Bail Bonds by Marvin Nelson, Inc. v. C.I.R.

• Decision Date: 08 July 1987
• Docket Number: No. 86-7519,86-7519
• Citation: 820 F.2d 1543
• Parties: -5272, 87-2 USTC P 9410, 23 Fed. R. Evid. Serv. 789 BAIL BONDS BY MARVIN NELSON, INC., a corporation, Petitioner-Appellant, v. COMMISSIONER OF the INTERNAL REVENUE SERVICE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 1543

820 F.2d 1543

60 A.F.T.R.2d 87-5272, 87-2 USTC P 9410,

23 Fed. R. Evid. Serv. 789

BAIL BONDS BY MARVIN NELSON, INC., a corporation, Petitioner-Appellant, v. COMMISSIONER OF the INTERNAL REVENUE SERVICE, Respondent-Appellee.

No. 86-7519.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted April 15, 1987.

Decided July 8, 1987.

Ondrej Kojnok, San Jose, Cal., for petitioner-appellant.

Roger M. Olsen, Michael L. Paup, Robert A. Bernstein, Nancy G. Morgan, Washington, D.C., for respondent-appellee.

Appeal from the United States Tax Court.

Before CHOY, Senior Circuit Judge, GOODWIN and TANG, Circuit Judges.

CHOY, Senior Circuit Judge:

Bail Bonds by Marvin Nelson, Inc., appeals the tax court's decision upholding the denial by the Commissioner of the Internal Revenue Service of certain tax deductions. We affirm.

BACKGROUND ¹

Marvin Nelson was a bail bondsman licensed in the state of California. In 1969, Nelson became a tax planning client of Harry Margolis. Under Margolis' guidance, Nelson's business was incorporated as Bail Bonds by Marvin Nelson, Inc. ("Bail Bonds"). Nelson was Bail Bonds' sole shareholder and president during the years at issue.

In devising tax planning for his clients, Margolis arranged a variety of transactions between entities controlled by or under the effective control of Margolis, and entities (such as Bail Bonds) set up by Margolis' clients. The Margolis organization referred to these entities as "system entities" because of their involvement with the Margolis tax planning "system."

Transactions between Margolis' clients and the system entities were recorded in a "system account." The account was an informal record of money paid into the system by the client, transactions undertaken with that money by the system entities, and money paid out of the system to the client. A "circulating" transaction occurred when funds were passed among system entities, with no money coming into or going out of the system.

I. Farila and Anglo Dutch Transactions

On May 11, 1969, Nelson executed a reinsurance agreement with Farila, N.V., a Netherlands Antilles corporation, whereby Farila purportedly undertook to become secondarily liable for Bail Bonds' losses arising from bail bond forfeitures. ² Farila was a system entity effectively controlled by Margolis. As it turned out, Farila never actually reimbursed Bail Bonds for any forfeitures incurred by Bail Bonds.

Bail Bonds made two premium payments to Farila: 1) $19,019.43 on March 20, 1970, and 2) $26,403.55 on May 12, 1971. In order to make the premium payments, Bail Bonds obtained two loans from Anglo Dutch Capital Corporation ("Anglo Dutch"). Anglo Dutch, a California corporation, was a system entity directly controlled by Margolis. The loans were as follows: 1) $15,000 on March 20, 1970, and 2) $25,000 on May 10, 1971. Bail Bonds issued promissory notes to Anglo Dutch, all stating a ten percent interest rate.

The proceeds of the $15,000 loan were in essence transferred from Bail Bonds to Farila and then shortly thereafter transferred to Nelson personally. ³ The tax court characterized the transfer as "part of the pre-arranged transfer of funds designed to produce a corporate level deduction for [Bail Bonds] with the monies transferred ending up in the hands of [Nelson]." The loan was apparently paid off in three installments to Anglo Dutch in 1970-71.

The proceeds from the $25,000 loan were circulated in the space of a few days as follows: 1) $25,000 loan entered in Bail Bonds' books; 2) $26,403.55 check issued by Bail Bonds to Farila as a premium payment; 3) $26,403.55 check deposited in Farila's bank account; 4) $25,000 transferred from Farila's bank account to Anglo Dutch's bank account. Thus, the $25,000 loan from Anglo Dutch circulated right back into Anglo Dutch's hands.

A separate money transfer was arranged in order for Bail Bonds to pay off the $25,000 Anglo Dutch loan. In late 1973, two bank accounts were set up in the name of Bail Bonds: account number 00020-16963 ("account 16963") and account number 00020-10161 ("account 10161"). ⁴ Each account was opened with a $100 deposit advanced by the Margolis office. On December 26, 1973, a check for $27,000--payable to Bail Bonds and signed by Nelson--was written on account 16963. At that time the account contained only $100. The check was deposited in account 10161. On the same day, a check for $26,693 payable to Anglo Dutch was drawn on account 10161. This amount served to pay off the $25,000 Anglo Dutch loan. On December 27, this series of transactions was belatedly funded by the deposit of a $27,000 check into account 16963. The source of these funds is not reflected in Bail Bonds' records. However, the system account maintained by the Margolis office for a system entity called Aruba Bonaire Curacao Trust Co., Ltd. ("ABC") shows a $27,000 loan to Nelson on December 27, 1973. Nelson was unable to recall this loan at trial, no promissory notes were introduced at trial to substantiate Nelson's liability for the loan, and no evidence was submitted to show that this loan was repaid to ABC. Thus, it is apparent that the $25,000 Anglo Dutch loan was paid off by circulating $27,000 from ABC to Anglo Dutch.

On its federal income tax returns for 1970, 1971, and 1973, Bail Bonds deducted the reinsurance payments to Farila and the interest payments to Anglo Dutch. The payments to Farila were deducted as ordinary and necessary business expenses pursuant to I.R.C. Sec. 162(a). The interest payments to Anglo Dutch were deducted pursuant to I.R.C. Sec. 163(a). The Commissioner of the Internal Revenue Service (the "Commissioner") disallowed the deductions. Bail Bonds petitioned the tax court for a redetermination of the deficiencies assessed by the Commissioner.

II. Proceedings of the Tax Court

In 1979, the case was tried in the tax court before Judge William H. Quealy. After the case was tried and briefed, but before the findings of fact and law were filed, Judge Quealy retired. The case was reassigned to Special Trial Judge Fred R. Tansill, who granted Bail Bonds' motion for a new trial.

Before the first trial, the parties had jointly moved for an order incorporating into the record the testimony of Alfred Harris, a former Margolis employee, given before the tax court in a previous unrelated case. The tax court granted the motion, treating it as a stipulation. At the second trial, the tax court denied Bail Bonds' request to withdraw the stipulation.

The tax court in the second trial held that the reinsurance agreement with Farila was a sham "designed to disguise a scheme of creating deductions by shifting money back and forth from one party to another through various intermediaries, all of which acted under the effective control or direction of Margolis."

In concluding that the Anglo Dutch loans were also shams, the tax court relied heavily on the sham nature of the Farila agreement. The court stated that "[i]f ... the [Farila] Agreement lacks economic substance, the loan will also be tainted." More specifically, the court found that the funds from Anglo Dutch were not valid loans creating obligations to pay deductible interest. The funds instead were ultimately returned without consideration to Anglo Dutch or Nelson. Thus, the court determined that the loan "proceeds merely circulated through various intermediaries as part of the scheme to create expense deductions for [Bail Bonds] and to funnel cash into the hands of [Nelson]." The court concluded that the Anglo Dutch loans did not constitute genuine indebtedness, and sustained the Commissioner's disallowance of the interest deductions.

On appeal, Bail Bonds contends that the tax court's decision contained errors of law in three respects: (1) the judge in the second trial improperly relied on the transcript of the first trial; (2) in the second trial, the tax court improperly enforced the

stipulation regarding the testimony of Alfred Harris; and (3) the tax court erroneously upheld the disallowance of Bail Bonds' interest deductions for the Anglo Dutch loans.

DISCUSSION

I. Second Trial Judge's Reliance on Transcript of First Trial

Bail Bonds argues that the trial judge in the second trial erred as a matter of law by reading the transcript from the first trial and relying on the transcript in rendering his decision. Where a judge is unable to complete his or her duties at a trial, a new trial ordinarily must be held if no findings of fact and conclusions of law have been filed. See Townsend v. Gray Line Bus Co., 767 F.2d 11, 17-18 (1st Cir.1985). Thus, it would be improper if, as Bail Bonds alleges, the tax court used the transcript of the first trial to dispose of the case. However, Bail Bonds has provided no evidence that the tax court simply used the prior transcript to decide the case. Rather, it appears that the court admitted parts of the transcript from the first trial, with reference to the relevant evidentiary rules. ⁵

The trial court's admission into evidence of parts of the prior trial's transcript is reviewed for abuse of discretion. See Arrow-Hart, Inc. v. Philip Carey Co., 552 F.2d 711, 713 (6th Cir.1977). There is no indication in the record that the tax court abused its discretion in this case. Specifically, there is no indication that the tax court's admission of parts of the first trial's transcript was in violation of the applicable rules of evidence. See generally Azalea Fleet, Inc. v. Dreyfus Supply & Machinery Corp., 782 F.2d 1455, 1460-61 (8th Cir.1986) (prior trial testimony admissible if in compliance with relevant evidentiary rules).

II. Stipulation From First Trial

Bail Bonds contends that, in the second trial, the tax court erred in enforcing the stipulation regarding the Harris testimony entered into during the first trial. Stipulations to the tax court are governed by Rule 91 of the Tax Court Rules of Practice and Procedure. Rule 91(e) states that: "The [Tax] Court will not...