Casa De La Jolla Park, Inc. v. Comm'r of Internal Revenue

• Decision Date: 13 March 1990
• Docket Number: Docket No. 28972-87.
• Citation: 94 T.C. No. 23,94 T.C. 384
• Parties: CASA DE LA JOLLA PARK, INC., A CALIFORNIA CORPORATION, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

94 T.C. 384

94 T.C. No. 23

CASA DE LA JOLLA PARK, INC., A CALIFORNIA CORPORATION, Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 28972-87.

United States Tax Court

Filed March 13, 1990.

C, a California corporation, was organized by M, a Canadian citizen and U.S. nonresident, to market time-share units in a 15-unit condominium. M held a promissory note from C which bore interest at 28 percent. B, a California bank, collected the proceeds from the time-share sales for C. R, a Canadian bank, had made substantial loans to M. As collateral for these loans, R held M's stock in BR, a Canadian public company of which M was president. When BR went into the Canadian equivalent of Chapter 11 bankruptcy reorganization, R sought further assurance of collection of M's debts. Accordingly, C directed B to remit to R directly the net proceeds of the time-share notes, otherwise due and payable to C. Held, C was responsible as a withholding agent under sec. 1441(a) for withholding tax on M's interest income. Tonopah & T.R. Co. v. Commissioner, 112 F.2d 970 (9th Cir. 1940), revg. 39 B.T.A. 1043 (1939), distinguished. Held further, we do not reach the issue of whether C is excepted from withholding responsibility under sec. 1441(c)(1) because it failed to meet the requirements of sec. 1.1441-4(a), Income Tax Regs. Chris John Wenthur, for the petitioner.

Sylvia L. Shaughnessy, for the respondent.

WRIGHT, JUDGE:

By notice of deficiency dated June 1, 1987, respondent determined deficiencies in petitioner's withholding of Federal income tax at source for taxable years ending December 31, 1982, and December 31, 1983, of $48,981 and $79,236, respectively.

The issues for decision are: (1) whether petitioner was responsible under section 1441(a) ¹ for withholding tax on interest income of its nonresident alien sole shareholder, and if so, (2) whether petitioner is excepted from liability under section 1441(c)(1) for not withholding the tax because the interest income item at issue was effectively connected with the conduct of a trade or business within the United States.

FINDINGS OF FACT

Some of the facts of this case have been stipulated and are so found. The stipulation of facts, together with the exhibits attached thereto, is incorporated herein by this reference.

Casa De La Jolla Park, Inc. (hereinafter referred to as petitioner) was incorporated under the laws of the State of California. Petitioner's principal place of business was in La Jolla, California, when it filed its petition in this case.

In early 1981, Donald J. Blake Marshall (Marshall), a Canadian citizen and nonresident of the United States, was approached by the principals of Versatyme Controls Corporation (Versatyme), a California corporation, who were seeking ‘bridge financing‘ for a property Versatyme intended to acquire and market on a time-share plan. Marshall, an engineer by training, was the president of Blake Resources Ltd. (Blake Resources), a Canadian public company that was involved in oil and gas exploration. Marshall was interested in investing in the United States because of what he perceived as a declining political climate in Canada for wealthy persons. Marshall had already made several investments in the United States -- as a limited partner in a small California real estate development and in a California farming operation, and had participated in the development of a Colorado shopping center.

Versatyme was interested in acquiring a 16-unit motel located in La Jolla, California (the La Jolla property). Marshall negotiated with Versatyme until April 1981, when he agreed to participate in the project. During that time, Marshall was somewhat involved in the development of marketing strategies for the time-share project, as well as negotiations with the project manager. Rather than advancing Versatyme the funds, however, Marshall decided to purchase the property himself and give Versatyme the option to buy the property from him. In order to shield himself individually from potential liability arising from the project, Marshall decided to hold the La Jolla property through a corporate entity. Accordingly, Marshall incorporated DJBM of California (DJBM), a California corporation, on April 10, 1981. Marshall initially capitalized DJBM with $10,000. The business purpose of DJBM was to acquire the La Jolla property and convert it into 15 condominiums to be sold as 750 time-share units (15 units for 50 one-week periods).

On April 10, 1981, Marshall, in his individual capacity, borrowed $1,000,000 from the Royal Bank of Canada (Royal Bank). The loan was to be repaid over a 5-year term. In a letter to Marshall dated April 10, 1981, the Royal Bank required a guarantee of the loan by Marshall's Canadian company, Battle Bend Holdings Ltd., as well as the hypothecation of 828,000 shares of Marshall's stock in Blake Resources. During 1981 and early 1982, Blake Resources stock was trading on the Toronto Stock Exchange at approximately $8 per share. The Royal Bank also required Marshall to assign all his shares of DJBM stock as security for the loan, as well as all his rights and interests in all of the time-share promissory notes from third parties as such notes were executed.

Marshall acquired 100 shares of DJBM on April 14, 1981, with the $1,000,000 loan proceeds from the Royal Bank. Also on April 14, 1981, DJBM acquired the La Jolla property for $1,000,000. DJBM acquired the property by Versatyme's assignment of its existing escrow rights in the property. Prior to its assignment to DJBM, and through arrangements with the seller of the property, Versatyme made certain improvements to the property. On April 14, 1981, DJBM was assigned as the insured on the policy covering the La Jolla property.

Simultaneously with DJBM's April 14, 1981, acquisition of the La Jolla property, Marshall granted Versatyme an exclusive option to acquire all of his DJBM stock. Under the option agreement, Marshall granted Versatyme the right to acquire all the stock for $1,200,000 in notes secured by deeds of trust and one-third of the ‘net venture profits‘ as defined in the option agreement. Versatyme had until June 16, 1981, to exercise the option. Thereafter, Versatyme received an extension of time to exercise its option. Between April 1981 and November 1981, Marshall advanced approximately $600,000 more to DJBM for the time-share project. Marshall also borrowed these funds from the Royal Bank.

On November 17, 1981, Versatyme exercised its option to purchase Marshall's DJBM stock and gave Marshall a promissory note for $1,200,000 payable in 60 monthly installments at an annual 15 percent interest rate, plus a percentage of profits upon the sale of the time-share units. At that time, Silverado Investments, Inc., which owned all of the stock in Versatyme, guaranteed Versatyme's obligation to Marshall and as collateral granted him a security interest in all of the issued and outstanding shares of Versatyme. Versatyme also granted Marshall a deed of trust in the La Jolla property for the purpose of securing Versatyme's promissory note to Marshall.

The sale and purchase agreement covering Versatyme's exercise of its option detailed specific provisions relating to the collection and disbursement of all cash, time-sharing promissory notes, time- share promissory note proceeds, and time-share trust deeds relating to the La Jolla property. By an agreement dated November 23, 1981, amending the sale and purchase agreement, the Bank of California (BankCal) was named as the collection agent for the collection and disbursement of the proceeds from the time-share notes and trust deeds. The sales and purchase agreement called for BankCal to make the following distributions of its collected proceeds:

1. to Marshall for the principal and interest due on the $1,200,000.00 promissory note from Versatyme;

2. to Versatyme for maintaining the operating reserves as provided in the budget;

3. to Versatyme, but only upon the written consent of Marshall; and 4. to Versatyme and Marshall pursuant to the terms of the earnout agreement.

Between November 30, 1981, and January 1, 1982, Versatyme closed sales on 154 time-share units, resulting in 143 time-share notes receivable and 11 cash sales. The 143 time-share notes, endorsed to Marshall as security for Versatyme's promissory note, were then endorsed in favor of BankCal under the terms of the collection and disbursement provisions.

In January 1982, Versatyme was unable to meet its obligation to Marshall on the promissory note. In anticipation of Versatyme's default, Marshall formed another California corporation, petitioner herein, to continue marketing the time-share units. On January 14, 1982, Marshall purchased all of the issued stock of petitioner (100 shares) for $10,000.00. Marshall was petitioner's sole shareholder and director. Petitioner acquired all of Marshall's interests and rights to the La Jolla property in exchange for a promissory note (shareholder loan) from petitioner to Marshall in the amount of $1,627,335 with interest at 28 percent per annum. The amount of the shareholder loan was based upon Marshall's total expenditures for the La Jolla property as of that time -- $1,000,000 for the purchase of DJBM stock and his additional advances to DJBM. By a reconveyance agreement dated January 15, 1982, petitioner also acquired all of Versatyme's rights to the La Jolla property in return for a release of Versatyme's obligations to Marshall.

By letter dated January 21, 1982, Versatyme's attorney advised BankCal of the transfer of rights in the La Jolla property by Versatyme to petitioner. Petitioner requested BankCal to continue its collection functions relating to the La Jolla property. BankCal thereafter remitted to petitioner payments collected on the time- share notes until August 1982. Petitioner continued to market the remaining time-share units until all the units were eventually sold.

In April 1982,...