U.S. v. Philatelic Leasing Ltd.

• Decision Date: 26 June 1986
• Docket Number: D,Nos. 763,817,s. 763
• Citation: 794 F.2d 781
• Parties: -5285, 86-2 USTC P 9509 UNITED STATES of America, Plaintiff-Appellee, v. PHILATELIC LEASING, LTD., Melvin Hersch, and Hambrose Stamps, Ltd., Defendants-Appellants. ockets 85-6198, 85-6200.
• Court: U.S. Court of Appeals — Second Circuit

Page 781

794 F.2d 781

58 A.F.T.R.2d 86-5285, 86-2 USTC P 9509

UNITED STATES of America, Plaintiff-Appellee, v. PHILATELIC LEASING, LTD., Melvin Hersch, and Hambrose

Stamps, Ltd., Defendants-Appellants.

Nos. 763, 817, Dockets 85-6198, 85-6200.

United States Court of Appeals, Second Circuit.

Argued Jan. 30, 1986.

Decided June 26, 1986.

Abram Chayes, Cambridge, Mass. (Roberts & Holland, New York City, Doros & Blessey, P.C., New York City, Jesse G. Silverman, Jr., Richard A. Levine, of counsel), for defendants-appellants.

William J. Brennan, Sp. Asst. U.S. Atty., New York City (Rudolph W. Giuliani, U.S. Atty., for S.D.N.Y., Gerald T. Ford, Steven E. Obus, Asst. U.S. Attys., of counsel), for plaintiff-appellee.

Before OAKES, WINTER and MINER, Circuit Judges.

OAKES, Circuit Judge:

The sale of tax shelters, by which taxpayers/investors obtain credits and deductions in return for investments involving risk, has lent itself to sufficient abuses to prompt statutory reform separate from the tax reform presently being discussed in the halls of Congress. The Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA"), Pub.L. No. 97-248, 96 Stat. 324 (pertinent portions codified in scattered sections of Title 26), sought to check the abuses by providing that anyone organizing or selling an interest in a tax shelter who makes "a gross valuation overstatement as to any material matter" will be subject to penalty. 26 U.S.C. Sec. 6700 (1982 & Supp. II 1984). TEFRA also authorizes the Government to seek an injunction against anyone subject to penalty under section 6700. 26 U.S.C. Sec. 7408 (1982 & Supp. II 1984). Here at issue is an injunction obtained against Philatelic Leasing, Ltd. (Philatelic), Melvin Hersch, its president, and Hambrose Stamps, Ltd. (Hambrose), with reference to a 1982 tax shelter scheme. United States v. Philatelic Leasing, Ltd., 601 F.Supp. 1554 (S.D.N.Y.1985) (Knapp, J.). Penalties under 26 U.S.C. Sec. 6700 have also been levied against the appellants, but the penalties are not involved in this appeal. We affirm the grant of the injunction. The subject of the shelter here involved was "stamp masters." These are plates used to produce stamps. The stamps involved bore the names of one of four islands located off the coast of Scotland: Staffa, Bernera, Eynhallow, and Grunay. These islands are privately owned and not independent political jurisdictions; two of them are uninhabited and another has only two residents. The stamps produced from the plates are not really postage stamps since they are not valid for the transmission of mail anywhere except between points on the islands or from these islands to the Scottish island of Mull; for the mail to go any farther regular postage stamps must be applied. One may assume that there is little use for postage stamps on uninhabited islands; on the other hand, there is a vast philatelic market and this shelter was purportedly directed toward the production of stamps for sale in this market.

The tax shelter was generated by Philatelic's lease of a plate to a taxpayer who acquired with the lease of the plate the right to produce approximately 58,000 stamps. The taxpayer then was supposedly to sell these sets of stamps to the public, Philatelic supplying the name of a distributor familiar with the stamp collecting market. The lease was for a seven-year term and required annual payments from the taxpayer to Philatelic ranging from $30,000 for a two-stamp master to $80,000 per year for an eight-stamp master. However, more than eighty percent of the "rent" paid by a taxpayer was in the form of notes on which he had no personal liability, while a substantial portion of the remaining liability was not due to be paid until 1990.

This arrangement was to provide the taxpayer with several benefits, the first of which was the assignment by Philatelic to him of Philatelic's right to an investment tax credit (ITC) amounting to 10% of the price that Philatelic had paid Hambrose to purchase the stamp masters. As will be seen, the purchase price paid by Philatelic was the inflated product of a series of transactions not at arm's length. The ITC available to a taxpayer/investor ranged from $15,000 for a two-stamp plate to $40,000 for an eight-stamp plate.

Second, the taxpayer obtained a tax deduction for lease payments in the form of either cash or notes allowable as deductions under the "at risk" rules for taxpayers. For a two-stamp master these deductible lease payments amounted to $7,500 in the first year and $30,000 in the second year. The third and final tax benefit consists of deductions for certain expenses incurred by the lessees, such as actual printing costs or fees paid to "distributors" of the "stamps."

By combining tax credits and deductions, the Philatelic 1982 shelter conferred, in tax shelter parlance, a "4-to-1 equivalent write-off." That is to say, a taxpayer would receive tax benefits four times greater than his actual cash outlay. Needless to say, the 4-to-1 write-off was advertised elaborately in the Philatelic brochure entitled "Confidential Offering Memorandum for the Leasing of Master Plates for the Production of British Local Stamps and Ancillary Products" and promoted in marketing program seminars run out of Newport Beach, California, whereby three to four hundred salespersons learned about the stamp master program and how to sell it. These salespeople were self-employed sellers in what one described as the tax shelter "industry"; certain of their advertising and overhead expenses were paid by Philatelic, and they received commissions out of cash paid by investors. The salespeople held free public seminars around the country on the Philatelic program; these seminars stressed the tax benefits of the program.

Several other aspects of this shelter should be mentioned. Of the 72-page offering memorandum provided to prospective investors, fifty were devoted to an opinion letter from the law firm of Friedman and Shaftan, P.C., of 4 Park Avenue, New York, New York, setting forth the tax consequences of investing in the shelter. Also included in the offering memorandum was a letter from that firm agreeing to represent Philatelic Leasing in connection with any challenge by the IRS and offering, upon request by a lessee/investor, to assist the lessee's counsel and accountants in the event of any such tax challenge unless satisfactory resolution was obtained at the initial IRS audit level. The memorandum also advised investors that they would receive written appraisals from so-called "recognized Philatelic (stamp) experts" that would both assure that the value of the masters was what it was represented to be and aid the investor in the event of IRS audit. Facts revealed at trial amply demonstrate that these appraisals were untrustworthy. The appraisers involved each arrived at precisely the same value for each of the stamp masters, certainly a remarkable feat. At trial, one failed to recognize the names of three of the four islands issuing the stamps and admitted that he had not prepared the appraisal, only signed it. Another stated at a deposition that he was "pretty sure" that stamps from one of the islands were actually valid for the international transmission of mail. And a third, who had participated as an appraiser in similar shelters in 1979, 1980, and 1981, withdrew from the 1982 program, the only one at issue here, because he believed the stamp masters were being overvalued.

The evidence indicated that Philatelic entered into 826 leases with taxpayers in 1982 and received over $16 million in cash from investors. Provided that the investors took their credits and deductions as per the offering memorandum, this would mean that taxpayers were able to obtain in that year alone some $64 million in tax benefits which, assuming that the investors were all in the 50% bracket, would translate into $32 million in tax savings. Hence, the interest of the Government in obtaining an injunction.

To understand the contentions of the parties, the arrangements between the various defendants appealing and not appealing are significant. The owners of the islands, who granted exclusive rights to issue the "stamps," received a relatively small amount--a few thousand pounds per island per year--from Crailheath, Ltd., or London & New York Stamp Co., Ltd., two British corporations owned by Clive Feigenbaum, a British stamp dealer. In transactions not at arm's length, Feigenbaum's British corporations sold the rights to Global International, Ltd. ("Global"). Global, a non-appealing co-defendant, is a Liberian corporation controlled by Feigenbaum; its only office is at a trust company in Monrovia, Liberia, and its sole officer is an Israeli attorney and friend of Feigenbaum's, Michael Shine. Feigenbaum began to use Global in 1979 to avoid having his British stamp companies directly linked to the shelter marketing operations in the United States. Following negotiations at which it was represented by Feigenbaum, Global sold the stamp master rights to Hambrose Stamps, Ltd., a corporation owned by one Herman Finesod and incorporated in 1979 by the previously-mentioned law firm of Friedman and Shaftan. Finesod hired appellant Melvin Hersch to act as president of Hambrose in 1980 and 1981, during which years Hambrose acquired stamp masters from Global and sold them to taxpayers who took ITCs based on their purchase price. For the 1982 program this approach was modified. Philatelic was established to lease, rather than sell, the masters to investors. On April 20, 1982, Hersch resigned from Hambrose to become president of Philatelic and Finesod became president of Hambrose. Philatelic was incorporated on April 23, 1982, by Friedman and Shaftan, and it began doing business in the same offices on the 28th floor of 950 Third Avenue in Manhattan that Hambrose had occupied, staffed by the people that Hambrose had employed, and aided by employees of other Finesod corporations who...