Rybak v. Comm'r of Internal Revenue
| Decision Date | 07 September 1988 |
| Docket Number | 24994-85,24683-86,24301-86,40665-86.,25054-85,25009-85,22292-86,45776-85,22868-85,25062-85,14094-86,22869-85,29693-86,25025-85,3759-86,25040-85,38662-85,19775-85,22909-85,1792-86,17034-85,22905-85,24968-85,8838-86,Docket Nos. 3544-85,7882-86,25015-85 |
| Citation | 91 T.C. 524,91 T.C. No. 36 |
| Parties | FRANCIS J. RYBAK AND JOYCE A. RYBAK, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Some of the petitioners entered into four different transactions, all of which were ‘generic tax shelters.‘ HELD: The transactions lacked economic substance, and are to be disregarded for Federal income tax purposes. Further, such transactions are ‘tax motivated transactions‘ under section 6621(c). Some of the petitioners also entered into a container leasing transaction, but failed to show that they were entitled the deductions and credits claimed. Some of the petitioners also entered into a franchise program to provide financial services, but petitioners failed to show they were entitled to the deductions claimed. Additions to tax under sections 6653 and 6659 determined. John M. Moore, for the petitioners.
Robert J. Kastl and James D. Hill, for the respondent.
These consolidated cases were assigned to Special Trial Judge Marvin F. Peterson pursuant to section 7456(d) 2 (redesignated as section 7443A(b) by the Tax Reform Act of 1986, Pub. L. 99-514, sec. 1556, 100 Stat. 2755), and Rules 180, 181 and 183. 3 The Court agrees with and adopts his opinion which is set forth below.
These consolidated cases were selected by counsel and approved by the Court to serve as test cases for resolving issues common to a group of approximately 500 petitioners who invested in several programs marketed by Structured Shelters, Inc. Appendix B lists the docket numbers, petitioners, tax years involved, deficiencies, additions to tax and increased interest determined for each year.
The issues for decision are (1) whether and to what extent petitioners are entitled to deductions and credits with respect to their investments in various master recordings; (2) whether and to what extent petitioners are entitled to deductions and credits with respect to their investments in Cocoa, Ltd.; (3) whether and to what extent petitioners are entitled to deductions and credits with respect to their investments in Preservation Research, Ltd. 1981; (4) whether and to what extent petitioners are entitled to deductions and credits with respect to their investments in Comprehensive Computer; (5) whether and to what extent petitioners are entitled to deductions and credits with respect to their investments in Lortin Leasing; (6) whether and to what extent petitioners are entitled to deductions and credits with respect to their activities as chartered representatives of SSI; (7) whether petitioners are liable for additions to tax under sections 6653(a) and 6659; and (8) whether petitioners are liable for additional interest pursuant to section 6621(c). 4
Some of the facts have been stipulated and are so found. The stipulations of fact, and exhibits attached thereto, are incorporated herein by this reference.
In 1979, Robert Iles, Sr. (Iles) began organizing Structured Shelters, Inc. (SSI) with the intent of using SSI to provide a nationwide tax investment planning system. Clients were solicited to use a financial analysis system created by SSI and to invest in various tax advantaged investments. SSI contacted investors and also used sales agents, called chartered representatives, to market its products. Chartered representatives are persons or entities which obtained the right to represent SSI in a specific geographic area. The fundamental goal of chartered representatives was to enroll clients in the SSI system.
Once enrolled in the SSI system, each client created an investment company as a sole proprietorship. Next, the investment company executed a Declaration of Trust, naming SSI as trustee. SSI was given absolute and exclusive power and authority to manage trust property and conduct the trust's affairs, without the consent of the beneficiaries, so long as the trustee and an agent concurred. The purpose of the trust was to allow SSI to acquire properties for the client. SSI believed that the trusts would protect the beneficiaries from personal liability with respect to any specific investment and ‘prove to the IRS and the SEC that the Buyer has retained a qualified offeree representative.‘
SSI and its clients also executed management agreements which provided that the client would pay commissions in the amount of 1% of his Adjusted Gross Income on a quarterly basis, and 10% of the cash proceeds received from any SSI recommended investment. The client was also required to timely submit all necessary information to update the client's financial statement on a quarterly basis. All of the commissions were payable to SSI in Cincinnati, Ohio. SSI promised, inter alia, to search out and recommend investments and defend any action by the Internal Revenue Service in the Tax Court at SSI's expense.
The first product provided for new clients was a Random Report. A Random Report is a statement of the client's financial condition and is the result of a computer analysis of certain financial and personal data provided by the client. The raw data was entered into the chartered representatives' computer and transmitted to the SSI mainframe computer. SSI's program analyzed the data and issued the report which calculated a budget and suggested various tax-advantaged investments. The cost for the initial Random Report was $155. Clients were required to update their reports quarterly at a cost of $20 per update.
During 1981, SSI marketed the Free Enterprise Trust investment program which consisted of a package of fur investments. Three of those four investments (The Children's Classics Series (Master Recording), Preservation Research and Development (Preservation Research) and The Nitrol Container (Lortin Leasing)) are at issue in this action, as well as several other programs that were marketed by SSI.
For convenience, our remaining findings of fact and opinion will be combined and grouped according to the program to which they relate.
In the music industry the term master recording refers to the original recording of a performance. These performances are usually recorded on tape. To mass market a master recording, the original recording is transferred to a ‘lacquer‘, by which grooves are cut into an acetate disc. The lacquer goes through an electroplating process in which it is sprayed with silver and dipped in nickel, and a different metal component called a ‘mother‘ is peeled off. 5 The mother undergoes an additional electroplating process which results in the creation of a mold, called a ‘stamper‘. Disc records are made by injecting a compound into the mold.
On October 19, 1981, SSI and Western Educational Systems Technology (WEST) entered into an agreement whereby SSI, on behalf of its investors, agreed to purchase 50 master recordings for $6,250,000. WEST agreed to produce the masters within 40 days after SSI made a $125,000 down payment. The balance of the purchase price consisted of SSI's assigning a receivable in the amount of $170,000 to WEST and the further assignment of notes that were to be given to SSI by its investors in the recordings. However, soon after the contract was executed, the parties agreed to substitute Oxford Productions (Oxford) for SSI.
On October 29, 1981, WEST and Oxford executed a Master Purchase and Security Agreement whereby Oxford purchased the masters at issue for a total price of $454,120 per master. The terms included a down payment of $7,000 in cash, and Oxford signed a purported recourse note in the amount of $447,120. Monthly note payments, from the proceeds, were to begin on January 1, 1982. The first three years of payments would be considered payments of principal, with interest to be computed on the unpaid principal balance at the end of the third year. The stated purchase price of each master, after a reduction for imputed interest on the deferred payments, was $250,000. Hal Landers and Phyllis Kapp, brother and sister, executed the agreement on behalf of WEST and Oxford, respectively.
On October 28, 1981, SSI and Oxford agreed that SSI would serve as Oxford's leasing agent for the masters. SSI would receive 20% of the proceeds from any lease generated by SSI as Oxford's agent. On October 29, 1981, Oxford agreed to lease the 50 masters to SSI for $400,000 and provide SSI with two copies of each master prior to November 15, 1981. SSI agreed to re-lease the masters prior to December 31, 1981. Oxford acknowledged the receipt of $295,000, which consisted of a $125,000 check and the aforementioned $170,000 receivable. The balance of $105,000 due on the lease was paid by the use of a note which was due June 30, 1982, or when funds were collected. In exchange for acting as the leasing agent SSI retained $100,000 of the $125,000 payment.
The master recordings at issue were produced for WEST by Lewis Merenstein Productions (Merenstein). To receive payment, Merenstein submitted invoices for work that had been performed. In the earliest invoice, dated ‘as of November 31, 1981,‘ Merenstein billed WEST $1,685.50 each, for three album tapes and metal parts. None of the three invoices is for work performed on any of the masters at issue herein. The invoice indicates that the three were ‘plated‘ in November of 1981. The next invoice is dated ‘as of May 31, 1982‘, and consists of a bill for 51 album tapes and metal parts at $1685.50 each. Twenty-four of these titles have an ‘S‘ designation, which indicates that those masters were produced for SSI.
During 1982, George Shea (Shea) wrote scripts for approximately 90...
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