Law v. Comm'r of Internal of Internal Revenue, Docket Nos. 17315-82

• Citation: 84 T.C. No. 64,84 T.C. 985
• Decision Date: 23 May 1985
• Docket Number: 10054-83.,Docket Nos. 17315-82
• Parties: WILLIAM J. LAW and HELEN M. LAW, Petitioners v. COMMISSIONER OF INTERNAL OF INTERNAL REVENUE, Respondent
• Court: United States Tax Court

84 T.C. 985

84 T.C. No. 64

WILLIAM J. LAW and HELEN M. LAW, Petitioners

v.COMMISSIONER OF INTERNAL OF INTERNAL REVENUE, Respondent

Docket Nos. 17315-82

10054-83.

United States Tax Court

FILED May 23, 1985.

P was a partner in a limited partnership organized to acquire and distribute a motion picture film. In the notice of deficiency and by amendment to his answer, the Commissioner has disallowed all of the loss claimed by P as his distributive share of the partnership's net loss, on the grounds, among others, that the partnership did not acquire depreciable interest in the film, that the partnership's depreciable basis in the film was overvalued, that the loss, if allowable, was limited to the amount to which P was ‘at risk,‘ and that the partnership's activities were not engaged in for profit. After trial, and after the Commissioner had submitted the opening brief and Ps had submitted a brief in answer, the Commissioner moved for leave to amend his answer a second time to assert the applicability of sec. 6621(d), I.R.C. 1954, as added by the Tax Reform Act of 1984, which imposes a higher rate of interest on substantial underpayments attributable to certain tax motivated transactions. HELD, the Commissioner's motion is denied because the proposed amendment, while not requiring a further trial, would unfairly prejudice Ps. REX A. GUEST, for the petitioners.

DAVID D. BAIER, for the respondent.

OPINION

SIMPSON, JUDGE:

On March 28, 1985, the Commissioner filed a ‘Motion for Leave to File Second Amendment to Answer,‘ pursuant to Rule 41(a) of the Tax Court Rules of Practice and Procedure. ¹ He seeks leave to amend his answer to assert the applicability of section 6621(d), Internal Revenue Code of 1954, ² as added by section 144 of the Tax Reform Act of 1984, Pub. L. 98-369, 98 Stat. 682, which increased the rate of interest on substantial underpayments attributable to certain tax motivated transactions. The petitioners, William J. and Helen M. Law, have filed a ‘Notice of Objection‘ to the Commissioner's motion.

The trial of this case was held on July 9 through July 12, 1984, and involved deficiencies determined to be owing by the petitioners for 1978 and 1979. The Commissioner filed the opening brief (because it bears the burden of proof on several issues) on October 10, 1984, and the petitioners filed their brief in answer on March 18, 1985. The Commissioner has not yet filed his reply brief.

Mr. Law became a partner in 1978 of an Illinois limited partnership (the partnership) organized to acquire and to distribute a motion picture film (the film). On their joint Federal income tax returns for 1978 and 1979, the petitioners claimed a distributive share of the partnership's net loss for those years. In the notice of deficiency and by a prior amendment to his answer, the Commissioner has disallowed all of the claimed distributive shares of the losses on numerous and alternative grounds, including: (1) The partnership is not entitled to the film depreciation deductions claimed on its partnership returns because it did not acquire a depreciable interest in the film; (2) if the partnership acquired a depreciable interest in the film, it is entitled to depreciation deductions smaller than those claimed because a nonrecourse debt included in the film's depreciable basis was too contingent to be a genuine indebtedness, because the face amount of the nonrecourse debt exceeded the fair market value of the interest acquired in the film, and because the partnership was required to use the income forecast rather than the double-declining balance method of depreciation; (3) the partnership's activities were not ‘engaged in for profit‘ within the meaning of section 183; and (4) the amount of Mr. Law's deductible share of the partnership losses is limited by section 465(a) to the amount for which he was ‘at risk.‘

Section 6621(d) provides for an increase in the interest rate due on underpayments where there is a ‘substantial underpayment‘ (an underpayment exceeding $1,000) in any taxable year ‘attributable to 1 or more tax motivated transactions.‘ Sec. 6621(d)(1) and (2). ‘tax motivated transaction‘ is defined as:

(i) any valuation overstatement (within the meaning of section 6659(c)),

(ii) any loss disallowed by reason of section 465(a) and any credit disallowed under section 46(c)(8),

(iii) any straddle as defined in section 1092(c) without regard to subsections (d) and (e) of section 1092), and

(iv) any use of an accounting method specified in regulations prescribed by the Secretary as a use which may result in a substantial distortion of income for any period. (Sec. 6621(d)(3)(A))

In addition, section 6621(d)(3)(B) provides that ‘The Secretary may by regulations specify other types of transactions which will be treated as tax motivated * * * and may by regulations provide that specified transactions being treated as tax motivated will no longer be so treated.‘

The Secretary has promulgated temporary regulations under the regulatory authority granted in subparagraphs (A)(iv) and (B). Sec. 301.6621-2T, Procedure and Administration Regs. (Temporary). The temporary regulations list several circumstances (not relevant to the case before us) in which the disallowance of a deduction or credit shall be treated as attributable to the use of an accounting method that may result in a substantial distortion of income and, thus, shall be a tax motivated transaction. ³ The regulations also specify, pursuant to section 6621(d)(3)(B), two additional types of transactions which will be treated as tax motivated transactions:

first, ‘Any deduction disallowed for any period under section 183, relating to an activity engaged in by an individual or an S corporation that is not engaged in for profit,‘ and second, ‘Any deduction disallowed for any period under section 165(c)(2), relating to any transaction not entered into for profit. ‘ Sec. 301.6621-2T, Q-4 and A-4, Proced. and Admin. Regs. (Temporary), 49 Fed. Reg. 50391-50394 (Dec. 28, 1984). Both section 6621(d) and the temporary regulations apply to interest accruing after December 31, 1984, on a substantial underpayment attributable to tax motivated transactions, regardless of the date prescribed for payment of the tax. Sec. 301.6621-2T, Q-10 and A-10, Proced. and Admin. Regs. (Temporary). The Tax Court has jurisdiction to determine the portion (if any) of a deficiency which is a substantial underpayment attributable to tax motivated transactions. Sec. 6621(d)(4).

In his motion to amend his answer, the Commissioner seeks to invoke the applicability of section 6621(d) on the grounds that the petitioners are liable for substantial underpayments in 1978 and 1979 attributable to a ‘valuation overstatement‘ (within the meaning of section 6659(c) ⁴) and to losses which are disallowed by reason of section 465(a). ⁵ Specifically, he contends that the partnership's losses resulted, for the most part, from excessive deductions for depreciation of the film caused by an overvaluation of the partnership's interest (if any) in the film. He also maintains that, if it is determined that the petitioners incurred deductible losses in 1978 and 1979 with respect to their investment in the partnership, the deductible portions of such losses are limited to the amount the petitioners were ‘at risk.‘ ⁶ The petitioners object to the Commissioner's proposed amendment as being unfairly prejudicial to them, because it would necessitate further trial and briefing.

Under section 6214(a), this Court has jurisdiction to consider a claim by the Commissioner for an increased deficiency or addition to tax at any time before the entry of a final decision. Ferrill v. Commissioner, 684 F.2d 261, 265 (3d Cir. 1982), affg. per curiam a Memorandum Opinion of this Court; Henningsen v. Commissioner, 243 F.2d 954 (4th Cir. 1957), affg. 26 T.C. 528 (1956) ⁷; see Koufman v. Commissioner, 69 T.C. 473 (1977). However, section 6214(a) does not give the Commissioner an unqualified right to amend his answer to claim an increased deficiency, addition to tax, or penalty. Commissioner v. Long's Estate, 304 F.2d 136 (9th Cir. 1962), affg. unreported orders of this Court; Commissioner v. Erie Forge Co., 167 F.2d 71 (3d Cir. 1948), affg. a Memorandum Opinion of this Court; Koufman v. Commissioner, supra. Section 7453 expressly authorizes this Court to adopt rules governing practice before it, and the Commissioner, like any other party before this Court, is required to conform to such rules. Commissioner v. Long's Estate, supra; Commissioner v. Erie Forge Co., supra; Koufman v. Commissioner, supra. Under Rule 41(a), pleadings may be amended after the case has been placed on a trial calendar and over the objection of the opposing party only by leave of the Court ‘when justice so requires.‘ Whether a motion seeking amendment should be allowed is within the sound discretion of the Court, and its decision will not be reversed unless it abuses its discretion. Commissioner v. Long's Estate, supra; Commissioner v. Erie Forge Co., supra.

In determining the justice of a proposed amendment, we must examine the particular circumstances in the case before us, for the exercise of discretion ‘may never be arbitrary and must be controlled by sound reason and fairness. ‘ California Brewing Assn. v. Commissioner, 43 B.T.A. 721, 725 (1941). If there is evidence of surprise or substantial disadvantage to the petitioner, the Commissioner's motion to amend should be denied because the purpose of section 6214(a) is to give the petitioner a fair opportunity to answer and resist the claim before it is considered by the Court. Ferrill v. Commissioner, supra at 265; Henningsen v. Commissioner, supra at 959; Helvering v. Edison Securities Corp., 78 F.2d 85, 91 (4th Cir. 1935), affg. in part and remanding 29 B.T.A. 483 (1933). On the other hand, in cases where there was no evidence of surprise or prejudice to the petitioner, this Court has been reversed...