986, Pub.L. No. 99-514, 100 Stat. 2085 (1986).

I.

We are cognizant that we are precluded from setting aside factual findings made by the Tax Court unless they are clearly erroneous. See 26 U.S.C. Sec. 7482 (which renders Rule 52(a) of the Federal Rules of Civil Procedure applicable to review of Tax Court decisions). Figgie Int'l, Inc. v. Commissioner, 807 F.2d 59, 63 (6th Cir.1986); Roth Steel Tube Co. v. Commissioner, 800 F.2d 625, 629 (6th Cir.1986), cert. denied, 481 U.S. 1014, 107 S.Ct. 1888, 95 L.Ed.2d 496 (1987). Legal determinations, however, are reviewable de novo.

Section 616(a) of the IRC, 26 U.S.C. Sec. 616(a), permits taxpayers to deduct "all expenditures paid or incurred during the taxable year for the development of a mine or other natural deposit (other than an oil or gas well) if paid or incurred after the existence of ores or minerals in commercially marketable quantities has been disclosed." To be a valid deductible mining development expense, the expense must have been paid to a mining contractor for its designated business purpose and not merely for tax avoidance. See generally Keller v. Commissioner, 725 F.2d 1173 (8th Cir.1984); Parker v. Commissioner, 86 T.C. 547 (1986). Notwithstanding petitioners' protestations to the contrary, there is no evidence showing that any amounts invested by the taxpayers were spent on mining development of their plots during 1978 or 1979. For example, the district court found that IME's expenses related to the Panama concession totalled $1,450 in 1978 and $49,500 in 1979 in contrast to investor claimed deductions of $13,012,329 for 1978 and $70,988,760 in 1979. Although the investors paid money to IME, there is no evidence showing that this money was, in fact, paid to a mining developer to develop their plots during the years at issue. That is, any development that was being done did not inure to the benefit of GFTD investors.

Pertinent treasury regulations provide that an actual interest in mining operations is necessary to deduct mining development expenditures. 26 C.F.R. Sec. 1.616-1(b)(3). The evidence here supports the trial...