Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-ca10-87-01916/USCOURTS-ca10-87-01916-0/pdf.json

Parties Involved:
Commissioner of Internal Revenue
Appellee
Carol N. James
Appellant
Jack S. James
Appellant

Document Text:

PUBLISH 

UNITED STATES COURT OF APPEALS 

TENTH CIRCUIT 

JACK S. JAMES and CAROL N. JAMES; 

GLEN E. MICHAEL and SYBIL H. 

MICHAEL ; A. F. BOUDREAU, JR., and 

KATHERINE F. BOUDREAU; DAVID G. } 

OWNBY and KATHLEEN OWNBY; JEFFRY H.) 

COPE and MARY E. COPE; and ) 

ROBERTS. COPE and PHYLLIS H. COPE,) 

) 

Petitioners-Appellants, ) 

) 

v . ) 

} 

COMMISSIONER OF INTERNAL REVENUE , ) 

) 

Respondent- Appellee. ) 

FILED 

U 0 • (}Jted States C:)JJrt of Appeals 

T{'rif.h Gr·:·ci~ 

MAR 2 G 1990 

ROBERT L. HOECKER 

Clerk 

Nos. 87-1913 

87-1916 

87-1918 

87-1919 

87-1959 

87-1960 

87 -196 1 

On Appeal from the United States Tax Court 

(Docket Nos. 27360-83, 29714-8 4, 33287-83 , 30508-84, 

24045-84, 40635-84, 40636-84) 

Tom G. Parrott (Charles N. Woodward of Lisle & Woodward, with him 

on the briefs}, Oklahoma City, Oklahoma , for PetitionersAppellants. 

Thomas R. Lamons , Attorney? Tax Division (Williams. Rose, Jr., 

Acting Assistant Attorney General, Michael L. Paup and Ann 

Belanger Durney, Atto r neys , Tax Div i s i on , with him on the brief) , 

Department of Justice , Washington , D. C. , for Respondent- Appellee. 

Before LOGAN , MOORE and TACHA, Circuit Judges. 

LOGAN , Circuit Judge. 

-1-

Appellate Case: 87-1916 Document: 01019729730 Date Filed: 03/26/1990 Page: 1 
Petitioners Jack James, Glen and Sybil Michael, A. F. 

Boudreau, Jr., David Ownby, Jeffrey Cope, and Robert Cope were 

investors, 1 either individually or through controlled entities, in 

joint ventures that purchased expensive computer systems already 

leased to large industrial corporations. These investors took 

deductions on their personal income tax returns for depreciation, 

for fees to the seller for continuing management services, and 

they took investment tax credits for purchases of the computer 

systems. The Commissioner of Internal Revenue disallowed the 

deductions and credits on the ground that the underlying 

transactions g i ving rise to these items were shams lacking 

economic substance. The United States Tax Court, in a unanimous 

reviewed dec ision, upheld the disallowances, agreeing that the 

transactions lacked economic subst ance. Jack S. James, 87 T.C. 

905 fl986). 2 Because we affirm on this basis, we do not address 

the Tax Court's a l ternat ive hol d i ngs. 

The Tax Court made detai led findings of fact which we 

summarize he re as briefly as we can. Communication Associates, 

Inc., Communica tions Associates Leasing, Inc., and Communications 

Leasing International, Inc. (co l lectively the "Communications 

1 Petitioners Carol James, Katherine Boudreau, Kathl een Ownby, 

Mary Cope and Phyllis Cope are parties solely because they signed 

joint income tax returns with the ir spouses for the relevant 

years. 

2 The Tax Court's opinion purported to address only the 

challenged investment tax credits and management fees deductions. 

87 T.C. at 906. But both petitioners and the Commissioner 

contend, and i t is apparent from the record, that the challenged 

depreciati on deductions we re also at issue before the Tax Court 

and remain a t issue on appeal. See Brief for Appellants at 12, 

18-19; Brief for Appellee at 15-16--&-n.l8. 

-2-

Appellate Case: 87-1916 Document: 01019729730 Date Filed: 03/26/1990 Page: 2 
Group")3 were related entities engaged in the business of 

purchasing computer equipment from manufacturers and leasing it to 

large-scale users that preferred to lease rather than buy their 

own equipment. In 1979 and 1980, petitioners Jack James and Glen 

Michael served as principal officers in certain of those 

companies. 

On December 28, 1979, peti t i oners A. F. Boudreau, Jr., Glen 

and Sybil Michael , and Jack Jones, either individually or through 

controlled entities, formed a joint venture (JV#l) for the stated 

purpose of investing in and leasing computer equipment. On that 

same date, JV#l and the Communications Group entered into three 

agreements: an agency agreemen t , an administrative services 

agreement, and a purchase agreement. In the agency agreement, 

JV#l appointed the Communications Group as its agent for 

pu·rchasing computer equipmen t and leasing it to end users. The. 

Communications Group was entitled to ~ct for JV#l without 

disclosing its agency status, and JV#l was not liabl e in any 

manner on debt incurred by the Communications Group to finance the 

computer equipment purchases. The administrative . services 

agreement stated that the Communications Group \-JOuld perform 

various administrative tasks associated with the leasing of 

computer equipment purchased by JV#l. For its services, the Group 

would receive annual managemen t fees over a seven-year period 

3 The term 11Comrnunica tions Group" will also be used to e n compass 

Mentco Corpora tion , the company that assumed responsibility for 

the administration and management of the Communicat ions Group's 

portfolio of leases in 1981. 

-3-

Appellate Case: 87-1916 Document: 01019729730 Date Filed: 03/26/1990 Page: 3 
starting at $72,000 and decreasing gradually to $ 39 ,600 in the 

fourth year. 

In the purchase agreement, the Communications Group agreed to 

sell JV#l a computer system which the Group had purchased from 

Amdahl Corp. in June 1979 and had l eased to Massey-Fe rguson , Inc . 

The Communica t ions Group financed the $3,211 , 000 purchase price by 

giving Amdahl an installment note payable in sixty-two monthly 

i nstallments plus a balloon payment. The Group also gave Amdahl a 

securi ty interest in the equipmen t . 

The l eas e to Massey-Ferg uson was also for a sixty- two-month 

term, providi ng f or monthly renta l payments commencing January 1 , 

1 980, in an amount exactly corresponding to the Group's monthly 

obligations to Amdahl. The Commun i cations Group assigned its 

right to recei ve monthly rental payments from Ma ssey-Ferguson to 

Amdahl. The lease was a "net·-ne t - net " or "triple net" lease 

wher e by the lessee was responsi b l e for install ation , maint enance , 

taxes, and insurance . 

JV#l's pur chase of the equ ipment was subjec t to Amdahl's 

securi ty interest , Massey-Ferguson's lease, and the assignment of 

rental payments to Amdahl . JV#l paid $2 million for the 

equipment. Al though it is not apparent fr om the purchase 

agreement itself, JV#l's $2 million purchased only a 52.6 % 

interest in the equipment, a markup of approximately 18.4% over 

52 .6% of the computer 's original purchase price. The remaining 

interest in t he computer was sold to othe r investors at 

approximately the same mar kup , giving the Commu n ications Group 

total proceeds of $3,801,250 . 

-4-

Appellate Case: 87-1916 Document: 01019729730 Date Filed: 03/26/1990 Page: 4 
JV#l financed this purchase by giving the Communications 

Group a demand note in the amount of $300,000, subsequentl y 

satisfied, and a recourse installment note for the balance of $1.7 

million. JV#l also became obligated to pay the Communications 

Group a $150,000 implementation fee. In addition , the purchase 

agreement gave the Communications Group a "nonexclusive r ight to 

remarket" the computer equ i pment upon expiration or termi nati o n of 

the lease, under which the Group was entitled to twenty-five 

percent of the net proceeds of any remarketing they arranged. 

The documentation surrounding JV# l's purchase and annual 

statements from the Communi cations Group to JV# l described the 

computer equipment as serial number 70078 leased t o Amdahl, while 

in fact, JV#l's equipment was serial number 1005 5 leased to 

Massey-Ferguson. Both a s u b l ease and a rel ease of this equipment 

beg i nning in 1984 we re at a monthly rental rate of less than te n 

percent o f the monthl y rental in the original lease. 

In June 1982, the original adm inistrative se rvices agreement 

was cancelled and a restated administrative services ag reement was 

ex ecut ed which provi ded for income pooling . Under this 

arrangement , the Communica tions Group would pool all ren ta l income 

from equipment it managed for JV#l and other investors and from 

its own computer equi pment a nd then allocate the income to the 

vari ous owners pursuant to a s tated formula . JV#l 's s hare o f 

poo led income was based on its proportionate investment in t he 

total pool, adjusted by a "TR factor ," whi ch allegedly adjus ted 

for equipment-specifi c differences such as use f u l life and 

maturity. The restat ed agr eement also sta ted that the "norma l 

-5-

Appellate Case: 87-1916 Document: 01019729730 Date Filed: 03/26/1990 Page: 5 
rental rate" of JV#l's equiment was equal to 21 .619% of its 

investment. If JV#l's share of the pooled income exceeded this 

rate, the Commun i cations Group was entitled to retai n the excess 

as a "performance fee." Further, the Group's annual management 

fe es were revised and set at a f lat rate of sixteen p er cent of 

adjusted pool rental inc ome . The net effect of these provisions 

was to ensure t hat JV#l's annual cash flow remained roughly at a 

break-even point during the term of the comput er ' s lease, with 

cash inflows from rental income almost exactly (within pennies) 

offsetting cash outflows in satisfaction of JV#l's various 

obliga tions to the Communications Group. In fact, in the three 

years before income pooling took effect the Communications Group 

inexplicably credited JV#l, not for the actual rental payments 

made by Massey-Ferguson, bu t for rental income which exactly 

offset JV #~ s annual obligations to the Group , a discrepa ncy of 

nearly $100,000 in 1980 . 

On January 15 , 1980, a second joint ventu re (JV#2) was formed 

by amendment of t he JV#l joint venture agreement, addi ng four new 

members--Robert Cope, Jeffrey Cope , David Ownby, and A. F. 

Boud reau, Jr., in his individua l capaci ty. JV#2 executed agen cy 

and admin istrative service agreements with the Communications 

Gr oup similar to those in effect fo r JV#l , except that JV#2's 

administrative services agreement n~ediately used income pooling, 

normal rental r ate , performance fee, and percentage management fee 

concepts subsequently used in JV#l's restated administrative 

services agreement. The effect of these p r ovisions was the same 

- 6-

Appellate Case: 87-1916 Document: 01019729730 Date Filed: 03/26/1990 Page: 6 
as for JV#l; that is, JV#2's annual cash flow was extremely close 

to breaking even. 

The structure of the transactions culminating in the sale of 

computer equipment to JV#2 t;olas the same as that used with JV#l. 

The Communications Group purchased three computer systems at a 

total cost of $3,305,284, financed through nonrecourse installment 

notes with different banks. The Group leased the systems to three 

different end users on a triple net basis for terms ranging from 

fifty-eight to eighty-four months and assigned the right to rental 

payments to the various financing banks. The Communications Group 

then sold the three systems, subject to the security interests, 

leases, and rent assignments, to JV#2 for a purchase price of $3.8 

million, an approximate fifteen percent markup over the Group's 

purchase price. JV#2 gave the Group an $817,000 demand note and 

an installment note for the baiance. JV#2 satisfied the demand 

note and also paid the Communications Group a $57,000 

implementation fee in December 1980. The Communications Group was 

again entitled to a twenty-five percent remarketing fee, but 

rather than the "nonexclusive right to remarket" it held on JV#l's 

equipment, the Group had a "right of first refusal to remarket" 

JV#2's equipment. 

In June 1985, one of JV#2's lessees declared bankruptcy and 

the bank holding the security interest in the computer equipment 

repossessed the equipment. The Communications Group repurchased 

the equipment from the bank at a price less than the principal 

balance remaining on its nonrecourse note to the bank. 

-7-

Appellate Case: 87-1916 Document: 01019729730 Date Filed: 03/26/1990 Page: 7 
Nevertheless, JV#2 continued its loan and other payments to the 

Group as originally scheduled. 

Upon review of these transactions, the Tax Court concluded 

that, in substance, JV#l and JV#2 merely purchased a package of 

tax benefits, not true ownership interests in the equipment. The 

court found and concluded that no true agency relationship existed 

between the joint ventures and the Communications Group; that many 

inexplicable anomalies in their relationship suggested that the 

joint ventures were not exercising the care reasonably expected of 

true owners; that the agreements between the joint ventures and 

the Group were designed to strip all potential cash flow from the 

joint ventures; and that even under the most optimistic 

projections of expected residual value, the joint venture could 

not reasonably expect a pretax profit from the purported 

purchases. It therefore ~pheld the Commissioner's disallowance of 

petitioner's depreciation and management fee deductions and 

investment tax credits because the nominal purchase by the joint 

ventures lacked economic substance. 

I 

It is well established that transactions lacking an 

appreciable effect, other than tax reduction, on a taxpayer's 

beneficial interest will not be recognized for tax purposes. See 

Knetsch v. United States, 364 U.S. 361, 366 (1960}. A transaction 

will be accorded tax recognition only if it has "economic 

substance which is compelled or encouraged by business or 

regulatory realities, is imbued with tax-independent 

considerations, and is.not shaped solely by tax-avoidance features 

-8-

Appellate Case: 87-1916 Document: 01019729730 Date Filed: 03/26/1990 Page: 8 
that have meaningless labels attached." Frank Lyon Co. v. United 

States, 435 u.s. 561 , 583-84 (1978). 4 

The Tax Court has at times applied a two-prong standard for 

guiding a sham determination. See , ~, Rice's Toyota World, 

I nc. v. Corrunissioner, 81 T.C. 184 , 202-03 & n. 17 , 209 (1983)., 

aff'd in part , rev 'd in part on other grounds, 752 F .2d 89 (4th 

Cir. 1985). The Fourth Circuit has expressly adopted this twoprong standa rd requiring both a subjective and an objective 

inquiry, in that "[t]o treat a transaction as a sham, the court 

must find [ 1] that the taxpayer was motivated by no business 

purposes other than obtaining tax benefits .. . and [2 ] that the 

transaction has no economic substance because no reasonable 

possibility of a profit exists." Rice's Toyota, 752 F.2d at 91 -

92. The better approach, in our view, holds that "the 

consideration o~ business purpose and economic substance · are 

simply more precise factors to consider in the [determination of] 

whether the transaction had any practical economic effects other 

than the creation of income tax losses." Sochin v. Commissioner, 

843 F.2d 351, 354 {9th Cir.), cert. denied, 109 s. Ct. 72 (1988). 

In reviewi ng the Tax Court's decision in this case , we accept 

all factual findings that are not clearly erroneous. And, based 

4 While most courts refer to these principles under the general 

heading of the sham transaction doctrine, some courts reserve the 

term "sham," as did the Tax Court in this case, see 87 T.C. at 

918, for transactions which occur only on paper-or do not, in 

fact , occur. Other courts distinguish between the mere pape r 

chase , calling it a factual sham, and transactions which do occur 

but lack economic substance, so-called substantive shams . See, 

, Killingsworth v . Commissioner, 864 F . 2d 1214 , 1216 & n.J 

(5th Cir. 1989); Kirchman v. Commissioner, 862 F . 2d 1486 , 1492 

(11th Cir. 1989). The Commissioner does not contend that the 

transactions at issue were factual shams . 

-9-

Appellate Case: 87-1916 Document: 01019729730 Date Filed: 03/26/1990 Page: 9 
upon these find ings, we review de novo the ultimate 

charac ter ization of the transactions as shams . See Frank Lyon, 

435 U. S. at 581 n.l6; Knetsch, 36 4 U. S . at 365 {characterizing 

sham f inding as conclusion of law); Newman v. Commissioner, No. 

89-40 51 (2d Cir. Jan . 23, 1990) (available on WESTLAW; to be 

published at 894 F.2d 560); Killingsworth v. Commissioner, 864 

F.2d 1214, 1217 (5th Cir. 1989) {substantive shams reviewable de 

novo); cf. Miller v. Commissioner , 836 F . 2d 1274, 1277 (lOth Cir. 

1988) (whether transactions were "ente red into for profit" for 

purposes of I.R.C. §§ 108 & 165(c) (2) reviewable de novo) . 5 With 

these s tandards in mind, we turn to a n analysis of the 

transactions at issue . 

II 

The Tax Court expressly found tha t the purchase-and-lease 

transactions involving the Communications Group, the various 

compu te r equipmen t manufacturers, the fi nancing banks, and t h e 

lessees of t he computer equipment were legi timat e t ransactio ns, 

negotiated at arm's length, reflecting competitive market terms . 

Pet itioners argue that since the Communications Group was 

nominall y their authorized agent in these legit imate transactions, 

5 Some circuits treat sham de t erminations as quest ions of fac t. 

See, · Keane v . Commissioner , 865 F . 2d 1088, 1090 (9th Ci r . 

1989); Rice 's Toyota , 752 F.2d 89 , 92 (4th Cir. 198 5) ; Comdisco, 

Inc. v . United States, 756 F . 2d 569, 575 (7th Cir. 1985) ; cf. 

Kirchman v. Commissioner, 862 F.2d 1486, 1490 (11th Cir . 1989) 

(sham determination normally a fact question , but reviewed de novo 

because Tax Court assumed it was legal conclusion). But see 

Amer ican Realty Trust v. Uni t ed States , 498 F.2d 1194,-rl98-99 

{4th Cir. 1974) (cited with approval in Fra nk Lyon); Swift Dodge 

v. Commissioner , 692 F.2d 651 , 652 (9th Cir . 1982) (ci ti ng Frank 

Lyon). In our view , this approach is inconsistent wi t h Frank 

Lyon, 435 U.S. at 581 n . l6. 

- 10-

Appellate Case: 87-1916 Document: 01019729730 Date Filed: 03/26/1990 Page: 10 
it is inconsistent for the Tax Court to find that the portions of 

this arrangement involving the joint ventures lacked economic 

substance. This argument is fundamentally in er~or. First, the 

Tax Court found that although the relationship between the joint 

ventures and the Communications Group was labeled a principalagent relationship, in substance the parties were principals 

acting for thei~ own account. The court noted that the large 

markup on the "sales" between the Communications Group and the 

joint ventures was inconsistent with an agency relationship, 

especially since the Group did nothing to enhance the value of . the 

computer equipment. The only se~vice provided by the Group was 

arranging financing, and the court found that the Group was more 

than fully compensated for this service through the substantial 

implementation, 

ventures paid .. 

management, and performance 

The Tax · .Court · also noted 

fees the joint 

that when the 

Communications Group repurchased at a savings computer equipment 

that one of the financing banks had repossessed, it did not pass 

these savings on to its purpo~ted principal, JV# 2 . 

We agree with the Tax Cour t's conclusion that the 

relationship between the joint ventures and the Communications 

Group was i nconsistent with a t rue agency. The parties were 

careful to structure their transactions separately , never allowing 

the Group to bind the joint ventures as their "agent." For 

example, the joint ventures expr essly disclaimed any liability on 

debt incurred by the Group to finance purchases "on behalf of" the 

joint ventu~es. Rather, the Group incurred nonrecourse 

obligations and the joint ventures gave the Group recourse notes. 

-11-

Appellate Case: 87-1916 Document: 01019729730 Date Filed: 03/26/1990 Page: 11 
This inured only to the benefit of the Communications Group, as 

evidenced by its savings on the repurchase of the repossessed 

equipment. Further, the Group never actually purchased equipment 

"on behalf of" the joint ventures, but instead executed separate 

purchase agreements with them. Although the joint ventures called 

the Communications Group their agent, the Group took no actions 

consistent with a true agency relationship. Therefore, they 

cannot claim that they were the principals in the Group's 

legitimate transactions. 

The petitioners' argument misses the mark for another reason. 

They appear to claim that this entire "deal" must stand or fall in 

toto. But, as the Tax Court found, there was no one unitary 

"deal." Rather, there were many individual actors and many 

individual transactions. The only transactions at issue in this 

. case are the purported sales by the Communications Group to the 

joint ventures. These sales cannot be legitimized merely because 

they were on the periphery of some legitimate transactions. 

Along these same lines, petitioners contend that the Tax 

Court's opinion was improperly based on a legally unprecedented, 

novel, and unique "bifurcated sham transaction theory." If the 

Commissioner treats a transaction as a sham, petitioners argue, he 

cannot allow certain deductions or credits related thereto and 

disallow others--a transaction either is a sham or it is not. In 

the present case, the Commissioner allowed the petitioners to 

deduct certain interest and lease acquisition costs, as well as 

professional fees, associated with the joint ventures, but 

disallowed depreciation and management fee deductions and 

-12-

Appellate Case: 87-1916 Document: 01019729730 Date Filed: 03/26/1990 Page: 12 
investment tax credits. The Commissioner also disallowed a 

current deduction of the implementation fees, but did allow them 

to be amort ized over five years. Petitioners maintai n that by 

allowing the joint ventures to deduct these expenses, the 

Commissioner has effectively conceded that the subject 

transactions have economic substance and business purpose . 

The "bifurcated transaction" approach does have a basis in 

established law , however. As the Fourth Circuit held in Rice's 

Toyota , "a sham transaction may contain elements whose form 

reflects economic substance and whose normal tax consequences may 

not therefore be disregarded ." 752 F.2d at 96 (allowing interest 

deductions on recourse debt even though underlying transaction was 

a sham); see also Bail Bonds by Marvin Ne lson , Inc. v. 

Commissioner, 820 F.2d 1543, 1549 & n.6 (9th Cir. 1987). We agree 

·that. within the framework of a sham transaction .a taxpayer may 

incur bona fide obligations wh i ch should be recognized for tax 

purposes. Here the Commissioner d i d not err in allowing the joint 

ventures' interest deductions on their recourse debt along with 

certai n other payments to outside parties. 

More troubling , however, is the Commissioner's acquiescence 

in the pet i tioners' amortizat i on of the so-called implementation 

fees . Given its view that the purported sale was without 

substance, it seems inconsistent to treat those fees as bona fide 

obl igations. Nevertheless, we do not accept that the Commissioner 

has conceded the transactions at issue had economic substance 

merely because it handled one item in a questionable manner. 

Petitioners have not shown that they were in any way prejudiced by 

-13-

Appellate Case: 87-1916 Document: 01019729730 Date Filed: 03/26/1990 Page: 13 
the Commissioner's conduct. In fact, they derived an otherwise 

unavailable benefi t in the amount of the allowed deductions. 

The Tax Court considered many facts which pointed ·to a lack 

of substance in the "sales" between the Communications Group and 

the joint ventures. Although the joint ventures purported to own 

the c omputer equipment, they did not exercise the care that would 

be expected from owners of multimillion dollar computer systems. 

Documentation and annual statements rega rding the 1979 "purchase " 

by JV#l incorrectly identified the serial number, lessee, and 

location of the equipment f?r several years, information which 

petitioner Jack James admitted at trial is very important to 

investors in computer equipment . Yet, thes e errors wer e not 

discovered until preparation for the tri al in this case . II James 

R. at 119-20 . The parties were not diligent enough in negotiating 

the 1979 "sale" to note in t.he purchase agreement the percentage 

interest sold. I n addition, the Tax Court no ted l arge 

discrepancies between actual rental payments and rental income 

allocated to JV#l before income pooling began . Although owners o f 

equi pment would presumably be most concerned with the income from 

their investment, the court not ed that ther e was no explanation 

for these discrepancies. 

The joint ventures paid fi fteen percen t and eighteen percent 

markups over the prices at which the Communications Group 

purchased the computer equ ipment . As noted previously, the Tax 

Court could find no justificati on for these substantial markups, 

especially in light of the substantial "fees 11 which the joint 

ven tures also paid the Group. Obviously unjustif ied markups a re a 

-14-

Appellate Case: 87-1916 Document: 01019729730 Date Filed: 03/26/1990 Page: 14 
potent indicator that a purported sale serves no function other 

than to provide the "purchaser" with inflated tax benefits. See 

Rice's Toyota, 752 F .2d a t 93 (sale and leaseback). 

The Tax Court also fou nd that the "sales" to the joint 

ventur es were structured to deprive the joint ventu res of any 

reasonable possibility of economic profit apart from potential tax 

savings. As noted previously, the net effect of income pooling, 

with payment of a performance fee in the amount of all income in 

excess of the stated normal rental ra te , was to strip all 

potenti al positive cash f l ow out of the hands of the joint 

ventures for the benefit of the Communica tions Group, while at t he 

same time assuri ng that cash flow would not be negative in any 

year. Therefore, the joint ventures would not be required to put 

up any more money. And even before income pooling was implemented 

for JV#l, the myster ious ren tal income disbrepan6ies achieved this 

same effect. The Tax Court cou ld find no evidence that wou l d 

justify the substantial management and performance fees. 

Petitione r A. F. Boudreau's accountant and consultant, who 

purpo rtedl y analyz ed these transactions for Boudreau, testified at 

trial that the decision to set the management fee at sixteen 

percent had no basis. II James R. at 189. The Tax Court found 

that the sole func tion of the substantial management and 

performance fees was to strip cash flow f rom the joint venture. 

Petiti oners cite several a uthorities for the proposition that the 

absence of a signif icant positive cash flow during the term of a 

lease should be considered a neutral factor. While this may be 

true as far as i t goes, whe n lack of cash flow is created by 

-15-

Appellate Case: 87-1916 Document: 01019729730 Date Filed: 03/26/1990 Page: 15 
extraordina ry management fees and inflated purchase prices and 

guaranteed through the provision of stop-gap performance fees, any 

element of neutrality rapidly dissipates. 

Because the joint ventures were assured no posi tive cash fl ow 

over the lives of the equipmen t leases, their only chance of 

recover i ng their initial investments, o ther than through hoped-for 

tax benefits, was through the residual value of the computers. 

See Rice's Toyota, 752 F.2d at 92-93 (where cash flow ove r life of 

lease was negligible, crucia l f ocus for profitability of purported 

sale-leaseback was expected residual val ue) . The parties 

stipulated at trial that at the time of each alleged purchase, the 

range of reasonable expected residual values for all of the 

equ ipment at i ssue was between zero and thirty-five percent of the 

manufacturers' original sale prices. Based on its own 

.computa t ions, the Tax Court found that even usin9 the most 

optimistic expec t ed residual value , each joint venture coul d 

reasona bly expect losses in excess of $6,000. 

The petitioners challenge the accur acy of these computations . 

Peti tioners first contend tha t the Tax Court erroneously deducted 

the twenty-five percent remarketing fee i n the expected profit 

calculations, since the Communications Group's right to remarket 

the computers was nonexclusive and the joint ventures may have 

remark eted them on t heir own or found someone else to do it for a 

smaller fee . Petitioners stress that two members of the joint 

ventures served a s principal officers in the Communi cations Group , 

and, therefore, they could protect the joint ventures' interests 

in this regard. But petitioners ignore the poten tial conflict of 

-16-

Appellate Case: 87-1916 Document: 01019729730 Date Filed: 03/26/1990 Page: 16 
interests inherent in such an arrangement . We believe tha t the 

Tax Court's treatment o f the remarketing fee was r easonable . 

Given the joint ventures' lack of supervision over the 

Communications Group's day-to-day handl ing of the transactions, 

the Tax Court could well have concluded that, in a s i tuat ion i n 

which the joint ventu res wer e alr eady pay ing exorbi tant fees to 

the Communications Group, at the end of each lease term the joi nt 

ve ntures would not inte rvene suddenl y in an attempt to minimize a 

cost that would pr o v ide another desirable tax d educ tion . This 

conclusion is even mo re appropriate i n the case of JV# 2 , in which 

the Group held a " right of first refusal" to remarket. Moreover , 

pe t itioners advance l i ttl e reason to be lieve that James and 

Mi chael woul d have stood gua r d to ensure tha t the joint venture 

saved money a t the expense of the Communications Group. The 

Group's failu r.e to pass on the savings of the r epurchased computer 

to JV#2 compels the opposite conclusion. 

Petitioners next argue, with r espect to JVtl only , tha t the 

Tax Court erred in calculating expecte d pretax profit by in e ffect 

deducting the $150 ,000 implementat i on fee twi ce. Petitioners 

fa iled to place in the record before the Tax Court any indica tion 

o f how the impl ementation fee was financed. 87 T. C. at 90 9 . 

Accordingly , t he court simply d educted the amount of t he fee in 

its calculations. The court also deducted payments of $3 0,811. 51 

on a promisso ry no te executed December 27, 1979. The record 

indicated neither the purpose nor the principal amoun t of the 

note . On appeal, petitioners for the first t i me argue t hat these 

paymen ts r ep resen ted annual installments on the p romi ssory note 

-17-

Appellate Case: 87-1916 Document: 01019729730 Date Filed: 03/26/1990 Page: 17 
through which the implementat ion fee was fi nanced. On this basis 

peti tioners cla im error. 

Pet itioners concede that they cannot rely on the alleged 

promissory note on appeal under Fed. R. App. P. lO (e}. They 

invit e this court to piece together bits of "circumstantial 

evidence" to infer the existence of this document, and then to 

conclude that the Tax Court erred in failing to divine the intent 

of their unexplai ned paymen ts. Their argument is entirely 

unpersuasive. The Tax Court' s conclusions wer e reasonabl e on the 

basis of the record before it, and they must stand on that basis. 

AFFIRMED. 

- 18-

Appellate Case: 87-1916 Document: 01019729730 Date Filed: 03/26/1990 Page: 18