Hie Holdings, Inc. v. Commissioner of Internal Revenue, T.C. Memo. 2009-130 (U.S.T.C. 6/8/2009)

Decision Date08 June 2009
Docket NumberNo. 5046-05.,No. 5047-05.,No. 5045-05.,5045-05.,5046-05.,5047-05.
PartiesHIE HOLDINGS, INC., HAWAIIAN ISLES KONA COFFEE CO., LTD., AND ROYAL HAWAIIAN WATER CO., LTD., ET AL.,<SMALL><SUP>1</SUP></SMALL> Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
CourtU.S. Tax Court

William C. McCorriston, Jonathan H. Steiner, Lisa W. Cataldo, R. John Seibert, Paul B. K. Wong, Christopher J. Cole, Brian R. Lynn, Christopher S. Rizek, Lawrence Inouye, Richard W. Craigo, and John Gaims, for petitioners.2

Kenneth C. Peterson, Paul K. Webb, Gordon L. Gidlund, and L. Katrine Shelton, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

LARO, Judge.

These cases are before the Court consolidated for purposes of trial, briefing, and opinion.3 In docket No. 5045-05, HIE Holdings, Inc. (Holdings), and two of its subsidiaries, Hawaiian Isles Kona Coffee Co., Ltd. (Hawaiian Isles Kona Coffee), and Royal Hawaiian Water Co., Ltd. (Royal Hawaiian Water), petitioned the Court to redetermine respondent's determination of deficiencies of $242,546, $77,602, $470,461, $280,489, and $519,760 in the affiliated group's Federal income taxes for its taxable years ended June 30, 1997, 1999, 2000 2001, and 2002, respectively.4 In docket No. 5046-05, Hawaiian Isles Enterprises, Inc. (HIE), petitioned the Court to redetermine respondent's determination of deficiencies of $1,057,181, $125,317, $175,524, and $799,433 in HIE's Federal income taxes for 199806, 200006, 200106, and 200206, respectively, and a $264,295 addition to HIE's 199806 tax under section 6651(a)(1).5 In docket No. 5047-05, Michael Boulware petitioned the Court to redetermine respondent's determination of deficiencies of $497,926, $603,406, $935,124, $1,339,019, and $874,551 in Michael Boulware's 1998 through 2002 Federal income taxes, respectively.

Following a trial of these cases held primarily in Honolulu, Hawaii, we decide five issues.6 First, we decide whether to sustain respondent's disallowances of HIE's deductions of net operating losses (NOLs), reported as arising from NOL carryovers from 198906 through 199606, to the extent of $1,636,322 for 199806 and of $1,184,192, $324,767, and $145,145 for 200006 200106, and 200206, respectively.7 We shall sustain those disallowances in full. Second, we decide whether to sustain respondent's disallowance of a $905,340 bad debt deduction HIE claimed for 199806. We shall sustain none of that disallowance. Third, we decide whether to sustain respondent's disallowances of professional fees deducted by HIE to the extent of $1,241,995, $1,159,635, $1,156,364, and $2,208,588 for 199806, 200006, 200106, and 200206, respectively, and of professional fees deducted by Holdings to the extent of $228,240, $1,383,710, $794,404, and $2,253,652 for 199906 through 200206, respectively. We shall sustain those disallowances to the extent stated herein. Fourth, we decide whether to sustain respondent's determinations that Michael Boulware received constructive dividends of $1,406,343, $1,513,055, $2,332,643, $3,380,947, and $2,231,120 for 1998 through 2002, respectively, primarily because the just-referenced professional fees were paid by his constructive withdrawals of funds from HIE and Holdings (collectively, subject corporations). We shall sustain those determinations to the extent stated herein. Fifth, we decide whether to sustain respondent's determination that HIE is liable for the addition to tax under section 6651(a). We shall sustain that determination in full.8

FINDINGS OF FACT
I. Preliminaries

Many facts were stipulated, and those facts are found accordingly. The approximately 2,000 stipulated facts and the thousands of exhibits submitted therewith are incorporated herein by this reference. The trial transcripts total 5,255 pages, and the number of pages in the exhibits total approximately 50,000. The Court has recorded on the docket sheets of these cases over 900 index entries.

The subject corporations are C corporations that during the relevant years used accrual methods to report their income and expenses for Federal income tax purposes on the basis of fiscal years ended on June 30.9 When the petitions commencing these cases were filed, the principal place of business of each subject corporation was in Hawaii.10 Also at that time, the "legal residence" of Michael Boulware as stipulated by the parties was in Hawaii; we understand him then to have been imprisoned at a U.S. penitentiary in California, specifically, the Lompoc Correctional Facility in Lompoc, California.

II. NODs
A. NOD Issued to HIE
1. General Information

On December 15, 2004, respondent issued a notice of deficiency (NOD) to HIE for 199806 and 200006 through 200206. The NOD contained three adjustments which are relevant herein.

2. First Adjustment—Disallowance of Portion of Deductions for NOLs
a. Overview

Respondent disallowed HIE's claim of NOL deductions for each year, except for $450,569 that was allowed for 199806.

b. Primary Determination

Respondent determined primarily that HIE failed to establish that it was entitled to an NOL deduction for 199806 of more than $450,569 or that it had an NOL carryover to apply to any of the other subject years. As part of this primary determination, respondent also determined that HIE was entitled to reduce its "miscellaneous income related to HIE's tobacco tax `self-correction'" (discussed infra) by $1,927,648 for 200006 and $962,426 for 200106.11

c. Alternate Determination
i. Overview

Respondent determined alternatively that adjustments to HIE's income and deductions for 198906 through 199706, the years in which HIE claims its NOL carryover to 199806 originated, limited HIE's NOL carryover to 199806 (and hence HIE's NOL deduction for that year) to $450,569 and resulted in no NOL carryover to any of the other subject years. Many of those adjustments, as discussed infra, related to the criminal indictment of Michael Boulware in part with respect to his 1989 through 1997 Federal income taxes.12

ii. Adjustments Related to Criminal Indictment

The adjustments for 198906 through 199706 that were related to the criminal indictment reflected the following determinations by respondent: (1) For 199006 through 199306, HIE failed to report $3,583,725 of income that was diverted to Michael Boulware from HIE's over-the-counter (OTC) sales of tobacco; (2) for 198906 through 199206, HIE failed to report $1,335,132 of income that was diverted to Michael Boulware and/or his mistress, Jin Sook Lee, from HIE's sales of coffee beans to Pele Trading, Inc. (Pele Trading); (3) for 199006 through 199306, HIE failed to report $1,265,458 of income that was diverted to Michael Boulware and/or Jin Sook Lee from HIE's sales of coffee beans to Hawaiian Kona Coffee Co., d.b.a. Hawaii Misuzu Coffee Co., Ltd. (Hawaii Misuzu);13 (4) for 199006, HIE improperly deducted $50,785 that HIE paid to Bonded Construction Co., Ltd. (Bonded Construction), for work that HIE reported was performed at HIE's coffee plant but which actually was performed to renovate Jin Sook Lee's residence in Honolulu at 1017 Makaiwa Street (Makaiwa house); (5) for 199306, HIE improperly deducted $638,427 that was diverted from HIE to Michael Boulware through certain fictitious leasing arrangements; (6) for 199506 through 199706, HIE improperly deducted $1,731,000 that HIE paid to a foreign entity, Harvest International King Coffee, Ltd. (Harvest International), which was then transferred to Michael Boulware through a second foreign entity, Forest Trading Corp. (Forest Trading); (7) for 199506, HIE improperly deducted $29,984 that HIE paid to Harvest International, which was then transferred on behalf of Michael Boulware to a domestic entity, Briggs Cockerham, L.L.C. (Briggs Cockerham); and (8) for 199506 and 199606, HIE improperly deducted $89,936 that HIE paid to Harvest International, which was then transferred on behalf of Michael Boulware to Anthony Oh Young and Gloria Oh Young through a foreign entity, Pacific Vendors Equipment, Ltd. (Pacific Vendors).

iii. Adjustments Unrelated to Criminal Indictment

The adjustments for 198906 through 199706 that were unrelated to the criminal indictment of Michael Boulware reflected respondent's determinations that HIE was not entitled to deduct: (1) Salaries totaling $1,040,000 reportedly paid during 198906 through 199406 to Michael Boulware's then wife, Mal Sun Boulware; (2) payments totaling $385,000 that HIE made during 198906 and 199006 to Paradise Roasting, Inc. (Paradise Roasting), a nonoperating entity that was the alter ego of Jin Sook Lee and was established to hide the transfer of HIE funds to Jin Sook Lee; (3) professional fees totaling $175,000 reportedly paid to Jin Sook Lee's sole proprietorship, Video Consultant, during 199006 and 199106;14 (4) bad debts totaling $1,800,000 that were written off during 199306, 199406, 199506, and 199706 as uncollectible but otherwise due HIE from Jin Sook Lee in her capacity as the sole trustee of the Glenn Lee Boulware Trust, a trust established for the primary benefit of the oldest son of Jin Sook Lee and Michael Boulware; and (5) certain other professional fees totaling $4,269,980 for 199406 through 199706.

iv. Some Specifics of Adjustments

Some specifics of the adjustments for 198906 through 199706 are as follows:

                198906 199006 199106 199206 199306 199404 199506 199606 199706 Total
                OTC sales       -0-      $506,464    $1,337,213    $719,755     $1,020,293      -0-          -0-        -0-        -0-    $3,583,725
                Pele Trading  $264,790  1,029,963        21,175      19,204         -0-         -0-          -0-        -0-        -0-     1,335,132
                Hawaii
                Misuzu          -0-       116,832       382,403     347,866        418,357      -0-          -0-        -0-        -0-     1,265,458
                Bonded
                Construction    -0-        50,785         -0-         -0-           -0-         -0-          -0-        -0-        -0-        50,785
                Leasing
                arrangement     -0-         -0-
...

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