Graf v. Comm'r of Internal Revenue

• Decision Date: 18 May 1983
• Docket Number: Docket Nos. 7888-80,9149-80.
• Citation: 80 T.C. 944
• Parties: WERNER GRAF and MARGUERITE GRAF, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENTMOHAMMAD and RASHIDA SHAFI, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

80 T.C. 944

WERNER GRAF and MARGUERITE GRAF, PETITIONERS

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENTMOHAMMAD and RASHIDA SHAFI, PETITIONERS

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket Nos. 7888-80

9149-80.

United States Tax Court

Filed May 18, 1983.

Petitioner Mohammad Shafi a cash basis taxpayer, is a doctor practicing medicine in Wisconsin. In 1977, petitioner entered into a tax shelter promoted by the International Monetary Exchange (IME), a Panamanian corporation, wherein he purported to provide dredging services in Panama. Petitioner paid $40,000 to a local subcontractor to do the actual work. IME allegedly advanced $30,000 on behalf of petitioner to the subcontractor. Thus, petitioner paid $10,000 in cash and issued a $30,000 promissory note to IME. The note was payable only out of profits from the sale of oceanfront lots created by the dredging operation. Held: Petitioner's obligation is inherently so contingent it cannot be treated as a loan for tax purposes. Thus, even if IME made the $30,000 advance, petitioner is entitled to no deduction for this amount since a cash basis taxpayer is not entitled to a deduction for payment by a note. Eckert v. Burnet, 283 U.S. 140 (1931).

Held, further, it is within the Court's discretion whether to hear respondent's motion for partial summary judgment with respect to only one docket which has been consolidated with another docket for purposes of trial, briefing, and opinion. Held, further, since there is no apparent prejudice or harm to petitioners in either docket, and the benefits of avoiding expensive and time-consuming litigation are obvious, respondent's motion is properly before the Court. Nelson S. Weine, for the petitioners.

Robert R. Rubin and James F. Kidd, for the respondent.

OPINION

FAY , Judge:

Respondent determined the following deficiencies in petitioners' 1977 Federal income tax:

+-------------------------+
                ¦Docket No.  ¦Deficiency  ¦
                +------------+------------¦
                ¦            ¦            ¦
                +------------+------------¦
                ¦7888-80     ¦$33,841.00  ¦
                +------------+------------¦
                ¦9149-80     ¦20,771.22   ¦
                +-------------------------+
                

These cases are consolidated for purposes of trial, briefing, and opinion. Petitioners in docket No. 9149-80 are presently before the Court on respondent's motion for partial summary judgment under Rule 121.¹ The only issue raised by respondent's motion is whether a deduction is allowable with respect to a $30,000 payment by note for certain dredging services allegedly performed in Panama.

Petitioners in docket No. 9149-80, Mohammad and Rashida Shafi, resided in Bayside, Wis., when they filed their petition herein.

Petitioner Mohammad Shafi (hereafter petitioner) is a physician practicing medicine in Wisconsin. In 1977, he entered a tax shelter promoted by the International Monetary Exchange (IME), a Panamanian corporation. Petitioners agree the exhibits attached to respondent's motion accurately reflect the transaction herein. The tax shelter is structured as follows.

Petitioner contracts to provide dredging services to a Panamanian landowner, Diversiones Internationales, S.A. (DISA), for the purpose of developing oceanfront lots. Petitioner then subcontracts with a local Panamanian firm, “Dredgeco,” to do the actual work. The cost of dredging is $40,000. The promoter, IME, finances 75 percent of this cost. Thus, petitioner pays $10,000 cash and delivers a $30,000 note to IME wherein IME then pays “Dredgeco” the entire $40,000 which is due before the actual dredging begins. Interest on the $30,000 note accrues at the rate of 10 percent per annum beginning January 1, 1978.

Upon completion, DISA is to pay petitioner $50,000 for his services. Any unpaid balance is to be assessed interest at 6 percent per annum. However, the $50,000 amount due petitioner is payable only out of one-half the profits generated by the sale of oceanfront lots created by the dredging services. In turn, and crucial to this case, petitioner is obligated to make payments on his note only out of 75 percent of his share of such profits.

In 1977, petitioner sent a $10,000 check and delivered his $30,000 promissory note to IME. On their 1977 Federal income tax return, petitioners claimed a $40,000 deduction. In his notice of deficiency, respondent disallowed the deduction in its entirety.

This case is but one of numerous similar tax shelter cases promoted by IME which are docketed in this Court. In his motion for partial summary judgment, respondent asks us to rule as a matter of law that petitioners are entitled to no deductions with respect to their payment by giving the $30,000 note.

For purposes of this motion, respondent accepts as true the facts in favor of petitioner. For example, respondent is willing to assume that $40,000 was in fact paid to “Dredgeco” for dredging services and that, to the extent otherwise allowable, this payment constitutes a deductible, as opposed to a capital, expense. Respondent's position is that, notwithstanding the truth of these assumptions, petitioners still are entitled to no deduction with respect to the $30,000 note.

It is well-established that a party moving for summary judgment has the burden of demonstrating that no genuine issue as to any material fact exists, and that he is entitled to judgment as a matter of law. Adickes v. Kress & Co., 398 U.S. 144, 157 (1970); Gulfstream Land & Development v. Commissioner, 71 T.C. 587, 596 (1979). This Court has entertained motions for summary judgment where, for purposes of such motion, the moving party concedes certain facts and relies on his legal theory. See Jacklin v. Commissioner, 79 T.C. 340 (1982); McLain v. Commissioner, 67 T.C. 775 (1977). Given “its salutary purpose in avoiding a useless, expensive, and time consuming trial where there is no genuine, material fact issue to be tried” Lyons v. Board of Ed. of Charleston, etc., 523 F.2d 340, 347 (8th Cir. 1975), such a motion can be particularly appropriate in a case such as the one before us.

At first blush, it would appear conclusive that petitioners, as cash basis taxpayers, would be entitled to no deduction with respect to their payment by note. It is well settled that the payment of an expense by a note does not give rise to a deduction for a cash basis taxpayer. Helvering v. Price, 309 U.S. 409 (1940); Eckert v. Burnet, 283 U.S. 140 (1931). Petitioners' whole case, however, is based on the theory that all amounts advanced by IME for dredging services are tantamount to loans from which petitioner made the requisite cash payment. For the following reasons, we are unwilling to allow petitioners a deduction for expenses paid out of such advances.²

It is well settled that a taxpayer cannot include a contingent liability in his cost basis for purposes of computing depreciation or amortization deductions. Denver & Rio Grande Western R. R. Co. v. United States, 205 Ct. Cl. 597, 505 F.2d 1266 (1974); Lemery v. Commissioner, 52 T.C. 367 (1969), affd. on another issue 451 F.2d 173 (9th Cir. 1971); Columbus & Greenville Railway Co. v. Commissioner, 42 T.C. 834 (1964), affd. per curiam 358 F.2d 294 (5th Cir. 1966); Albany Car Wheel Co. v. Commissioner, 40 T.C. 831 (1963), affd. per curiam 333 F.2d 653 (2d Cir. 1964); Redford v. Commissioner, 28 T.C. 773 (1957). Contingent liabilities have also been held to preclude a current deduction for intangible drilling costs. CRC v. Commissioner, 693 F.2d 281 (3d Cir. 1982), revg. on different grounds Brountas v. Commissioner, 73 T.C. 491 (1979); Brountas v. Commissioner, 692 F.2d 152 (1st Cir. 1982), revg. on different grounds 73 T.C. 491 (1979); Gibson Products Co. v. United States, 637 F.2d 1041, 1047 (5th Cir. 1981).

In Denver & Rio Grande Western R. R. Co. v. United States, supra, the United States Court of Claims granted the Government's motion for partial summary judgment and held, as a matter of law, that the taxpayer could not include in its cost basis contingent liabilities incurred to finance construction of a railroad line. The taxpayer agreed to construct a 39-mile spur line to provide rail service to a potash mine located in Moab, Utah. Even though all the funds necessary to build the line were advanced on behalf of the taxpayer, the taxpayer's obligation was contingent on the shipping of sufficient potash. The Court held that absent a binding obligation on the part of the taxpayer to repay all such advances, it was “impossible to value the obligation assumed.” Denver & Rio Grande Western R. R. Co. v. United States, 205 Ct. Cl. at 603, 505 F.2d at 1270. The Court noted that innumerable happenings could prevent repayment, e.g., strikes or labor shortage, reduced demand, or advanced mining technology rendering the mine obsolete. Thus, the Court held the obligation could not be included in the taxpayer's cost basis.

Similarly, the loan herein is utterly and inherently so contingent and speculative that its repayment cannot be predicted with any degree of accuracy. Payable solely out of profits, it is wholly contingent upon the success or failure of the foreign dredging operation. Thus, not only do oceanfront lots first have to be produced, but those lots have to be sold at a profit before any payments on the loan are required. And then, only 50 percent of those profits are subject to payment on the note. Given the terms of this agreement and given the clearly abusive tax shelter out of which this case arises, we find petitioner's obligation is so contingent that it cannot be treated as a loan for tax purposes.³

We do not imply that a loan will not be recognized for tax purposes simply because it is payable solely out of profits. By its nature, however, such a loan necessarily takes on the flavor of an investment.⁴ Only when, in an objective sense, there is a reasonable certainty that full repayment will occur will such a loan be recognized. See and compare Harlan v. United States, 409 F.2d 904, 909 (5th Cir. 1969); Ortmayer v. Commissioner,...