1 These cases were consolidated for purposes of trial,

briefing, and opinion.

T.C. Memo. 1997-154

UNITED STATES TAX COURT

DON A. CHAN AND CECILIA CHAN, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

EASTIMPEX, A CALIFORNIA CORPORATION, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 2993-95, 3058-95.1 Filed March 26, 1997.

Wendy Abkin and Richard J. Sideman, for petitioners.

Debra K. Estrem, for respondent.
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2 All section references are to the Internal Revenue Code in

effect for the taxable years in issue, and all Rule references

are to the Tax Court Rules of Practice and Procedure, unless

otherwise designated. 

 MEMORANDUM FINDINGS OF FACT AND OPINION

GERBER, Judge: Respondent determined deficiencies in,

additions to, and an accuracy-related penalty on Federal income

tax for individual petitioners Don and Cecilia Chan as follows:2

 Accuracy

 -related

 Additions to Tax Penalty 

 Sec. Sec. Sec. Sec. Sec.

Year Deficiency 6653(a)(1) 6653(a)(1)(A) 6653(a)(1)(B) 6661 6662(a)

1987 $934,911 --- $46,746 

1 $61,350 ---

1988 708,273 $35,414 --- --- 30,992 ---

1989 693,857 --- --- --- --- $14,667

1 50 percent of the interest due on the portion of the underpayment

attributable to negligence.

Respondent determined deficiencies in and additions to

Federal income tax for corporate petitioner Eastimpex for the

taxable years ending March 31, 1988 and 1989, as follows: 

 Additions to Tax 

Sec. Sec. Sec.

Year Deficiency 6653(a)(1)(A) 6653(a)(1)(B) 6661 

1988 $766,321 $38,316 

1 $191,580

1989 815,234 --- --- 203,809 

1 50 percent of the interest due on the portion of the underpayment

attributable to negligence.

 

After concessions, the issues for decision are: (1) Whether

certain payments by corporate petitioner Eastimpex to its related

supplier were costs of goods sold, (2) whether individual
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3 The parties' stipulation of facts, along with the attached

exhibits, is incorporated herein by this reference. 

petitioners realized constructive dividends from Eastimpex, (3)

whether individual petitioners are liable for additions to tax

under sections 6653 and 6661 for 1987 and 1988 attributable to

the constructive dividends, (4) whether individual petitioners

are liable for an accuracy-related penalty under section 6662 for

1989, (5) whether corporate petitioner is liable for an addition

to tax under section 6653(a)(1)(A) and (B) for taxable year

ending March 31, 1988, (6) whether corporate petitioner is liable

for an addition to tax under section 6661 for taxable year ending

March 31, 1988, and (7) whether individual petitioners are liable

for additions to tax under sections 6653 and 6661 for 1987 and

1988 for their failure to report interest income from an overseas

bank account. 

FINDINGS OF FACT3

At the time the petitions were filed, petitioners Don A. and

Cecilia Chan (individual petitioners) resided in San Francisco,

California, and petitioner Eastimpex (corporate petitioner), a

California corporation, had its principal place of business in

San Francisco, California. Individual petitioners are married.

Individual petitioners own 100 percent of the stock in

corporate petitioner. They began Eastimpex in 1971 and

incorporated Eastimpex in 1977. Eastimpex imports oriental food

and other goods from Taiwan and elsewhere for sale in the United
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States. It began as the sales representative of Shin I Food

Factory Ltd. (Shin), a Taiwanese oriental food manufacturing

company started by petitioner husband's father, Henry S.T. Chan

(Henry). Eastimpex owns the exclusive worldwide distribution

rights to Shin products. During the years in issue, Eastimpex's

gross sales were about $20 million, and Shin products accounted

for 25 percent of Eastimpex's sales. 

While in college in the United States, petitioner husband

began selling food manufactured by Shin. After college,

petitioner husband returned to his family in Taiwan to work at

Shin for about a year. At Shin, petitioner husband worked on the

manufacturing line and at the head office in export sales,

soliciting customer orders. In the early 1970's, petitioner

husband returned to the United States with petitioner wife to

work as a sales representative for Shin. 

Henry began Shin with Lily Chan (Lily), petitioner husband's

mother. Lily and Henry had three children, petitioner husband

and two daughters (the Lily Chan family). Henry also had four

children from his marriage to Wan Yang Chen (the Wan Yang Chen

family).

When Shin began, Lily and Henry held the majority of Shin

stock, and Henry worked as Shin's general manager. Their two

daughters were each given 10 percent of Shin. They did not

participate in the management of Shin during the years in issue

and initially received the stock in order to increase the number
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of shareholders. At Shin's inception, petitioner husband was not

made a shareholder because he was attending school in Hong Kong. 

Stanley Lee (Stanley), Henry's former son-in-law through a

daughter from the Wan Yang Chen family, also owned 18 percent of

Shin and worked as Henry's assistant. Otherwise, the Wan Yang

Chen family had not been involved in the operations of Shin. 

Henry retired as Shin's general manager in 1982 and was

replaced by Stanley. Also, at the time of Henry's retirement,

Lily gave petitioner husband a 30-percent share of Shin. Until

mid-1986, petitioner husband and his immediate family owned 75

percent of Shin. Henry intended for Shin to be a family

business; Henry passed away on March 21, 1987. Petitioner

husband is the only one of Henry's children involved in operating

Shin. Petitioner husband has served on Shin's board of directors

since 1982 and has been its chairman since 1986. In 1986, the

only board members were petitioner husband, Lily, and Stanley. 

During the years in issue, petitioner husband and his

immediate family (his mother Lily and his two full sisters) owned

slightly over 50 percent of Shin, and petitioner husband was

Shin's largest shareholder with 30 percent. In the late 1980's,

Lily gave 3 percent of Shin to Priscilla Tay (Priscilla),

petitioner wife's sister. Both Lily and Priscilla had lived with

individual petitioners for a number of years during the 1980's

and had developed a close relationship. Priscilla also worked
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for Eastimpex from 1986 to 1988. During the years in issue, Lily

owned less than 3 percent of Shin. 

Despite petitioner husband's 30-percent ownership, Shin has

not paid him a dividend since he became a shareholder. However,

other shareholders of Shin have received dividends during that

time. In addition, Shin made large, unreimbursed distributions

to Lily and distributions to satisfy Lily's contractual

obligation at a time when she owned less than 3 percent of Shin. 

In 1986, Henry transferred his 18-percent share of Shin to a

member of the Wan Yang Chen family, Daniel Chen (Daniel). Also

in 1986, a dispute arose between the Wan Yang Chen family and the

Lily Chan family as a result of Shin's failing to pay a share of

its profits to Wan Yang under a prior agreement. In the prior

agreement, it was agreed that Henry, Lily, and Wan Yang would

divide Shin's profits equally among them. However, Wan Yang

received payments pursuant to the agreement for only 1 or 2

years. Daniel was causing problems at Shin because he felt that

the Lily Chan family had acquired too many of Henry's assets to

which the Wan Yang Chen family had a right. Daniel also

improperly removed some corporate documents from Shin's office. 

Stanley felt that he could not handle the situation and flew to

the United States to tell petitioner husband that he was

resigning. Edward Chiu (Edward) replaced Stanley as Shin's

general manager. Petitioner husband and Edward met in 1975

through business dealings between Eastimpex and a food supply
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company that Edward owned. Petitioner husband and Edward were

close personal friends. Petitioner husband personally chose

Edward to succeed Stanley as Shin's general manager. 

When Edward became the general manager, he negotiated a

resolution to the family dispute. At a meeting with petitioner

husband and Edward, Der-San Chen, representing the Wan Yang Chen

family, voiced his concern that the Lily Chan family had acquired

a large portion of Henry's assets. The Wan Yang Chen family

believed that Henry had wished to give it something. The two

families entered into a written agreement (1986 Agreement) which

required Lily, petitioner husband, Eastimpex, and Edward to pay

$1.25 million to the Wan Yang Chen family. The agreement did not

allocate the payments for which each party would be responsible. 

However, it was the parties' understanding that petitioner

husband acted only as a guarantor and was liable only if Lily

failed to pay. As part of the agreement, Edward received the 

18-percent share of Shin that Daniel had received from Henry. 

Edward paid the portion of the $1.25 million payment equal to the

value of the 18-percent share of Shin he acquired. 

In exchange for the $1.25 million, the Wan Yang Chen family

agreed to forgive the failure to make payments to Wan Yang under

the prior agreement and to not make any further claims to Henry's

assets. In addition, Daniel returned the improperly removed

corporate documents and did not file a criminal complaint that he

had prepared alleging that Shin paid excessive commission to
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Eastimpex. Daniel had threatened to file the complaint if he was

not satisfied with the resolution of the dispute.

Also in 1986, it was decided that a bank account should be

opened in the name of Shin to receive payments from Eastimpex at

Coast Savings and Loan in San Francisco (Coast). In 1987, the

account was moved to First Pacific Bank in Hong Kong (First

Pacific). In the business relationship between Eastimpex and

Shin, Shin provided a price list for goods. The price list

generally contained two handwritten prices under columns headed

"EP" and "NP", with the "EP" price being slightly lower than the

"NP" price. The amount of the difference between the two list

prices varied with each good, and the Shin price list reflected

two prices only for goods that Shin manufactured. Shin sold

goods to Eastimpex at the lower "EP" price (the invoice price). 

Eastimpex paid the invoice price to Shin through a letter of

credit or wire transfer. A few months later, Eastimpex deposited

the difference between the invoice price and the higher "NP"

price (the full list price) into the Coast or First Pacific

accounts in Shin's name (the deposited amounts). 

Eastimpex treated both the invoice price and the deposited

amounts as the cost of goods sold on its tax returns for the

years in issue and subtracted both amounts from gross receipts to

determine gross income. Eastimpex does not have invoices for the

deposited amounts. However, Eastimpex's records show the check

numbers of the checks used to make the deposits, references to
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4 The account number for the Shin I Food Co. at the Coast

Savings and Loan in San Francisco changed twice after it opened

and became a term account. The signatories and account name

remained the same. The term "Coast account" refers to all of

(continued...)

the original invoice, and the date and amount of each deposit. 

Although Eastimpex purchased goods from other Taiwanese

manufacturers, it used a two-tier payment system only with Shin. 

No other manufacturer ever requested that Eastimpex pay for goods

with two payments. In addition, none of the other manufacturers

provided an invoice for an amount less than the amount that

Eastimpex paid for goods. 

The Coast and First Pacific accounts were subject to

periodic reconciliations by Eastimpex and Shin to ensure the

deposits were being made. However, Lily or Priscilla held the

passbooks from the Coast and First Pacific accounts, and no one

at Shin ever saw the passbooks. Shin never received any bank

statements concerning the accounts from Coast or First Pacific. 

Shin did not record the deposited amounts as income on its books

and records although it recorded the invoice prices as income. 

The Coast and First Pacific bank accounts were not listed as

assets on Shin's books and records. In addition, Shin reported

only the invoice price as income to the Taiwanese Government. 

Petitioner husband knew that Shin did not report the deposited

amounts as income. 

The Coast account was opened on August 6, 1986, in the name

of "Shin I Food Co."4 with Edward and Ken Chen, Shin's principal
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4(...continued)

these accounts. 

accountant, as signatories. Coast bank was chosen by petitioner

husband because it was convenient to Eastimpex's office for

making deposits. All deposits to the Coast account were from

Eastimpex, drawn on an Eastimpex bank account. All deposited

funds remained in the account until it was closed. 

On September 14, 1987, a letter was obtained from petitioner

husband's office at Eastimpex and delivered to Coast by an

Eastimpex employee, directing the Coast account be closed and the

balance, totaling $322,200.01, be issued in checks as follows:

Name Amount

Priscilla Tay (sister of petitioner wife) $86,651.00

Stanley Lee (Shin's general manager until 1986) 32,093.00

Edward Chiu (Shin's general manager from 1986) 48,548.47

Shin I Food Factory Co. 154,907.54

Edward and Ken Chen signed the letter authorizing the closure. 

The four checks were given to petitioner husband. The check

issued to Stanley was deposited into his personal account, and

the check issued to Edward was negotiated overseas. The check

issued to Shin was endorsed by Lily and deposited in the First

Pacific account. The check issued to Priscilla was deposited

into an Eastimpex account and then wired to her personal bank

account in Hong Kong. 

In 1987, the account was opened at First Pacific in the name

of "Shin I Food Co." with Edward, Ken Chen, Lily, and Priscilla

as signatories. At that time, Eastimpex opened a subsidiary in
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Hong Kong, and it was decided that the subsidiary would make the

deposits. First Pacific was chosen by petitioner husband because

it was convenient to the subsidiary. All deposits to the First

Pacific account were from Eastimpex, drawn on an Eastimpex bank

account. 

Funds in the First Pacific account were used to satisfy

personal obligations of Lily under the 1986 Agreement. In

addition, the two-tier payment system ended in 1990, the same

year that the required payments under the 1986 Agreement were

completed. One of the payments under the 1986 Agreement was made

with a check drawn on the First Pacific account in the amount of

$166,687 payable to Daniel Chen. In addition, another payment

due under the 1986 Agreement corresponds to a $314,912

distribution from the First Pacific account to Lily in October

1988. The timing and amount of the withdrawal correspond to the

timing and amount due to the Wan Yang Chen family under the 1986

Agreement. None of the money in the First Pacific account was

withdrawn for business purposes of Shin. 

In 1984, petitioner husband and Lily opened an interestbearing account at Standard Chartered Bank (Standard Chartered)

in London with approximately $1.5 million from the sale of real

estate located in Canada. Based on their proprietary interest in

the real estate, the interest from the Standard Chartered account

was attributable 49 percent to petitioner husband and 51 percent

to Lily. In 1989, petitioner husband transferred his share of
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the account to the United States. Individual petitioners failed

to report any of the interest income from the Standard Chartered

account in 1987 and 1988. The parties settled the amount of

individual petitioners' deficiency attributable to the interest

income for 1987 and 1988 in the amounts of $15,731 and $19,722,

respectively. 

Petitioner husband was aware of the Standard Chartered

account and its balance. Statements from the Standard Chartered

bank account were addressed to "Chan Don A. & Lily Chan". In

prior years, the statements were usually mailed to Eastimpex's

office. During the years in issue, however, the statements were

mailed to an address in Hong Kong. Individual petitioners

received mail regarding their personal finances at their personal

address as well as at their Eastimpex office. They depended on

Eastimpex's bookkeepers to turn over mail received at Eastimpex

to petitioners' accountant. Individual petitioners did not file

Treasury Form 90-22.1, Report of Foreign Bank and Financial

Accounts, during the years in issue to disclose the overseas bank

account, as required. 

OPINION

Corporate petitioner Eastimpex has failed to produce

invoices for a portion of the amount it claimed as the cost of

goods sold. Eastimpex contends that it did not receive accurate

invoices of its costs in order to help its related supplier Shin

conceal income from the Taiwanese Government. Eastimpex asserts
- 13 -

that this scheme was devised only to avoid Taiwanese tax and not

to deceive the Internal Revenue Service in any way. We do not

find this explanation to be credible. 

Individual petitioners contend that Shin lent the deposited

amounts to its shareholders. Once Shin was repaid, it used the

money to pay farmers and workers in cash. Shin does not have

receipts for these payments. We do not accept petitioners'

elaborate explanation of Shin's lending practices. Rather, we

find that petitioner husband controlled both Shin and Eastimpex

and used the alleged payments to Shin as a way to give money to

his mother. Lily received substantial distributions from the

accounts and held the account passbooks although she owned a very

small percentage of Shin. There is no evidence that Lily repaid

Shin for these alleged loans or that Shin made withdrawals for

business purposes from the Coast and First Pacific accounts. 

These factors indicate that the subject accounts were created for

the personal purposes of individual petitioners and not created

for business purposes of Shin. The admittedly deceptive

recordkeeping was used in part to benefit individual petitioners. 

Respondent determined that the deposited amounts were not

paid to Shin for the purchase of goods and thus disallowed their

treatment by Eastimpex as the cost of goods sold. Respondent

further determined that the deposited amounts constituted

constructive dividends from Eastimpex to individual petitioners. 

Cost of Goods Sold
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The first issue we consider is whether Eastimpex is entitled

to treat the deposited amounts as part of its cost of goods sold. 

The cost of goods purchased for resale in a taxpayer's business

is subtracted from gross receipts to compute gross income. Sec.

1.61-3(a), Income Tax Regs. Such costs are not deductions and,

therefore, are not subject to the limitations on deductions

contained in section 162. Max Sobel Wholesale Liquors v.

Commissioner, 630 F.2d 670, 671-672 (9th Cir. 1980), affg. 69

T.C. 477 (1977); see secs. 1.61-3(a), 1.162-1(a), 1.471-3, Income

Tax Regs. The treatment of the payments on the books of the

parties to the transaction, while of some evidentiary value, is

not controlling. Metra Chem Corp. v. Commissioner, 88 T.C. 654,

660 (1987) (citing Estate of Lehr v. Commissioner, 18 T.C. 373,

380 (1952)). Taxpayers bear the burden of proof with regard to

the cost of goods sold. Rule 142(a). Taxpayers must keep

sufficient records to substantiate the cost of goods sold. Sec.

6001; Wright v. Commissioner, T.C. Memo. 1993-27. 

Eastimpex claims that the deposited amounts were the second

part of a two-tier payment system for goods it purchased from

Shin where the total of the two payments (the invoice price and

the deposited amount) equals the total cost of the goods. 

Corporate petitioner therefore argues that the deposited amounts

should be considered the cost of goods sold. There is no dispute

regarding whether the invoice price represents the cost of goods

sold. Respondent contends that the deposited amounts were not
- 15 -

paid to Shin for goods and argues that Eastimpex and Shin used

the two-tier payment system to divert funds for the personal

benefit of individual petitioners. We find that Eastimpex has

failed to prove the deposited amounts were for the cost of goods

sold. 

Corporate petitioner has produced invoices that establish

the first payments were for the purchase of goods from Shin. 

However, it has not produced invoices from Shin for the deposited

amounts. In addition, the invoices provided by Eastimpex do not

contain any indication that they cover only a partial billing for

the goods. Rather, Eastimpex contends that the amount of the

deposits can be recreated by comparing the invoice price with the

full list price from Shin's price list and offers canceled checks

for the deposited amounts. In addition, petitioner husband gave

self-serving testimony that the deposited amounts were for the

cost of goods sold. 

Eastimpex offered an excuse for its failure to produce

invoices associated with the deposited amounts which we do not

find credible. First, it was explained that the Taiwanese

Government would not permit a deduction for expenses without an

invoice or evidence of payment. In that regard, it is contended

that Shin used cash to purchase its agricultural raw materials

because local farmers refused to give Shin accurate receipts for

its purchases. In addition, Shin paid its seasonal workers in

cash. Accordingly, Shin could not substantiate these items and,
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thus, could not use them to reduce its income on its Taiwanese

returns. Shin did not give invoices to Eastimpex for the alleged

total sales price so that Shin could underreport its income in

order to offset its inability to claim deductions for all of its

expenses. If we accede to Eastimpex's argument, we would be in

the somewhat curious and dubious position of allowing Eastimpex

to reduce gross income for the alleged cost of goods sold for

which it lacks invoices justified by Shin's not obtaining a

similar reduction against Taiwanese taxes because it also lacked

invoices. 

The evidence offered by Eastimpex only proves that the

deposits were made. Eastimpex has failed to prove that it made

the deposits for goods it purchased from Shin. The mere

coincidence that the deposited amounts equal the difference

between the invoice price and the full list price does not prove

that Eastimpex paid these amounts for goods, especially given the

fact that petitioner husband controlled both Eastimpex and Shin.

Petitioner husband and his immediate family owned slightly

more than 50 percent of Shin, and petitioner husband was Shin's

largest shareholder with 30-percent ownership. Petitioner

husband may not have asserted his power over Shin on a daily

basis. However, petitioner husband acknowledged that he had

sufficient control over Shin, based on his family's majority

ownership, to change its management. In addition, petitioner

husband served as chairman of Shin's board of directors. He also
- 17 -

chose his close personal friend, Edward Chiu, as Shin's general

manager.

Petitioner husband argued that he could not command his

mother and sisters to do as he wished. Although petitioner

husband may not be close to his sisters, as he contends, there is

no evidence of family discord or that his sisters participated in

decision-making at Shin. Henry intended for Shin to remain a

family business, and petitioner husband was the only child of

Henry that was involved in Shin's operations. 

Petitioner husband controlled both corporate petitioner

Eastimpex and Shin and used the two-tier payment system to skim

profits from Eastimpex. The majority of the deposited amounts

were then dispersed to or for the benefit of petitioner husband's

mother, Lily, who never repaid Shin. Petitioner husband used the

two-tier payment system to reduce Eastimpex's income tax by

claiming the deposited amounts as costs. At the same time,

petitioner husband reduced Shin's Taiwanese income tax by not

recording the deposited amounts as income on Shin's books and

eliminating any possible evidence that the payments could be

treated as income to Shin. As a result, Shin, with petitioner

husband's help, was able to avoid reporting the deposits as

income to the Taiwanese Government. We find that Eastimpex did

not make the deposits as payments for the cost of goods sold. 

Thus, Eastimpex cannot treat the deposited amounts as part of the

cost of goods sold.
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Constructive Dividends

The second issue we consider is whether the deposited

amounts constitute constructive dividends to individual

petitioners. A dividend is a distribution of property by a

corporation to its shareholders out of its earnings and profits. 

Sec. 316(a). Dividends are taxable as ordinary income to

shareholders to the extent of the earnings and profits of the

corporation. Sec. 316. A dividend need not be formally declared

or even intended by the corporation. Noble v. Commissioner, 368

F.2d 439, 442 (9th Cir. 1966), affg. T.C. Memo. 1965-84;

Commissioner v. Makransky, 321 F.2d 598 (3d Cir. 1963), affg. 36

T.C. 446 (1961); Sachs v. Commissioner, 277 F.2d 879 (8th Cir.

1960), affg. 32 T.C. 815 (1959). In addition, the distribution

need not be made to a shareholder but only for the shareholder's

personal benefit. Cirelli v. Commissioner, 82 T.C. 335, 351

(1984); Edgar v. Commissioner, 56 T.C. 717 (1971). The

determination of whether a constructive dividend has occurred is

a question of fact which depends on each case. Hardin v. United

States, 461 F.2d 865 (5th Cir. 1972). 

Disallowed corporate expenditures are not automatically

treated as constructive dividends to the owner of the

corporation. Rather, the nondeductible expense must also

represent some economic gain or benefit to the shareholder. Palo

Alto Town & Country Village, Inc. v. Commissioner, 565 F.2d 1388,

1391 (9th Cir. 1977), affg. in part, revg. and remanding in part
- 19 -

T.C. Memo. 1973-223. It is well established that a transfer

between related corporations can result in a constructive

dividend to a common shareholder if the transfer was made

primarily for the personal benefit of the common shareholder. 

Gulf Oil Corp. v. Commissioner, 87 T.C. 548, 565 (1986); Gilbert

v. Commissioner, 74 T.C. 60 (1980); Schwartz v. Commissioner, 69

T.C. 877 (1978); Rapid Elec. Co. v. Commissioner, 61 T.C. 232,

239 (1973). 

To determine whether an intercorporate transfer is a

constructive dividend to the common shareholder, we apply a twopart test. Sammons v. Commissioner, 472 F.2d 449, 451 (5th Cir.

1972), affg. in part, revg. in part and remanding T.C. Memo.

1971-145; Gulf Oil Corp. v. Commissioner, 89 T.C. 1010, 1029-1030

(1987), affd. 914 F.2d 396 (3d Cir. 1990). The first part of the

test is objective: whether the transfer caused property to leave

the control of the transferor corporation and thereafter the

taxpayer/shareholder was able to exercise control over the

property, directly or indirectly, through some instrumentality

other than the transferor corporation. Individual petitioners

argue that petitioner husband was not a signatory on the accounts

as evidence of his lack of control. Petitioner husband also

denies that he was involved in any decisions regarding the

accounts, such as closing the Coast account, the amount of the

deposits or the prices charged by Shin, or ending the two-tier

payment system. However, we find such facts to be insignificant
- 20 -

in determining whether petitioner husband controlled the accounts

as the controlling shareholder of Shin. Individual petitioners

allege that Edward Chiu, an 18-percent shareholder, made these

decisions and actually controlled Shin as its general manager. 

The fact that petitioner husband permitted Edward to make day-today decisions does not mitigate or change petitioner husband's

control of Shin. Indeed, petitioner husband had the ability to

fire and replace Edward. We hold that petitioner husband

exercised control over the bank accounts through his controlling

interest in Shin, as described above, satisfying the first part

of the Sammons test. 

The second part of the test is subjective: whether the

transfer was prompted by a shareholder purpose of the common

owner rather than a business purpose of the transferor

corporation. Sammons v. Commissioner, supra. The second test is

to differentiate between normal business transactions and

transactions intended to benefit a common shareholder. Id. at

451-452. If the transfer between the commonly controlled

corporations related to the business operations of the transferor

corporation, no constructive dividend occurred. 

Courts have interpreted this prong of the Sammons test to

require not only a subjective intent to primarily benefit the

common shareholder but also an actual primary economic benefit to

the shareholder. Stinnett's Pontiac Serv. Inc. v. Commissioner,

730 F.2d 634 (11th Cir. 1984), affg. T.C. Memo. 1982-314; Kuper
- 21 -

v. Commissioner, 533 F.2d 152, 160 (5th Cir. 1976), affg. in part

and revg. in part 61 T.C. 624 (1974). The benefit to the

shareholder must be a direct, tangible benefit. Rapid Elec. Co.

v. Commissioner, supra; Ross Glove Co. v. Commissioner, 60 T.C.

569, 595 (1973). 

Individual petitioners contend that the bank accounts do not

constitute constructive dividends to them because they did not

receive the funds from the accounts. As we held above, corporate

petitioner has failed to prove that the deposits were made for a

business purpose; i.e., cost of goods sold. Petitioners provided

convoluted and somewhat perplexing reasons for Shin's wanting to

maintain the two-tier payment system. First, as stated above,

Shin wanted to understate its income to offset its inability to

subtract cash expenditures for which it lacked receipts. Because

Eastimpex's payment of the invoice price was cleared through

Taiwan's central bank, petitioners contend that the Taiwanese

Government had a record of the invoice price as income from

sales. Second, Shin viewed the exchange rate used by the central

bank as less favorable than the street rate for U.S. currency and

wanted to receive some funds in U.S. dollars to exchange outside

of the central bank system. Third, Shin maintained the accounts

so that shareholders and employees with a need for U.S. dollars

could have easy access to them as the Taiwanese Government

imposed currency restrictions that impaired the ability to obtain

U.S. dollars. 
- 22 -

Individual petitioners presented a complicated system of

recordkeeping used by Shin to avoid reporting the deposited

amounts as income. They contend that Shin shareholders and

employees borrowed money from the Coast and First Pacific

accounts and repaid Shin in Taiwanese currency within a short

period of time. Shin permitted the alleged borrowers to retain

any benefit they received from a favorable street rate. Shin

recorded the repayments as an inflow from a shareholder; thus, on

Shin's books, it would appear as if the money was due back to a

shareholder. However, Shin did not record the names of the

shareholders that made the alleged advances. Once the payments

were recorded on Shin's books, Shin would use the money to pay

farmers and seasonal workers with cash. Shin recorded the

payments to the farmers and workers as outflows to shareholders. 

Thus, it would appear as if the shareholders were repaid for the

fictitious advances. 

We do not believe that individual petitioners created this

elaborate scheme to benefit Shin without any expected benefit to

Eastimpex or themselves. Nor do we fully believe that Shin used

the deposited amounts to pay farmers and seasonal workers or that

Shin's shareholders ever repaid Shin for the money it gave them. 

Substantial amounts from the accounts were dispersed to or for

the benefit of family members of individual petitioners who did

not reimburse Shin. 
- 23 -

Lily received a $314,912 distribution from the First Pacific

account in October 1988. Shin's records do not show an inflow

from a shareholder at that time that would indicate that Lily

repaid this amount to Shin. Shin's chief accountant, Ken Chen,

who was responsible for Shin's muddled recording system, could

not identify the recorded inflows that would reflect Lily's

repayment even though Ken Chen claimed it was his duty to ensure

borrowers repaid the alleged loans. We find that Lily did not

repay this amount to Shin. 

At trial, petitioner husband claimed that he did not

question the reasons for the withdrawals, nor did he care who

received the funds. We find it hard to believe that a 30-percent

shareholder would not care who was receiving the profits from his

company. This is especially so given the fact that petitioner

husband never received a dividend from Shin while other

shareholders with smaller shareholdings were receiving dividends. 

Lily was less than a 3-percent shareholder but was receiving

substantial advances from Shin that were not repaid. Lily

generally held the passbooks from the Coast and First Pacific

accounts and never showed them to anyone at Shin. Lily used the

money from the accounts to pay the money she owed under the 1986

Agreement. In addition, the accounts were first opened when the

1986 Agreement was entered into and closed when Lily finished

making the payments due under that Agreement. A distribution to

a family member of the shareholder can constitute a sufficient
- 24 -

personal benefit to the shareholder to render the distribution a

constructive dividend to the shareholder. See Hardin v. United

States, 461 F.2d at 872; Cirelli v. Commissioner, 82 T.C. 335

(1984); Marcy v. Commissioner, T.C. Memo. 1994-534; Synder v.

Commissioner, T.C. Memo. 1983-692; Proctor v. Commissioner, T.C.

Memo. 1981-436; Fenn v. Commissioner, T.C. Memo. 1980-229. We

hold that individual petitioners personally benefited from the

transfer to Lily, and that amount is a constructive dividend from

Eastimpex to individual petitioners. 

Based on the above reasoning, we also find that the $116,687

paid from the First Pacific account to Daniel Chen under the 1986

Agreement constitutes a constructive dividend to individual

petitioners. In addition, we find that the check issued from the

Coast account payable to Priscilla in the amount of $86,651 is a

constructive dividend to individual petitioners. We do not find

petitioner husband's uncorroborated testimony that Lily

ultimately received the money from this check to be credible. 

Even if Lily did receive the money, individual petitioners did

not present any evidence that the money was repaid to Shin. Nor

have individual petitioners proved a business purpose for this

check. Regardless of whether Lily or Priscilla received the

money, we find that individual petitioners received a personal

benefit because the money was given to one of their relatives

without a proven business purpose. Thus, the check issued to
- 25 -

Priscilla constitutes a constructive dividend to individual

petitioners. 

Edward and Stanley also received money from the Coast and

First Pacific accounts. Edward stated that he received the money

because he had a need for U.S. funds, but he could not remember

what he used the money for. Edward also contends that he repaid

the money to Shin within a short period of time. Respondent

suggests that Edward and Stanley may have received these checks

because individual petitioners owed them money or as their take

of a scheme to divert funds from Eastimpex. However, there is no

evidence that the payments to Stanley and Edward provided any

personal economic benefit to individual petitioners or were for a

purpose of individual petitioners. Thus, we find that these

amounts are not constructive dividends to individual petitioners,

regardless of whether Edward and Stanley repaid the amounts to

Shin.

Alternatively, individual petitioners argue that Eastimpex

had a valid business reason for any payments under the 1986

Agreement because the Wan Yang Chen family threatened the

stability of Shin, which was a major supplier of Eastimpex. 

There was no evidence that Daniel Chen would obtain control of

Shin. Rather, he threatened to expose the two-tier payment

system to the Taiwanese Government. Individual petitioners

contend that Eastimpex did not receive any benefit from the twotier payment system except a delay in having to pay for a small
- 26 -

portion of its alleged costs. These facts do not present a valid

business reason for Eastimpex to make payments under the 1986

Agreement.

Additions to Tax and Penalty

Respondent determined additions to tax under section

6653(a)(1)(A) and (B) against individual petitioners for 1987

attributable to their receipt of constructive dividends and

against Eastimpex for taxable year ending March 31, 1988,

attributable to its improper treatment of the deposited amounts

as cost of goods sold. Section 6653(a)(1)(A) imposes an addition

to tax of 5 percent of any underpayment attributable to

negligence or disregard of rules or regulations. If that

addition applies, section 6653(a)(1)(B) imposes an addition to

tax equal to 50 percent of the interest payable on the portion of

the understatement of tax attributable to negligence. Respondent

also determined an addition to tax against individual petitioners

under section 6653(a)(1) for 1988. 

Negligence is the failure to do what a reasonable and

ordinarily prudent person would do under the circumstances. 

Neely v. Commissioner, 85 T.C. 934, 947 (1985). "Disregard"

includes any careless, reckless, or intentional disregard of

rules or regulations. Sec. 6653(a)(3). Petitioners bear the

burden of proving that the additions to tax do not apply. Rule

142(a); Luman v. Commissioner, 79 T.C. 846, 860-861 (1982).
- 27 -

Respondent also determined additions to tax under section

6661 against individual petitioners for 1987 and 1988 and against

Eastimpex for taxable year ending March 31, 1988. Section

6661(a) provides an addition to tax of 25 percent of the amount

of any underpayment attributable to a substantial understatement

of tax. Section 6661(b)(2)(A) defines the term "understatement"

as being the excess of the amount of tax required to be shown on

the return for the taxable year over the amount shown on the

return. An understatement is substantial if it exceeds the

greater of 10 percent of the tax required to be shown on the

return or $5,000 ($10,000 in the case of corporate petitioner). 

Sec. 6661(b)(1)(A). The amount of the understatement can be

reduced if substantial authority existed for the taxpayer's

treatment of the item in dispute. Sec. 6661(b)(2)(B). 

Respondent determined an accuracy-related penalty against

individual petitioners under section 6662(a) for 1989. Section

6662(a) imposes a penalty of 20 percent of the portion of an

underpayment attributable to one or more of the items set forth

in section 6662(b). In the notice of deficiency, respondent

determined that petitioners' underpayment was due to: (1)

Negligence or disregard of rules or regulations, (2) a

substantial understatement of tax, or (3) a substantial

overvaluation statement. See sec. 6662(b)(1)-(3). The section

6662 accuracy-related penalty does not apply with respect to any

portion of an underpayment if reasonable cause exists for the
- 28 -

underpayment and the taxpayer acted in good faith with respect to

such portion. Sec. 6664(c)(1). The determination of whether the

taxpayer acted with reasonable cause and in good faith depends

upon the pertinent facts and circumstances. Sec. 1.6664-4(b)(1),

Income Tax Regs.

Petitioner husband is an experienced businessman who devised

a bewildering payment system between two related corporations

which he controlled. Eastimpex admitted that its purpose in

using the two-tier payment system was to help Shin conceal income

from the Taiwanese Government. Eastimpex also used the payment

system to increase the amount it claimed as the cost of goods

sold knowing that it would be unable to substantiate the

deposited amounts. In addition, individual petitioners used the

two-tier payment system to divert funds to their relatives. We

find that individual petitioners and Eastimpex acted negligently

and without substantial authority with regard to the deposited

amounts and are liable for the above additions to tax and penalty

as determined by respondent. 

In addition to the additions to tax and penalty with respect

to the issues involving the deposited amounts, respondent also

determined additions to tax against individual petitioners under

section 6653(a)(1)(A) and (B) for 1987, under section 6653(a)(1)

for 1988, and under section 6661 for 1987 and 1988 attributable

to their omission of interest income from the Standard Chartered

account from their tax returns. Failure to report large amounts
- 29 -

of income on a return has been found to be indicative of

negligence. Anders v. Commissioner, 68 T.C. 474, 493 (1977). 

Individual petitioners knew that they received interest

income from the Standard Chartered account. In addition, the

Standard Chartered account had a substantial balance and earned a

significant amount of interest. However, petitioners did not

inform their accountant about the interest income or the

existence of the account. The bank statements from the Standard

Chartered account were addressed to both petitioner husband and

Lily Chan. For a time, the statements were sent to the Eastimpex

office. During the years in issue, the statements were mailed to

an address in Hong Kong. Petitioner husband gave inconsistent

testimony about where Lily was living during the years in issue. 

Individual petitioners maintain that they reasonably relied

on the Eastimpex bookkeepers to provide tax information to their

tax return preparer because they received mail regarding personal

finances at Eastimpex. However, individual petitioners admitted

that they received mail regarding interest income at their

personal address as well as at Eastimpex's offices. Thus, we

reject petitioners' contention that their failure to report the

interest income was a reasonable oversight. We find that

individual petitioners are negligent and lack substantial

authority with regard to their failure to report interest income

from the Standard Chartered account and are liable for the

additions to tax. 
- 30 -

After concessions by all parties and to reflect the

foregoing, 

Decisions will be entered

under Rule 155.