Inverworld, Inc. v. Commissioner, Docket No. 27089-90.

• Decision Date: 27 June 1996
• Docket Number: Docket No. 27090-90.,Docket No. 3441-93.,Docket No. 3444-93.,Docket No. 27089-90.,Docket No. 3442-93.,Docket No. 3443-93.
• Citation: 71 T.C.M. 3231
• Parties: InverWorld, Inc. et al.<SMALL><SUP>1</SUP></SMALL> v. Commissioner.
• Court: U.S. Tax Court

71 T.C.M. 3231

T.C. Memo. 1996-301

InverWorld, Inc. et al.¹ v. Commissioner.

Docket No. 27089-90.

Docket No. 27090-90.

Docket No. 3441-93.

Docket No. 3442-93.

Docket No. 3443-93.

Docket No. 3444-93.

United States Tax Court.

Filed June 27, 1996.

Turner P. Smith, New York, N.Y., Nancy E. Delaney, and Robert D. Whoriskey, for the petitioner in Docket No. 27089-90. Turner P. Smith, Nancy E. Delaney, T. Barry Kingham, and Robert D. Whoriskey, for the petitioner in Docket No. 27090-90. Turner P. Smith, New York, N.Y., and Nancy E. Delaney, for the petitioners in Docket Nos. 3441-93, 3442-93, 3443-93, and 3444-93. Jill Frisch, Peter J. Graziano, and Maria Stabile, for the respondent.

Contents

                                                                                                       [CCH
                                                                                                       Pages]
                  I.   STATEMENT OF ISSUES .......................................................     3237
                      A.  Issues With Respect to LTD ...............................................     3237
                      B.  Issues With Respect to INC ...............................................     3237
                      C.  Issues With Respect to Holdings ..........................................   3237-3
                 II.  FINDINGS OF FACT .............................................................   3237-3
                      A.  Petitioners ..............................................................   3237-3
                      B.  Petitioners' Returns .....................................................   3237-3
                      C.  Creation of LTD ..........................................................   3237-3
                      D.  Creation of INC ..........................................................   3237-4
                      E.  Structure and Operation of LTD's Promotion, Service, and Sales ...........   3237-4
                      F.  INC's Consulting Agreement With LTD ......................................   3237-6
                      G.  Research .................................................................   3237-7
                      H.  Financial Accounting and Client Statements for LTD .......................   3237-8
                      I.  IRS Audit During Spring 1987 .............................................   3237-8
                      J.  The Transition to Multi Valores ..........................................   3237-8
                      K.  Accounting Firm Audit ....................................................   3237-9
                      L.  LTD's Receipts ...........................................................   3237-9
                          1.  Management Fees ......................................................   3237-9
                          2.  Interest Income ......................................................   3237-9
                              a.  U.S. Certificates of Deposit and Bank Deposits ...................   3237-9
                              b.  Loans ............................................................   3237-10
                              c.  Non-U.S. Certificates of Deposit and Term Deposits ...............   3237-11
                              d.  Pace Investments .................................................   3237-11
                              e.  MMA II ...........................................................   3237-11
                          3.  Currency Exchange Transactions Income ................................   3237-12
                              a.  Currency Swaps ...................................................   3237-12
                              b.  Currency Transactions ............................................   3237-12
                          4.  Sales Commissions and Fees ...........................................   3237-13
                              a.  Currency Fund ....................................................   3237-13
                              b.  FEIM Fund ........................................................   3237-13
                              c.  Matric Fund ......................................................   3237-14
                              d.  Inversat Fund ....................................................   3237-14
                              e.  TVA ..............................................................   3237-14
                

                              f.  Client Incorporation and Trust Creation ..........................   3237-15
                              g.  Legal Advice Income ..............................................   3237-15
                              h.  Letters of Credit ................................................   3237-15
                              i.  Foreign Exchange Investments .....................................   3237-15
                              j.  Treasury Bills ...................................................   3237-15
                              k.  Wires and Checks .................................................   3237-16
                              l.  Gold and Silver Futures ..........................................   3237-16
                              m.  Project Income ...................................................   3237-16
                              n.  Income From Investments ..........................................   3237-16
                              o.  Other Commission Income/Other Commissions and Fees ...............   3237-16
                              p.  Other Income .....................................................   3237-17
                      M.  Amounts Subject to Withholding Tax .......................................   3237-17
                III.  OPINION ......................................................................   3237-18
                      A.   Whether LTD Was Engaged in Trade or Business Within the United States ...   3237-18
                           1.  Background ..........................................................   3237-18
                           2.  Section 1.864-4(c)(5)(i), Income Tax Regs., Engaged in a Banking
                               Business Test .......................................................   3237-18
                      B.   Whether Each Item of LTD's Income Was Effectively Connected .............   3237-30
                           1.  Character and Source Rules ..........................................   3237-30
                           2.  Application of the Character and Source Rules .......................   3237-31
                               a.  Management Fees .................................................   3237-31
                               b.  Service Fees ....................................................   3237-31
                                   (1)   U.S. Certificates of Deposit and Bank Deposits ............   3237-31
                                   (2)   Non-U.S. Certificates of Deposit and Term Deposits ........   3237-33
                                   (3)   Pace Investments ..........................................   3237-33
                               c.  Interest Income .................................................   3237-33
                                   (1)  Loans ......................................................   3237-33
                                   (2)  MMA II .....................................................   3237-34
                               d.  Currency Exchange Transactions Income (Currency Swaps and
                                   Currency Transactions) ..........................................   3237-34
                               e.  Sales Commissions and Fees ......................................   3237-34
                                   (1)  Currency Fund, FEIM Fund and Matric Fund ...................   3237-34
                                   (2)  Inversat Fund ..............................................   3237-35
                                   (3)  TVA ........................................................   3237-35
                                   (4)  Client Incorporation and Trust Creation, Legal Advice
                                        Income, and Letters of Credit ..............................   3237-36
                                   (5)  Foreign Exchange Investments ...............................   3237-36
                                   (6)  Treasury Bills, Wires and Checks, Gold and Silver Futures
                                        Project Income, Income from Investments, Other
                                        Commission Income, Other Commissions and Fees, and
                                        Other Income ...............................................   3237-36
                           3.  Effectively Connected Income Rules ..................................   3237-36
                               a.  Introduction to the Rules .......................................   3237-36
                               b.  Section 1.864-4(c)(5), Income Tax Regs., Banking Activity Test ..   3237-36
                               c.  Section 864(c)(2)(A) Asset-use Test .............................   3237-37
                               d.  Section 864(c)(2)(B) Business-Activities Test ...................   3237-37
                               e.  Section 864(c)(4)(B) Rules for Income From Sources Without the
                                   United States ...................................................   3237-37
                           4.  Application of the Effectively Connected Income Rules ...............   3237-39
                               a.  Management Fees .................................................   3237-39
                               b.  Service Fees ....................................................   3237-40
                                   (1)   U.S. Certificates of Deposit and Bank Deposits ............   3237-40
                                   (2)   Non-U.S. Certificates of Deposit and Term Deposits ........   3237-41
                                   (3)   Pace Investments ..........................................   3237-42
                               c.  Interest Income .................................................   3237-42
                                   (1)   Loans .....................................................   3237-42
                                   (2)   MMA II ....................................................   3237-45
                               d.  Currency Exchange Transactions Income (Currency Swaps and
                                   Currency Transactions) ..........................................   3237-46
                               e.  Sales Commissions and Fees ......................................   3237-47
                                   (1)  Foreign Source TVA Commissions .............................   3237-47
                                   (2)  All Commissions and Fees Excepting the Foreign Source
                                        TVA Commissions ............................................   3237-47
                      C.  Whether LTD and INC are Liable for Withholding Tax .......................   3237-48
                          1.  Background

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