Larsen v. Comm'r of Internal Revenue
| Decision Date | 30 December 1987 |
| Docket Number | Docket No. 32893-83 |
| Citation | 89 T.C. 1229,89 T.C. No. 87 |
| Parties | VINCENT T. LARSEN AND LOUISE LARSEN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
P, an individual, entered into four separate transactions with F concerning the sale and leaseback of certain computer equipment. Each transaction, individually identified as the A, H, IRV 1 and IRV 2 Transaction, was subject to prior leases between F and certain end users. The purchase price of each transaction was paid with a recourse note and a nonrecourse installment note. Each purchase agreement required that P assume a certain portion of nonrecourse indebtedness incurred by F to acquire the equipment. Such assumption by P did not increase the amount of the purchase price. The assumed amount, as determined by F, was the amount necessary in each transaction to provide P with an at risk amount necessary to deduct losses without limitation under sec. 465. P and F also entered into certain remarketing agreements and residual sharing agreements. P elected the half-year convention method of depreciation for the taxable year ended 1979.
HELD, the H and the A Transactions are determined to be shams devoid of economic substance which shall be disregarded for Federal income tax purposes. HELD FURTHER, the IRV 1 and IRV 2 Transactions are imbued with economic substance and shall be recognized for Federal income tax purposes where P acquired the benefits and burdens of ownership. HELD FURTHER, P acquired a present depreciable interest in the IRV 1 and IRV 2 Transactions. HELD FURTHER, P was entitled to deduct interest paid with respect to each recourse note and with respect to the nonrecourse installment notes in the IRV 1 and IRV 2 Transactions. HELD FURTHER, P was at risk within the meaning of sec. 465 with respect to the recourse notes in the IRV 1 and IRV 2 Transactions. HELD FURTHER, P was not at risk within the meaning of sec. 465 with respect to the assumed amounts within the assumption agreements. HELD FURTHER, P was not entitled to depreciate the computer equipment acquired in the IRV 1 and IRV 2 Transactions pursuant to the half-year convention method of depreciation for the taxable year ended 1979 because he was subject to the limitation as provided in sec. 1.167(a)- 11(c)(2)(iv)(c), Income Tax Regs. HELD FURTHER, P is liable in each transaction for an amount of additional interest determined pursuant to sec. 6621(c). Thomas F. Topel, J. Marquis Eastwood, Kenneth L. Cutler, and Maureen H. Parkinson, for the petitioners.
Randall G. Durfee and Joel A. Lopata, for the respondent.
Respondent determined deficiencies in petitioners' 1 Federal income tax as follows:
+----------------+
¦Year¦Deficiency ¦
+----+-----------¦
¦1979¦$33,087 ¦
+----+-----------¦
¦1980¦55,280 ¦
+----------------+
The primary issues for our determination are whether petitioner's transactions with respect to certain computer equipment were structured as a tax-avoidance scheme devoid of economic substance which should be disregarded for Federal income tax purposes and whether petitioner acquired the benefits and burdens of ownership. Subsidiary issues for our determination are (1) whether the ownership interest acquired, if any, was a present depreciable interest; (2) whether petitioner was entitled to deduct interest paid with respect to certain recourse and nonrecourse notes; (3) whether petitioner was at risk within the meaning of section 465 2 with respect to certain recourse notes and assumption agreements; (4) whether petitioner was entitled to elect the half-year convention method of depreciation for the taxable year 1979 and whether petitioner was entitled to use the double declining balance method of depreciation for certain computer equipment; and (5) whether petitioner is liable for an additional interest amount determined pursuant to section 6621(c). 3
Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference.
Petitioners resided in the State of Montana at the time their petitioner herein was filed.
Petitioner received a Bachelor of Science degree in petroleum geology from Texas Tech University. Petitioner is a geologist, petroleum exploration consultant and investor. Petitioner's investment experience relates primarily to investments in mineral interests and real estate. In addition to his own judgement, petitioner consults and relies on the judgement of his attorney Gary Everson for investment advice.
In four separate transactions that are the subject of this case, petitioner purchased 4 certain computer equipment manufactured by International Business Machines Corporation (‘IBM‘) and certain computer equipment manufactured by Honeywell Information Systems, Inc. (‘Honeywell‘).
Finalco is the principal subsidiary of Finalco Group, Inc., formerly Financial Analytics Corporation, a publicly-held corporation, the stock of which is traded over-the-counter and reported in NASDAQ quotations. The principal offices of Finalco and Finalco Group, Inc., are located in McLean, Virginia. During the years in issue, Finalco was a closely-held company.
During the years in issue, Finalco typically engaged in leasing transactions involving electronic data processing equipment in which Finalco negotiated and entered into a lease with an end-user, purchased the equipment, financed the purchase with a lending institution, and resold the equipment in a sale and leaseback transaction with an independent third party. The resale of the equipment provided Finalco with much of the capital necessary to generate additional lease transactions. In addition to generating transactions through its own marketing programs, Finalco also acquired equipment subject to existing end-user leases from other leasing companies. During its fiscal year ending June 30, 1979, Finalco entered into lease transactions of approximately $129,000,000 based on the original cost of equipment. John F. Olmstead (‘Olmstead‘) was president of Finalco at the time petitioner entered into the transactions.
Lease Pro, Inc., (‘Lease Pro‘) is a Montana corporation engaged in the purchase, sale and leasing of computer equipment. Lease pro has served as a general partner in a partnership that leases personal property, other than computer equipment, and owns an interest in a leased building. During the years in issue, Lease Pro was owned by J. L. DuBois (‘DuBois‘) and Dean Schennum (‘Schennum‘). DuBois acted as the sales agent at Lease pro. Schennum acted as business manager and administrator. DuBois and Schennum are also the principals in DuBois- Schennum Assoc., Ltd., a Montana corporation organized in August of 1980, and registered with the National Association of Securities Dealers (‘NASD ‘) for the purpose of acting as a broker-dealer. Lease Pro acted as sales agent for Finalco in the pursuit to locate investors. Lease pro received a commission in the amount of ten percent of the equity investment, including cash and any recourse note. During 1979 and 1980, Lease pro's revenue attributable to Finalco arranged computer lease transactions approximated 90 percent of all revenue it earned. Lease pro had no shareholders, officers, directors, or employees in common with Finalco Group, Inc., its affiliates, or subsidiaries.
Petitioner purchased from Finalco certain peripheral computer equipment manufactured by IBM and Honeywell and subject to leases (‘End User Leases ‘) with independent third parties (‘End Users‘). Although there were four separate transactions, there were only three End Users: Hon Industries, Inc. (‘Hon‘), Anaconda Industries (‘Anaconda‘) and Irving Trust Company (‘Irving ‘), with Irving being the End User in two transactions. Each transaction shall be identified by reference to the End User as follows: the ‘Hon Transaction,‘ the ‘Anaconda Transaction,‘ the ‘Irving 1 Transaction,‘ and the ‘Irving 2 Transaction,‘ (the Irving 1 Transaction, and Irving 2 Transaction may sometimes collectively be referred to as ‘the Irving Transactions‘). The equipment purchased in each transaction shall be referred to as the ‘Hon Equipment,‘ ‘Anaconda Equipment,‘ ‘Irving 1 Equipment,‘ and ‘Irving 2 Equipment,‘ respectively. At times the pieces of peripheral equipment involved in those transactions will be referred to collectively as the ‘Equipment.‘
I. THE HON TRANSACTION
Finalco agreed to purchase the Hon Equipment from Honeywell pursuant to a Sale Agreement and Equipment Schedule (the ‘Honeywell Sale Agreement‘) executed by Finalco and Honeywell. The Honeywell Sale Agreement was dated August 29, 1979, by Finalco and January 18, 1980, by Honeywell. The Honeywell Sale Agreement required Honeywell to ship the Hon Equipment in September of 1979. According to Richard Meise (‘Meise‘), the executive who signed the Honeywell Sale Agreement on behalf of Honeywell, it was standard practice for Honeywell to ship goods after receiving a signed contract from a customer but before Honeywell executed the agreement. Honeywell shipped the Hon Equipment in September of 1979, as required by the Honeywell Sale Agreement. Hon accepted the Hon Equipment as installed and operational on September 15, 1979. Finalco was obligated to pay for the Honeywell equipment when it was shipped to Hon. Finalco acquired the Hon Equipment on September 15, 1979, the date of Hon's acceptance of such equipment and of the Honeywell Bill of Sale to Finalco.
Finalco leased the Hon Equipment to Hon pursuant to a Master Lease Agreement dated August 13, 1979, which was later amended on October 22, 1979, January 21, 1980, and March 15, 1980 (the ‘Hon Lease‘). The initial term of the Hon Lease was 60 months commencing September 15, 1979. The monthly rental was $1,963.83. The first amendment dated October 22, 1979, deleted items of equipment from the Hon...
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